Great connectivity, value not fully appreciated

2Q09 results above expectations. Suntec reported a 6.6% YoY increase (+2% QoQ) in 2Q09 DPU to 2.98¢. Annualised DPU came in at 11.9¢, 20% above our and consensus estimates. Revenue was up 8.9% YoY underpinned by higher rents achieved for Suntec City and Park Mall properties. Suntec will trade ex-2Q09 distribution on 3 Aug 2009. Price target raised to S$1.24 (S$0.80 previously) to reflect a lower of cost-of-equity assumption of 9.6% and a higher terminal growth rate of 3% (nil previously).

Less than 5% of total office NLA left for renewal for FY09. For 1H09, Suntec renewed and signed 375,000 sqft of office space. With this, the remaining office leases expiring in FY09 amounts to approximately 84,000 sq ft or 4.5% of the total office NLA. Office occupancy fell to 94.8% from 97.4% following the return of spaces by UBS and IDA.

Still under-rented but positive rental reversion unlikely to transpire. Passing rents for Suntec City office average about S$6/sqft, marginally below spot transactions of between S$6-7/sqft. Management acknowledged that it is clearly still a tenants’ market and the focus on tenant retention remains paramount. In our view, management will likely shift their focus to occupancy optimisation at the expense of rental rates, capping the likelihood of positive rental reversion in the coming quarters.

Retail reprieve on overall earnings. With retail contributing to 53% of overall income, we expect earnings prospects to remain favourable compared to CCT. We believe the spectre of higher retail footfall at Suntec City is likely to transpire when the Circle Line becomes fully operational in 2010. The opening of Esplanade and Promenade stations will materially enhance Suntec’s traffic footfall, a case that is currently seen in ION Orchard mall, given its connectivity with Orchard MRT. The stock is still undervalued as current share levels appear to still price-in recapitalisation expectations, a case that is unlikely to transpire, in our view. At current prices, Suntec offers investors an attractive dividend yield of 8.2% for FY10. Stock still undervalued at current levels. Trade stock to S$1.24 (~7.1% yield).

Retail kicker in 2010

• Above expectations. 2Q09 results exceeded both the Street and our expectations on a stronger topline, better net property income margins, and lower interest expense. Distributable income of S$47.7m (+14% yoy) and DPU of 2.98cts (+7% yoy) form 32% of our full-year forecasts. 1H09 DPU of 5.9cts also exceeded expectations at 64% of our FY09 forecast. Net property income of S$48.8m (+6% yoy) was boosted by positive reversions for Suntec City and Park Mall properties.

• Office occupancy down 2.6% pts qoq. Committed occupancy for the office portfolio was 94.8%, down from 97.4% as at Mar 09. This was mainly due to lower occupancy at Suntec Offices of 92.5% (from 96.3% in Mar 09) when major tenants IDA and UBS returned a total of 60,000sf of space during the quarter. Negotiations for part of the space with prospective tenants are ongoing. Leases secured for the quarter averaged S$8.24psf (-17% qoq).

• Retail occupancy stable. Committed occupancy for the retail component averaged 98.4%, down marginally from 98.8% in the last quarter. Leases secured for the quarter averaged S$10.98psf (-1%).

• Asset enhancement work for Suntec City. The manager has commenced asset enhancement work in Suntec City, including: 1) an upgrading of office lobbies for all five office towers; and 2) the construction of a glass external façade, a covered walkway linking the entrance of the Promenade MRT station to Suntec City Mall, and new retail units along the promenade. The work is expected to be completed by mid-2010, in conjunction with the opening of the Promenade station. The bulk of capital expenditure would be borne by the MCST of Suntec City.

• Maintain Outperform; target price raised to S$1.28 (from S$1.07). In view of the strong 1H, we have moderated our rental decline assumptions by 5-10%; assumed higher net property income margins of 75.5% (from 74.3%); and factored in higher amortisation costs for adding back to distributable income. Our DPU forecasts for FY09-11 rise by 8-20%. Our target price rises accordingly to S$1.28 (discount rate 9.4%), still based on DDM valuation.

Suntec REIT reported gross revenue for 2QFY09 of $64.5 million (+8.9% y-o-y, flat q-o-q)), net property income was $48.7 million(+6.2% y-o-y, flat q-o-q). Distributable income was $47.7 million(+13.5% y-o-y, +2.9% q-o-q). DPU for the quarter was 2.977 cents (+6.3% y-o-y, +2.0% q-o-q).

Office portfolio reversionary rent continues to show a downward trend. It has fallen 38.9% from a year ago at $13.50 to 8.24. Occupancy of the office portfolio has also been sliding down from 1Q08 at 99.8% to 94.8% in 2Q09. These reflect the office sector is still reeling from the effects of recession. The retail portfolio is more resilient with occupancy maintaining above 98%. The office portfolio accounts for 47% of total revenue while the retail portfolio contributes 53%.

As previously announced, Suntec has no near term refinancing concern. It has successfully secure $825 million of term loan in April 2009. The next loan maturity is in 2011 with loan amount of $532.5 million. The current gearing is 34%.

Valuation & recommendation. We believe that demand for office space will take time to pick up following the nation’s exit from recession in the last quarter. We make no changes to our assumptions and have a FY09F DPU forecast of 10.05 cents which translates to a dividend yield of 9.5%. Fair value remains unchanged at $0.94 and retain our Hold recommendation