A positive move

• Private placement of S$152.9m
• Balance sheet strengthened, minimal DPU dilutive impact
• Maintain Buy with TP of $1.38

S$152.9m private placement. Suntec Reit has completed a private placement of 128.5m new units at S$1.19 each, which was >5x oversubscribed. The issue price represents a 6.5% discount to the VWAP price of $1.2724 and 4.6% discount to the adjusted VWAP of $1.2475. Gross proceeds of S$152.9m (net S$149m) will be used to reduce bank borrowings. The new units will not be entitled to the advance dividend distribution.

Minimal dilutive impact. We view this exercise as a positive strategic move on the group’s capital management exercise. Post placement, gearing is anticipated to decline to 31.5% from 34.3%, increasing the flexibility of its balance sheet. In terms of DPU impact, FY10 DPU estimate of 9cts is lowered by 3.3% to 8.7cts, after adjusting for interest savings.

Maintain Buy. We maintain our Buy call for Suntec. Post placement, FY10 DPU yield remains attractive at 6.8%, on the higher end of its comparable peer range. Suntec’s properties are well located and is expected to benefit from the expected increased vibrancy of the Marina Bay area when the Marina Bay Sands IR is opened. Our adjusted target price of $1.38 offers potential absolute return of 14.6%.

Wait For Clearer Signals

Downgrade to Equal-weight, wait for clearer signals: Suntec Reit has out-performed the STI by 19% from 3 months ago and is now marginally below our price target. Given the recent strong share price performance and our view that fundamentals have not substantially improved to warrant a change in our DCF-driven valuation, we are downgrading Suntec Reit to an Equal-weight rating.

Rental decline appears to be stabilizing, but for Office rents – rent increase is still some time away: Office rental declines appear to be stabilizing, with office rents down 12% and down 13% in 2Q09 and 3Q09 respectively, having declined 55% since the peak in 3Q08. 3Q09 showed a marginal positive net absorption of 32k sq ft and anecdotal evidence suggests that leasing activity has picked up recently given the
stabilization of the global and Singapore economy. However, given the large upcoming supply of ~2.6m sq ft in the next 2 years, we think it is too early to hope for positive office rental growth and we expect rents to bottom in 2011. Retail rents paint a more upbeat tone, with median central rents down 7% from the peak and down 1% QoQ. A study of upcoming retail supply in our report “Look Through The Cycle”, dated October 22, 2009, suggests that upcoming supply is well spread out in Singapore and we expect positive retail rent growth of 4% in 2010 as demand picks up with the improving economy and opening of two new integrated resorts.

What’s next: In the near term, we believe that the market will be focused on Suntec Reit’s 2009 asset valuations. We only expect a relatively small 4% decline in asset values, and for gearing to reach 38% by the end of 2009. We believe the risk of Suntec Reit undertaking an equity raising to shore up its balance sheet post asset devaluation is low, but believe the perceived risk will continue to be an overhang on the share price until details of the asset valuations are known.

Relative value & retail attraction

Office income at turning point. In 3Q09, Suntec REIT reported a decline of 11.4% QoQ and 41.9% YoY in average achieved Suntec City Office rents to S$7.30 per square foot per month. 22.2% of the REIT’s total office NLA (including One Raffles Quay) expires in 2010. Office REITs have yet to feel the full brunt of falling rents because of the time lag created by the three-year leasing cycle. But 2007 leases, which were secured as the market began its meteoric ascent, finally begin to expire in 1Q10. We believe we have approached the inflection point where spot rents are lower than passing rents on expiring leases, impacting revenue and distributions unfavorably.

Potential dilution risk. In 2009, Suntec avoided resorting to a dilutive equity issue to refinance a chunky CMBS maturity. Looking ahead, Suntec could see gearing increase due to a fall in office asset values at the 4Q09 portfolio revaluation. With declining office income and book value risk, Suntec could decide to go the acquisition route in 2010. It is likely to keep aggregate portfolio gearing unchanged or lower, necessitating a combination of both equity and debt financing on any purchase. Assets could be acquired from the original vendors of the Suntec assets, which have (presumably) been de-levering the parent portfolio as seen with the recent Fortune REIT [NOT RATED] transaction and the sale of both the Suntec City Convention Centre and Suntec City’s property manager. Asset yields are unknown -creating potential dilution risk.

Relative value and retail attraction. Suntec has appreciated over 9% since our October upgrade. Current price-to-book of 0.65x compares favorably to the 0.73x averaged in 2006, though the 11% value gap is partially offset by the revaluation risk in 4Q09. We see relative value versus CapitaCommercial Trust [HOLD, S$1.13], which is trading at 0.78x book and 5.4% FY10F yield. Gearing for the two is also fairly comparable (34.3% Suntec, 31.2% CCT) but note that CCT’s property valuations are more recent.

We note that Suntec’s strong retail portfolio, which should benefit from the revitalization of the Marina Bay area and the full opening of the new Circle Line, is consistently undervalued. Retail income should also support distributions. We have changed our assumptions, including on the pace and extent of the recovery in office rents from FY12 onwards. Our SOTP value for Suntec increases from S$1.21 to S$1.43. Adjusting for fund-raising risks, we derive a fair value of S$1.40 (prev: S$1.21). Maintain BUY (15.6% total return).