Suntec – DMG

Prime office rents could be rising at a faster pace

2Q10 results within expectations. Suntec reported 2Q10 DPU of 2.53¢ (-15.1% YoY; +0.6% QoQ), representing 26% of our FY10 DPU forecast of 9.57¢. Despite an improvement in office occupancy, net property income fell 2.8% on the back of negative rental reversion. Suntec will trade ex-2Q10 distribution on 30 July 2010. We raise our DDM-based TP to S$1.71 (from S$1.56) based on higher terminal growth assumption. Suntec trades at an attractive FY10 yield of 6.6%. Maintain BUY.

Suntec retail occupancy rose marginally. Suntec REIT’s portfolio office occupancy rose to 97.6% from 96.9% in 1Q10. Both Park Mall and One Raffles Quay remain 100% occupied while Suntec City office registered a 1.1ppt QoQ improvement in occupancy to 96.6%. Similarly, Suntec’s retail occupancy saw an occupancy improvement of 1.5ppt to 98.7%, due largely to the 1.9ppt rise in Suntec City mall’s occupancy, which now stands at 98.3%.

Small office floor plate tenants paying S$8/sqft. In the analyst briefing, management mentioned that lease renewals for tenants with small floor plate requirements recently paid S$8/sqft at Suntec City office, while larger ones went at the top end of the S$7-8/sqft range. This is in contrast with CBRE’s 2Q10 reported prime rents of S$6.90/sqft. While management did not disclose the number of such deals that were signed, we are upbeat that this signals a strong inflection of office rents within the sector.

Raise TP to S$1.71 on higher terminal growth assumptions. Judging from the dynamics of the current economic growth momentum, it could take anywhere between 12-18 months for excess office supply to be absorbed, thereby resulting in a tight market by early 2012. Rental growth prospects are likely to be robust once excess capacity is absorbed. Our new TP of S$1.71 assumes a terminal growth assumption of 4% (3.3% previously). Stock trades at 5.6% yield at our TP, a reasonable peg in our view.