Suntec – OCBC

One of the Highest-Leveraged S-REITs; Maintain HOLD

Performance in 2010. Suntec REIT has made a total distribution of 9.266 S-cents1 , for the period from 1 Jan 2010 to 8 Dec 2010, with an average DPU yield of 7.1%2 . It share price has also appreciated 11.9% YoY, from a low of S$1.23 on 25 May to a high of S$1.56 on 29 Oct. It has recently completed its acquisition of a one-third interest in MBFC1, which is financed 72% by a loan facility (S$1,105 m) and 25% by private placement of new units (S$428.2m). Its private placement was 3.1x oversubscribed on 29 Nov at an issue price of S$1.37, bearing testimony to investor’s confidence in its latest “Premium Grade A” assets acquisition.

Moody’s downgrade. Nonetheless, Moody downgraded Suntec’s corporate family-rating from Baa1 to Baa2 and its senior unsecured ratings from Baa2 to Baa3 on 15 Dec. The downgrade reflected the substantially debt-funded acquisition of the one-third stake in MBFC1, which will weaken Suntec’s financial profile, by increasing its aggregate leverage ratio from 33% to 41.5%3 . At the same time, Moody’s also expects Debt/EBITDA to increase to 9-10x, up from 8.3x, with EBITDA/Interest around 3-3.5x (from 4.3x) over the next two years

Retail slide looming. On the portfolio end, the completion of the Circle Line MRT asset enhancement works at Suntec City was less favorable than expected. We noticed that retail crowds have thinned considerably, especially in the evenings and weekends (when there are no major shows at Suntec Convention). It appears that the ‘rejuvenation of Orchard Road’ has stolen much of the traffic, and Suntec City Mall now relies heavily on its office-catchment during weekdays. If the trend persists, this may impact rental income, considering that Suntec derives some 53% of its total gross revenue from retail rentals and 47% from office leases. We think that the MBFC1 acquisition will help to boost the proportion of office to retail mix for Suntec, and help mitigate some of the topline effects of thinning traffic at Suntec City Mall, but this is, nonetheless, still a temporary fix.

Maintain HOLD. We recognize that the MBFC1 transaction has long-term strategic benefits, and provides Suntec with exposure to “Premium Grade A” properties in Singapore. The acquisition will also enable greater income diversification, with NPI contribution from Suntec City estimated to reduce from 75.9% to 58.9%. However, the initial NPI yield of 4% in FY11 provides little upside in comparison with its average distribution yield of 7.1%, in our opinion. At 41.5% gearing, it is also one of the highest leveraged S-REITs among the 25 listed on SGX, with little debt headroom for further acquisitions in 2011. Maintain HOLD with a revised fair value of S$1.55.

1 Computed based on summing the quarterly DPUs and Advanced DPU.

2 Computed based on Total DPU (Annualized) divided by Average Closing Price from 4 Jan to 8 Dec 2010.

3 Assuming that proceeds are not used for repaying the One Raffles Quay Pte Ltd (ORQPL) shareholder’s loan.