3Q09 results ahead; improvement in occupancy rates

3Q09 DPU of 2.92cts (+2% YoY, -2% QoQ) came in ahead of our forecast with 9M09 DPU of 8.82cts making up 80% of our FY09E. Earnings were underpinned by organic growth from the Suntec City properties which made up 86% of total revenue.

Improvements in occupancy; retail relatively stable. While contracted office rents continued to trend down (leases secured in 3Q09 for Suntec City averaged S$7.30psf vs S$8.24psf in 2Q09 & avg passing rents of ~S $8psf), occupancy rate improved QoQ fr 94.8% to 96.4% for the office portfolio. Majority of the office leases maturing this yr have been renewed, with only 14,000sf (or 0.8%) left vs 527,000sf at the bgn of the yr. Mgmt has commenced work for leases exp.in FY10 with ~65,000sf or 14% of exp.space renewed.

Similar improvements in occupancy were seen for retail, with avg occupancy rates rising from 98.4% to 99.1% in 3Q. Avg rents for Suntec City Mall were relatively stable at S$10.96psf (S$10.98psf in 2Q). The proportion of retail leases exp. in FY09 has been reduced to 180,500sf (17.3% of total) with the lease with Carrefour (exp in Dec) constituting the bulk.

Balance sheet remains healthy with gearing at 34.3%, and financing cost is relatively low at 2.88%. With the refinancing of the S$700m CMBS completed, the next major refinancing due is the S$400m club loan due in June 2011.

Maintain Buy with TP of S$1.26 pegged to parity to DDM. While 4Q09E DPU is expected to be weaker on higher financing cost upon the drawdown of the S$825m club loan & issue of the deferred units, we believe Suntec is on track to meet our 11cts (flat YoY) FY09E DPU forecast. The office sector deterioration has been well reflected in our view, with the stock trading at 0.6 P/B and yielding 9.3% for FY09E implying a wide 667bps spread over the 10-yr bond.

Rebound In Occupancy

Quick Comment – 9M09A Ahead of Our Expectations at the Net Income and Distributable Level, with Net Income and Distributable 81% and 82% of our full-year estimates even though Gross revenue and Net property income was in-line with expectations. Variance due to lower than expected finance charges and higher than expected revenue from ORQ. We maintain our Overweight rating and price target of S$1.30.

Operating Conditions Improving At The Margin. Occupancy for both office and retail portfolio appear to have troughed in 2Q09, with both rebounding to 99.1% and 96.4% respectively (Exhibit 6). We estimate that every 10% decline in occupancy results in 17% decline in Net property income, and a rebound in occupancy is comforting. As expected, retail and office rents continue to soften in 3Q09. However, the rate of decline has improved, with office rents -11% in 3Q09 compared to -17% in 2Q09 and retail rents at Suntec City Mall -0.2% in 3Q09 compared to -0.6% in 2Q09. We continue to expect a softening of office rents in the next 3 years given the large upcoming supply, but maintain our view that retail rents will trough in 2009. With retail contributing ~55% of Suntec’s NPI, Suntec should benefit from this rebound in retail rents.

Unchallenging Valuations: Suntec is trading at an average dividend yield of 6.16% (FY10e and FY11e), a 354bp spread over the current 10yr SGS yield of 2.62%. Furthermore, current implied capital values of S$1,937 for retail and S$958 for office (based on S$1.18/share) look undemanding given 3Q09 prime Grade A office capital value S$1,700 psf and our expectation of S$1,500 psf capital value as we believe capital values will hold up better than rents in this office downcycle. We maintain our view that investors should look past the potential capital raising overhang as (1) capital raising is not necessarily negative for stock price performance based on other S-Reits performance (2) based on our estimates, gearing in FY11 is still manageable at 39.7% and with debt pushed back to FY11, there are no near term refinancing risks.

3QFY09 Results

Suntec REIT reported gross revenue for 3QFY09 of $61.9 million (flat y-o-y, -3.9% q-o-q)), net property income (NPI) was $47.0 million(+3.1% y-o-y, -3.6% qo-q). Distributable income was $47.7 million(+8.8% y-o-y, flat q-o-q). DPU for the quarter was 2.921 cents (+2.3% y-o-y, -1.9% q-o-q).

On a year-on-year basis, top-line revenue was little changed, however quarterly performance registered negative growth, indicating the still dismal operating environment.

Office portfolio reversionary rent continues on its downward slide. We estimate that It has fallen approximately 45.9% from the peak rental achieved in the 1st half of FY08. Although leases were secured at continually lower rents, occupancy rate of the office portfolio has shown encouraging sign of recovery. Office occupancy rate for 3QFY09 was up 1.6ppt at 96.4%. This could indicate optimism among tenants as they lock in the low rentals now. Similarly, the retail portfolio also showed improvement in occupancy. 3QFY09 occupancy rate improved 0.7ppt to 99.1%. The office portfolio accounts for 46% of total revenue while the retail portfolio contributes 54%.

Suntec has total debt of $1.88 billion and gearing of 34.3%. Next refinancing requirement is in 2011 with debt of $532.5 million.

Valuation & recommendation. We believe Suntec portfolio is showing sign of recovery as leasing activities resumed as indicated by Suntec improving occupancy. We upgrade our portfolio occupancy forecast for FY09F from 97.6% to 99.3%. We raise our gross revenue forecast by 4.3% from $233.1 million to $243.1 million. FY09F DPU correspondingly increased by 5.1% from 10.05 cents to 10.56 cents. We raised our DCF derived fair value from $0.94 to $1.13. Maintain Hold recommendation.

Holding steady

• Maintain Outperform; target price raised to S$1.43 (from S$1.37). 3Q09 results were in line with Street and our expectations. We remain positive that the opening of the Marina Bay Integrated Resort and new train stations in 2010 will provide catalysts for Suntec’s retail sector.

• In line. 3Q09 DPU of 2.92cts was in line with consensus and our expectations as declining interest base rates mitigated a weaker topline caused by lower occupancy in the office segment. Additionally, lower interest expenses for One Raffles Quay (also due to declining interest base rates) resulted in higher dividend contributions to Suntec REIT’s distributable profit. YTD distributable income of S$141.8m (+15% yoy) and DPU of 8.8cts (+8% yoy) form 81% of our full-year forecasts. We expect 4Q09 topline to dip as this quarter’s lower passing rents kick in and higher interest rates are applied to new loan refinancing that would be drawn down. 3Q09 net property income of S$47m (+3% yoy) was boosted by tighter control of propertyrelated expenses.

• Occupancy up qoq. Office occupancy was 96.4%, up 1.6% pts from 94.8% as at Jun 09. This was mainly due to higher occupancy at Suntec Offices of 94.8% (from 92.5% in Jun 09) as returned space in 2Q09 was gradually filled up. Leases secured for the quarter averaged S$7.30psf (-11% qoq). Including One Raffles Quay, there was only 0.8% of total net lettable area left for renewal in FY09. Retail occupancy averaged 99.1% (+0.7% qoq), while retail rents secured for Suntec City (the main retail component) remained flat qoq at S$10.96psf.

• Opening of Marina Bay IR and train stations could boost retail. We believe the opening of the Marina Bay Integrated Resort by 1Q10 and two new train stations (Esplanade and Promenade Circle Line stations) by 2H10 are wild cards that could boost Suntec’s retail segment. We make no changes to our DPU estimates, but roll our target price one year forward. Our DDM-derived target price rises accordingly to S$1.43 from S$1.37 (discount rate of 8.8%). Maintain Outperform on expectations of retail catalysts.

Upgrading on relative value

DPU declines QoQ. Suntec REIT (Suntec) posted S$61.9m in 3Q09 gross revenue, up 0.8% YoY but down 4% QoQ. Net property income (NPI) of S$47m rose 3.1% YoY and fell 3.6% QoQ. Suntec will distribute 2.921 S cents per unit, up 2.3% YoY but down 1.9% QoQ. This is the first quarterly decline in distributions after 18 straight quarters of DPU growth since listing. While both revenue and NPI missed the mark, 3Q DPU was 5% higher than our estimate because of lower-than-expected interest costs.

Suntec Office occupancy up. In 2Q09, two tenants re-delivered part of previously-leased space at Suntec City Office Towers (SCOT), driving occupancy down to 92.5% as of June-end. Occupancy has now improved to 94.8% as of September-end. Average achieved rents of S$7.30 per square foot per month are down 11.4% QoQ and 41.9% YoY. We believe we have approached an inflection point where the margin of safety between passing rents on expiring leases and spot rents reverses. The manager said 22.2% of total office NLA (including One Raffles Quay) will expire in 2010.

Playing the long game. Recently 1) Suntec has acquired an interest in Suntec City Convention Centre for S$25m; and 2) the REIT manager has acquired the property manager for Suntec City. In both cases, the seller was Suntec City Development (SCD) Pte Ltd, the original seller of the Suntec City asset at IPO. SCD is slowly reducing its direct exposure to the Suntec City development but affiliated parties own stakes in both the REIT and the REIT manager. From the perspective of Suntec and its manager, these transactions are small but have strategic significance in tightening control over the Suntec City development. This also corresponds with past behavior – Suntec has been amassing strata space at SCOT.

Relative value. Our revised earnings estimates now reflect actual 9M09 figures and incorporate contributions from the Convention purchase. We see relative value versus CapitaCommercial Trust [CCT, HOLD, FV: S$1.13]. Suntec is trading at a 185-basis point discount to CCT based on our FY10F estimates. Gearing for the two is also fairly comparable (34.3% Suntec, 31.2% CCT). Income is also supported by Suntec’s retail portfolio vis-à-vis CCT. We also believe negative office rent reversions are priced in, and the key bone of contention now is how the sub-sector recovers. Suntec is well-positioned to benefit from the revitalization of Marina Bay. Upgrade to BUY with revised fair value of S$1.21 from S$1.00 previously (10.3% total return).