A laggard play

Flattish growth. Macquarie MEAG Prime REIT’s (MMP) 4Q06 came in within expectation. Top-line came in at S$22.6m, improving 1% QoQ, with NPI (Net Property Income) at S$17.2m (-1% QoQ). However, distributable income per unit (DPU) was better at 1.47 cents, improving 2% QoQ. The lower NPI was attributed to higher property expenses (mainly depreciation) as the result of the installation of escalators linking Wisma Atria basement to Orchard road. This is a non-tax item and is distributed back to unitholders, hence the higher DPU.

Organic growth to come from office. Presently, MMP’s retail space enjoys fairly high rentals and will see very little space up for renewal in 2007. So we do not anticipate this segment to be the growth driver. However, on the office segment we expect about 182,000 sq ft (about 70% of office space) of leases to come up for renewal over the next 2 years. More importantly, these expiring leases have a rental rates averaging at only about S$5 psf/mth, whilst present market rates are closer to S$8 psf/mth. So we can expect about a 60% rise in rates for these spaces. This higher rate in turn will translate to an increase in revenue of about S$3.0m p.a. over the next 2 years. In light of the good reversions, we have adjusted our FY07 and FY08 DPU forecasts from 5.90 cents and 6.02 cents to 6.12 cents and 6.37 cents respectively.

Where are the acquisitions? In so far as acquisition is concerned, MMP has been fairly disappointing. In the current results announcement again, there was no news of potential acquisitions. Relative to all its S-REITs peers, MMP stands out as one of the few REITs not to have bought anything since IPO. On a positive note, MMP has recently beefed up its investment team and is targeting acquisitions in China, Japan, Malaysia and Singapore. We remain hopeful of some positive developments soon.

Maintain Buy with higher revised fair value. Since our valuation upgrade in December, MMP has done exceedingly well, rising by about 17% over the last month. However, even at present trading range, its price to book of about 1.0 times remains very low relative to its peers’ P/B of 1.4-1.8 times. We thus remain positive on MMP and see it as one of the lowest-risk REITs with low expectation of growth. We see these traits as defensive and thus maintain our BUY rating and with a revised fair value of S$1.32 (from S$1.22) on the back of higher office valuations.

Stable retail growth

Consistent distribution backed by resilient rents. MMP has been consistently delivering distributions of 1.44 cents per unit quarterly. Management has dispelled concerns of the tunnel closure on basement retail rents as basement space leases are still being transacted at above S$60 levels.

Competition not an issue. New malls such as Orchard Turn, Orchard Central and Somerset Central are coming up, bringing on additional 1.2m sf of retail supply by FY09, yet there is still room to grow for retail stock in Singapore. With retail space per capita of about 7 sf, Singapore trails behind HK’s 11 sf and Japan’s 12 sf, according to Knight Frank.

Revaluation expected on the back of strong physical market. Office space in Orchard Road is enjoying positive spillover demand from tight office vacancy in prime office space at about 2.7% currently. MMP is already looking at S$8 rentals for some of its office space. With about 16% of MMP’s assets exposed to office, upward revaluation is likely given that its office portfolio is currently only valued at 900 psf. Upward revaluation will potentially enhance debt capacity and NAV.

Is the wait finally over? MMP has been lagging behind other REITs in terms of acquisitions since listing in Sept 05. Management is targeting to deliver an acquisition by 1H07, after which a certain degree of yield compression may set in. Currently MMP is trading at 5% yield compared to retail S-REITs trading at 4%.

Maintain BUY, TP S$1.29. Forward yield of 5% is supported by limited downside from retail rents from the two prime retail assets in Orchard Road. With prime retail rents growing by 4.5% in FY06, we expect retail rents to continue rising for the next three years. We have raised our retail rental growth assumptions from 2% to 5% for FY07 to FY09 and DPU estimates in the range of 3.6%-4.6%. Therefore we have accordingly raised our DCF derived target price of S$1.29. Maintain Buy.