Only time will tell

At a Glance

• DPU slightly below expectation pending Toshin’s lease rental reversion

• Healthy reversion for Wisma Atria leases despite AEI works

• Healthy balance sheet and ready for acquisitions

• Maintain BUY at lower $0.71 TP

Comment on Results

Slightly below expectations. Gross revenue and NPI posted flat growths in 4Q11. However, DPU fell 2.9% due to higher tax and finance expenses. Full year DPU was 4% below our forecast on the back of higher property expenses and the absence of additional income assumed from Toshin’s rental reversion. Stripping the latter off, DPU will be a marginal 2% lower.

Wisma Atria new look ready in Sep12. Footfall grew by 9% y-o-y but retail sales were down 4% in the same period due to the commencement of asset enhancement works in Jul’11. However, renewal remained robust with some leases locked in higher rates in excess of 20% compared to preceding rents. Occupancy will remain at 95% for the next two quarters before heading up in 3Q after completion of the AEI works in Sep this year.

Toshin’s lease yet to be resolved. The court has dismissed Toshin’s appeal on the rent review in Jan 2012. SGReit has submitted an appeal against that decision and hearing will take place in Feb 2012. We are assuming flat rental growth vs 10% previously till more clarity and guidance are given.

Balance sheet is healthy. Only 3% (S$27m) of its debts are due for refinancing in FY12 and gearing is a healthy 30.8% after the trust took in S$28m revaluation gain, mainly from Wisma Atria Ngee Ann City but was partially reversed by its Japan Properties.

Recommendation

Maintain Buy at a lower TP of S$0.71. We continue to like SGReit for its undemanding valuation at 0.64x P/BV. We have lowered out TP by 7.9% to S$0.71 and reduced our FY12/13 DPU by 8-9% as we revised down our rental forecast, as well as no conversion of the CPUs till 2016 instead of the earlier 2013. Meanwhile, re-rating catalyst will be from possible accretive acquisitions and better than expected rental reversions.

Starhill’s Q4 DPU falls 2.9%

STARHILL Global Real Estate Investment Trust (SGReit) posted a 4.7 per cent decline in income available for distribution to $22.2 million for the fourth quarter ended Dec 31, 2011, from $23.3 million a year back.

Income to be distributed to unitholders also fell 2.9 per cent during the same period to $19.6 million. Correspondingly, Q4 distribution per unit (DPU) dipped 2.9 per cent to 1.01 cents from 1.04 cents a year earlier. This was mainly attributed to rental disruptions from the asset redevelopment works at Wisma Atria and negative rental reversions in Singapore office space, which also led to a 0.6 per cent decline in net property income (NPI) to $36.5 million for the quarter.

For the full year, SGReit posted NPI of $143.6 million, a 10.1 per cent increase from $130.5 million.

Income available for distribution also rose 10.1 per cent year-on-year to $90.8 million from $82.5 million, while annualised DPU for FY2011 rolled in at 4.12 cents, translating to a yield of 7.3 per cent using the Reit’s closing price of 56.5 cents as at Dec 30, 2011, the last trading day of 2011.

Gearing levels remained at a healthy 30.8 per cent as at the end of the financial year, leaving comfortable debt headroom for future acquisitions, the company said. In addition, a $65 million unsecured revolving credit facility maturing in December 2013 was obtained, enhancing the group’s financial position. Management also highlighted that there will be no debt refinancing till 2013.

Demand for the Reit’s office space also remained healthy, with occupancy levels within the Wisma Atria and Ngee Ann City offices rising to 95.8 per cent and 94.9 per cent respectively as at Dec 31. Take-up for retail space at both assets was also strong as leases expiring last year managed to secure positive rental reversions.

The company said the asset redevelopment of Wisma Atria is ‘on track’ and is slated to be completed in the third quarter of this year. So far, more than 75 per cent of the double-storey facade units fronting Orchard Road have received pre-committed leases and the manager will try to ‘minimise disruptions’ with a ‘two-phase handover’ of the finished units over the first half of 2012.

Yesterday, the counter closed unchanged at 60 cents.

Judge denies Starhill’s request to set new rental

Existing rent review mechanism ‘still operable’, she says

A SINGAPORE High Court judge has denied an application by Starhill Global Reit for the court to set new retail rental rates with its master tenant, Toshin Development Singapore, in Ngee Ann City mall, saying that an existing rent review mechanism is ‘still operable’.

Starhill wanted the court to determine the prevailing market rent of the Toshin lease after a dispute erupted between the parties over the rent review process.

Toshin, a unit of Takashimaya, leases more than 225,000 square feet in Ngee Ann City, which it then sub-leases to luxury brands such as Chanel, Louis Vuitton, Burberry and Tiffany & Co.

But in a grounds of decision issued last Friday and made public yesterday, High Court Justice Lai Siu Chiu declined to order an inquiry into the market rental rate of the premises, saying she ‘had (her) reservations about the legitimacy of this remedy’.

‘In substance, the latter remedy would amount to the court substituting its own terms for those in the lease agreement, which was a contract made between the parties,’ Justice Lai wrote.

Starhill claimed that the review mechanism was no longer workable because Toshin had allegedly breached its lease when it ‘unilaterally’ hired seven valuers from July 2010 to February 2011 prior to a joint conduct of the rent review exercise for a new rental term starting on June 8, 2011.

Starhill alleged that if any of the seven valuers that had been engaged by Toshin were to participate in the rent review process, then their findings would be ‘tainted by conflicts of interest’.

But Justice Lai found ‘that the valuers were not involved in a conflict of interest, and . . . (Toshin) had not obtained any unfair advantage by engaging seven of the eight valuers in 2010’.

‘(Toshin’s) objectives in engaging valuers for the 2010 valuation included the need to plan (its) business operations for the future, including negotiations with its sub-tenants on rental rates; and also the need for the Takashimaya group . . . to prepare reports for its shareholders,’ Justice Lai wrote.

‘I’m hard pressed to discern any apparent bias. I had opined . . . that conflicts of interest in the sense of the valuer being conflicted between (Starhill’s) and (Toshin’s) interests are not an issue in this case. Further, the possibility of financial interest in future remuneration from (Toshin) to the valuers was not alleged in this case,’ she wrote. ‘To my mind, there was no justification for the independence of the valuers to be compromised by an allegation of bias.’

Starhill has appealed against Justice Lai’s decision to the Court of Appeal, which is scheduled to hear the case next month. Toshin is represented by senior counsel Cavinder Bull of Drew & Napier LLC.

Sealed in 2008, the lease agreement between Starhill and Toshin will expire in 2013 and rental renewals are due every three years.

Under the rent review mechanism, both parties will agree on the new rental rate, which has a cap of not more than 25 per cent from current rates.

If no consensus is reached, both parties will jointly nominate three valuers. Should there be no agreement on the nomination, they could jointly request that the three valuers be nominated by the president of the Singapore Institute of Surveyors and Valuers.

Timeless appeal

• Malls in prime KL locations, with distinct tenant mix

• Opportunity to increase Lot 10 revenue through AEI

• Maintain BUY and S$0.76 TP

Strong foothold in KL shopping scene. SGREIT’s two retail malls – Starhill Gallery and Lot 10 – have a strong foothold in KL’s prominent Bukit Bintang shopping district. After completing Starhill Gallery’s AEI, its modern iconic facade will cement its crème de la crème position. It has signed on exciting new retailers to refresh and enhance its tenancy mix. Currently, both malls and the new space created at Starhill Gallery are master-tenanted to Katagreen Development, a subsidiary of YTL Corp. until 2016, with option to renew for another three years. Occupancy rates at both malls are >95%.

Lot 10 might be next for AEI, we see only upside. Lot 10 now houses several beauty/spa tenants on the 3rd and 4th floors. But the master tenant could bring in more fashion retailers, including new-to-market brands, which are usually higher yielding tenants. We also see opportunities for the REIT to expand the mall’s NLA by converting carpark space and building new annex blocks.

Making KL a shopping destination. The government’s efforts to rejuvenate Bukit Bintang will have positive impact on the malls. Construction of a new MRT station located adjacent to Lot 10 will start next year, and is expected to be ready in 4-5 years. Plans for covered walkways to link KLCC to Bukit Bintang district will also create >10m sf of retail space to attract more tourists. Completion of this public infrastructure could boost the malls’ accessibility.

Wisma Atria will see similar transformation. AEI works at Wisma Atria will be completed in 3Q12, and underpin FY12 earnings growth. SGREIT is now trading at attractive 0.6x P/BV, and offers 7.4%-7.7% DPU yields for FY11/12.

Let’s focus on the fundamentals!

At a Glance

• Portfolio performance remained healthy, 9M11 DPU makes up 73% of our FY11 estimates

• Improve Supply/Demand outlook for prime retail space to drive prime retail rents

• Slight dilution (c.2%) in DPU in FY11, if Toshin lease renewal takes place in FY12

• Maintain BUY, TP raised to S$0.76

Comment on Results

3Q11 result is in line with expectations. Revenue and NPI fell by a marginal 3% and 4% to S$44.0m and S$34.5 m respectively, due to lower contributions from its Singapore, Japan and Malaysia portfolios. However, lower interest expense and dividend to CPPU holders helped to mitigate the decline resulting in a flattish distributable income of S$19.4m or DPU of 1.0 Scts. 9M11 DPU makes up 73% of our FY11 estimates.

Slide in occupancies expected to be transitional. The occupancy for Wisma Atria office rose 2.6 ppt to 94.6%, while Ngee Ann City office occupancy slipped by 4.8 ppt to 91.8% upon the lease expiry of a mid-sized tenant. However, the group has found a replacement tenant and occupancy should head back to the same level next quarter. Monthly rents signed remained healthy at S$9 -10 psf. Meanwhile, demand for retail space at Wisma Atria remains strong on the back of expansion from existing tenants with reversions as high as 20% from preceding rents.

Better outlook for prime retail space, Toshin renewals could only take place next year. Going forward, the improved supply and demand dynamics along Orchard Rd as well as the upcoming year-end festive season should continue to help lift average retail rents at Wisma Atria and Ngee Ann City. The main concern has centred on Toshin’s lease renewal at Ngee Ann City, which was due in June this year. We estimate that DPU in FY11 will be diluted by a marginal c1.8% if resolution takes place in FY12. In Australia, David Jones’ lease has been revised up by c. 6% upon the review in August and full contribution will be seen in 4Q. After refinancing of its loan upon the expiry of the cross currency swaps, interest rate fell marginally from 3.49% to 3.44% while gearing rose 2ppt to 32%due to the higher exchange rate.

Recommendation

Maintain BUY. SGreit continues to offer attractive FY11/12F yields of 7.1 – 7.4%. Valuation remains attractive at 0.7x P/BV. Maintain BUY, we raised our DCF backed TP to S$0.76 as we rolled forward our numbers to FY12F.