4QDPU Highest since IPO; More Rental Upside ahead

4QDPU of 1.04 S-cents. Starhill Global REIT reported 4Q10 gross revenue of S$45.6m, up 33% YoY and 0.9% QoQ. Distributed income rose 7.6% YoY and 4% QoQ to S$20.2m. For FY10, gross revenue jumped 23.1% to S$165.7m, which was in line with our expectations. The revenue increase was attributed to the contribution from Starhill Gallery and Lot 10 in Malaysia, and David Jones Building in Australia, which were acquired in 2010. Distributed income was also 3% higher at S$75.7m. 4Q10 DPU is 1.04 S-cents – the highest ever achieved in a quarter since Starhill’s IPO in Sep 2005. This was 7.2% higher than the 0.97 S-cents paid out in 4Q09. On an annualized basis, the latest distribution represents a yield of 6.42%1 .

Rentals act in its favor. As at 31 Dec 2010, Starhill’s Singapore retail and office occupancy was 99.1% and 92.5% respectively. We are also witnessing decelerating declines in its office rental income, signaling that negative rental reversion for Starhill’s office portfolio is likely to bottom out in 2011. In addition, about 87% of its gross office rents will expire by 2013. We believe that Starhill stands to gain from the prime office rental recovery, which just begun experiencing doubledigits growth rates (12.2%) on a quarterly basis in 4Q10 (according to CBRE). On the retail side, we think that Prime Orchard rents are also likely to pick up pace soon, due to the following reasons: (1) Prime Orchard rents have declined and narrowed significantly from suburban rents over the past year. It is only logical to go upwards, since suburban rents sets the floor to prime Orchard rental rates. (2) Orchard retail supply has stabilized; we do not expect mega, large-scale malls coming up like what we have seen in 2009-2010. (3) Shopper traffic along Orchard road have burgeoned much, correlating to the increase in tourist arrivals to Singapore. This is likely to exert upward pressure on rental rates. In our opinion, Starhill is poised to capitalize on the rental upside ahead, especially given that one of its major tenants at Ngee Ann City, Toshin Development (constitutes 20% of Starhill’s gross rental income) is up for rental review (with upwards only provision) in Jun 2011.

Valuation still Compelling. Starhill is currently trading at a PBR of 0.71x, which is lower than its historical PBR of 0.73x since listing. We still think that this discount is unwarranted, given its prime assets positioning, strong sponsor and sound financials. Rental escalation ahead serves as strong catalyst. Maintain BUY with an increased fair value estimate of S$0.74.

Well-positioned for growth

• 4Q10 results in line with expectations

• Positive master lease rental reversion and improving office sector fundamentals to underpin growth

• Maintain Buy with S$0.78 TP

In line with expectations. 4Q10 distribution income rose 7% y-o-y to S$20.2m on the back of a 33% jump in gross revenue to S$45.6m and a 37% increase in NPI to S$36.7m. The increase was mainly attributed to contributions from Starhill Gallery and Lot 10 in Malaysia, and David Jones Building in Australia, which were acquired in 2010. On a q-o-q basis, gross revenue and NPI rose by 0.9% and 2.7% respectively, thanks to the continued improvement in Wisma Atria and Ngee Ann City’s office occupancies and higher rental income for its Chengdu property. There was a revaluation surplus of S$76.4m in 4Q10 from its Singapore and newly acquired properties, lifting its fully diluted book NAV to S$0.84.

SG properties revenue continues to grow. Annual footfalls to Wisma Atria increased 22% yoy to 27m in 2010. Our forecast of about 13m tourist arrivals this year is expected to have a favorable impact on retail rents. Meanwhile, revenue from the office portion of Wisma Atria also saw a smaller contraction this quarter (-12.0% in 3Q10 vs -6.2% 4Q10). We expect this trend to continue as office occupancies improve further on the back of demand from new tenants such as new-to-market retailers and uptick in rental rates. Toshin and David Jones master leases are up for renewal in June and Aug 2011, respectively. Toshin’s lease reversions are capped at 25% above preceding levels and we have factored in a conservative 10% upside reversion vs the 20% adjustment in the last cycle. For David Jones, we expect rental hikes of 6%-8%.

Maintain Buy and S$0.78 TP. The stock offers FY11/12F yields of 6.7-6.9%, translating to a total return of 23%. Gearing remains healthy at 30.2%. Potential AEI works to increase NLA at Wisma Atria and possible new acquisitions could provide future catalysts. These have not been factored into our forecast.

Luxe at a bargain

Event

• Rental rates of prime retail space along Orchard Road have remained firm and look set to climb amid a rosy economic outlook and in the absence of new supply over the next two years. Starhill, which derives two‐thirds of its revenue from Ngee Ann City and Wisma Atria in Orchard Road, is poised to enjoy positive rental reversions. We reiterate our BUY recommendation and target price of $0.80.

Our View

• Approximately 20% of Starhill’s retail leases in Singapore will expire this year. We estimate that the current passing rent of its expiring leases is about 30% below the prime retail space rent in Orchard as of 4Q10. With prime retail rents heading north and no new supply in sight, we have factored in positive rental reversions over the next two years.

• Suburban retail rents, on the other hand, may come under pressure as 1.3m sq ft of new retail supply come to the market in the next two years. This includes Clementi Mall (193,750 sq ft), JCube (204,000 sq ft) and Changi City Point (207,000 sq ft). That prime retail rents may increase and suburban retail rents may get squeezed indicates that the gap between the two could start to widen from the current narrow band.

Starhill, with its value proposition as an undervalued prime retail REIT, should benefit.

• With suburban retail REITs like Frasers Centrepoint Trust and CapitaMall Trust trading at a premium of 20‐30% to their book value, Starhill appears to be a good bargain at just 0.7x P/NAV.

Action & Recommendation

We reiterate our BUY rating and target price of $0.80, based on an attractive forward DPU yield of 6.7%. Starhill will continue to enjoy stable rental income from its overseas assets thanks to the long‐term leases. Acquisitions and asset enhancements could be the major catalysts for re‐rating.

New beginning beckons

We initiate coverage on Starhill Global REIT with a BUY recommendation and target price of $0.80/share. Starhill owns 13 prime commercial properties in stable, high‐growth markets in the Asia Pacific, with retail rental making up 87% of group revenue in 3Q10. DPU growth is bolstered by medium‐ and long‐term leases that provide income stability and rental upside potential, as well as acquisition opportunities. With a clear target to double asset size and the backing of a strong and committed sponsor, Starhill is poised for a new beginning. At 0.7x FY10 P/B and 6.8% FY11F yield, the stock is deeply undervalued.

Steady income from defensive rental structure

Starhill has a stable of master and long‐term leases that comes with built‐in positive rental reviews every few years. This ensures a steady stream of longterm income for the group. Around 44% of its total revenue this year comes from such leases. Its medium‐term leases, which are typically for three years, have rental tied to gross turnover, thus allowing Starhill to ride on market rental recovery and rising consumption in retail markets such as Singapore.

Asset size to double in five years

Unlike many other REITs, Starhill’s REIT manager has a clear target to double Starhill’s portfolio from $2.6b currently to at least $5b in five years. The REIT manager has been sourcing for third‐party assets in China, Australia, Singapore and London, and has a few deals on the negotiating table.

Committed sponsor with deep pocket

Starhill’s sponsor is YTL Corporation Berhad, one of the largest companies listed on Bursa Malaysia. YTL aspires to own a portfolio of prime commercial properties globally under the luxury Starhill brand, and the REIT is a viable vehicle to achieve its dream. Its financial prowess and commitment should provide Starhill with the necessary support for acquisitions.

Sharp discount hard to ignore; initiate with BUY

Starhill is trading at a steep 30% discount to its NAV in stark contrast to the 10‐30% premium commanded by its peers. We think this could be because of the lack of asset enhancement initiatives on its part. Its FY11F DPU yield of 6.8% offers a yield spread as high as 160bps over the yield of some of its retail peers. We initiate coverage with a BUY recommendation and target price of $0.80/share, based on the Dividend Discount Model.