AEI Completion To Provide Buffer Against Headwinds

Investment Highlights

Singapore property portfolio propping up growth. Starhill Global REIT (SGREIT) recorded growth of 4.4% YoY in its net property income (NPI) for 2QFY2012, which was mainly buoyed by an improving performance of its Singapore property portfolio. Gross revenue, meanwhile, witnessed an increase of 4.8% YoY in the same quarter. As at the end of 2QFY2012, SGREIT has a portfolio occupancy rate of 99.5%.

Comfortable debt headroom. SGREIT’s gearing stands at around 30.5%, which is a healthy level. The company has a weighted average debt maturity of 1.8 years. SGREIT has S$576mil worth of debt maturing in FY2013. According to the company’s management, SGREIT is in the midst of discussions with banks to refinance the AUD$63mn term loan, which is maturing in January 2013, with an expected maturity beyond 2016.

An increasingly challenging macro environment. SGREIT generates 62.8% of its gross revenue from Singapore, leaving it heavily exposed to the underlying macroeconomic trends in the market. SGREIT’s retail

assets, namely Wisma Atria and Ngee Ann City, are positioned in the mid‐to high‐end segment, which means that its clientele comprises largely of discretionary spenders. The company’s portfolio does not consist of

Takashimaya department stores. Therefore, we do not believe the company is likely to escape unscathed from a broad‐based retail spending slowdown. Retail sales growth in Singapore (excluding automobile sales), in YoY terms, is showing waning signs of momentum, signalling more cautious discretionary spending in the near future.

Asset enhancement initiatives completion at Wisma Atria to partly cushion against economic slowdown. The majority of asset redevelopment works at Wisma Atria has already been completed in 2QFY2012, generating a return on investment (ROI) of around 12.8%, which exceeded the company’s initial projected ROI of 8%. Thanks to its AEI at Wisma Atria, SGREIT recognised positive rental reversions and higher occupancy rates. While the near‐term operating environment is likely to serve up greater challenges, the completion of its AEI at Wisma Atria should leave SGREIT better positioned in the current macroeconomic climate.

Trading at a forward dividend yield of 6.3%, according to Bloomberg consensus estimate, SGREIT continues to offer a decent yield, particularly amid the current low interest rate climate. The company has a price‐to‐book ratio of 0.85.

Keep on shopping

• 2Q12 results in line with expectations: 1H DPU forms 51% of our forecast

• Improving office occupancy and Wisma Atria’s AEI to drive earnings

• Maintain BUY at a higher S$0.77 TP

Highlights

2Q12 DPU of 1.08 Scts in line. Gross revenues and net property income came in at c.5.0% higher at S$46.4m and S$37.1m respectively. The stronger performance was largely attributed to Wisma Atria post AEI, which has also locked in a higher ROI of 12.8% vs its initial target of 8%. Assets in Japan and China have also seen better performances due to the strengthening of their local currencies. As a result, distributable income (net CPPU holders) had come in at S$21.0m, which translates to a DPU of 1.08 cts (+3.8%yo-y, +1.0% q-o-q). On a sequential basis, its performance had remained relatively stable, despite a seasonally-weak quarter.

Our View

More to come for Wisma Atria AEI. Going forward, the earnings are still likely to be SG driven. Post AEI, Wisma Atria occupancy has strengthened from 95% to 99.5%, while committed leases in the last 12 months have risen by 33% on a blended basis. That should continue to filter down to 2H earnings. Meanwhile, the outdoor area with the upgraded façade has also created opportunities for hosting promotional events, which in turn would help to drive footfall and revenues. Therefore, footfall and retail sales which are still 9% and 22% lower respectively y-o-y, are expected to improve sequentially.

Strong SG office performance, Chengdu bottoming out. Its office portfolio has also seen a strong uptick from 95% a quarter ago to 98.4%. Committed leases in the last six months were also 19% higher, with signing rents at c.S$9.50 vs FY13 expiring rents of c.S$8.50. While the trust will see close to 40% of the office leases in term of revenues expiring next year, we think its differentiated tenant mix from the CBD and high occupancy should help mitigate leasing risks. Meanwhile, Chengdu property, which has seen a weaker performance due to tenant renovations and competition from newly-opened malls, should bottom out this quarter upon the opening of a major tenant – Zegna in 3Q12.

Proactive capital management. The reit has already started to look at various funding sources for its S$551m loan for refinancing in FY13 and is likely to refinance its S$81m Aussie loan this year. The remaining loan will likely be financed by a mixture of MTN and bank loans, with staggered maturities for diversifying its financing sources and for extending debt maturity.

Recommendation

BUY call maintained, TP raised to S$0.77. FY12/13 yields of 6.2% and 6.5%, backed by a visible organic growth outlook remain attractive. Gearing at 30.5% also means that there is ample room for acquisitions growth. Our revised TP offers a total return of 16%.

Positioned for Greater Upside

1H12 earnings inline. SGREIT’s 2Q12 revenue rose by 5% YoY to SGD46.4m, while the distributable income for unitholders increased by 4% YoY to SGD21m. 1H12 revenue at SGD92.4m, up 3% YoY, was 50% of our FY12 forecast and consensus estimate. 1H12 DPU at 2.15 SG-cts, up 2% YoY, was 50% of ours and consensus estimate.

Wisma Atria harvesting upside. Wisma’s AEI is completed in 2Q12 with all Orchard road fronting stores commencing business. ROI is 12.8%, exceeding the initial target of 8%. (CAPEX ~SGD31m), representing an annualized incremental NPI of SGD3.9m (based on secured tenancies as at 30 Jun 2012). Positive rental reversions of ~33% was achieved for leases committed between Jul 2011 to Jul 2012, since the start of the AEI. Wisma’s 2Q12 retail revenue rose 7.5% QoQ to SGD13.045m while average passing rent is up SGD34.29 psf/mth from SGD33.30 psf/mth last quarter, according to our estimates.

Portfolio review. Wisma’s retail and office occupancy improved to 99.5% and 99% from 95.3% and 96.8% last quarter respectively. Similarly, Ngee Ann City retail maintained at full occupancy while Ngee Ann City office occupancy improved to 98% from 97% last quarter. However, we noted that there was a 520bps occupancy dip in the Japan portfolio (representing 4.3% of 2Q12 revenue), due to a sharp occupancy decline in the Daikanyama mall (from 100% in 1Q12 to 62.6% in 2Q12).

Toshin rental review. Despite the court tussle having gone before the Singapore court of appeal, Toshin has exercised its option to renew Ngee Ann City (NAC) retail for another 12-year term, expiring in 2025, thus lowering the lease expiry in 2013 from 89.6% of gross rent last quarter to 3.8%. The next rent review will be in 3-years time. Toshin constitutes 88.6% of NAC retail gross rent as at 30 Jun 2012 and is SGREIT’s largest tenant (18.8% of portfolio gross rent). 2Q12 average passing rent at NAC retail stays at depressed levels of SGD13.60 psf/mth from our estimates. We expect marginal increment until the next rent review.

Deserving better. A prime retail play trading at a sharp 20% discount to its book value, Starhill Global REIT deserves better in our opinion. For one, its key assets are in the coveted Orchard Road area, where tight supply and the entry of new international retailers should give it greater bargaining power in terms of leasing its space. We like Starhill for the rental upside at Wisma Atria and income stability in Malaysia and Australia. At 6.1% FY12F yield, we reiterate BUY with a DDM-derived TP of SGD0.76.

ANOTHER QUARTER OF STRENGTH

•Stable 2QFY12 performance

•Wisma Atria redevelopment mostly done

•Positive contribution not fully reflected

Consistent set of 2QFY12 results

Starhill Global REIT (SGREIT) reported NPI of S$37.1m (+4.4% YoY) and distributable income of S$23.3m (+2.0% YoY) for 2QFY12, in line with our projections. DPU came in at 1.08 S cents (+3.8% YoY), after netting off S$2.3m in distribution to CPU holders. Together with the distribution in 1Q, 1HFY12 DPU amounted to 2.15 S cents, meeting 49.6% of our FY12 DPU forecast (50.0% of consensus). This translates to an annualized DPU yield of 6.2%.

Strong numbers from Wisma Atria

Wisma Atria was the key driver for the quarterly performance, thanks to improved office occupancy (99.0% vs. 92.0% a year ago) and comparatively higher rentals following the asset redevelopment (AEI) at its retail segment. We understand that SGREIT had achieved positive rental reversions of 33% for leases committed at the property, since the start of refurbishment works (Jul 2011 – Jun 2012). In addition, management updated that the AEI at Wisma Atria was substantially completed in the quarter and that the ROI of 12.8% based on annualized NPI had exceeded its initial target of 8%.

Maintain BUY

As at 30 Jun, SGREIT’s portfolio occupancy rate improved 50bps QoQ to 99.5% as a result of higher occupancies at all properties except Daikanyama in Japan. Aggregate leverage also remained healthy at 30.5% (30.4% in 1Q), with no debt refinancing until Jan 2013. In our view, SGREIT’s growth potential has yet to be unleashed as the full impact of positive rental reversions may only be realized in the upcoming quarters. The stock is currently trading at a P/B of 0.8x, one of the lowest among other retail REITs. We now raise our fair value from S$0.70 to S$0.74, as we factor in higher rental assumptions on both its retail and office segments. Maintain BUY. Other catalysts, we note, may come from interest savings from refinancing of its outstanding debts, favourable outcome from court appeal pertaining to the master lease arrangement with Toshin Development (expected latest by Sep 2012) and divestment of Japan properties at attractive valuations.

Great Singapore Sale starts here

• Higher contribution from Wisma Atria in the 2H and upward rental reversion from Malaysia master tenant lease to boost DPU by at least 8%

• No overhang from CPU with minimal dilution of 0.4 -1.2%

• Maintain BUY, TP raised to S$0.75

Strong portfolio performance. Occupancies for Starhill Global REIT’s (SGReit) Singapore office portfolio are back to pre-crisis levels, while Chengdu property’s revenue should improve in 2H with the refreshed tenant mix. More importantly, we see visible growth catalysts coming from: (1) Wisma Atria, as the AEI works complete in 3Q12. About 20% of the mall’s NLA is expected to enjoy close to 50% increase in rents post AEI works. Rental revenue to rise in 2H12 as all the stores that are part of the AEI works including Cortina, Coach and Tory Burch flagship stores have opened. (2) Upward rental reversion of its Malaysia master lease which constitutes 17% of its gross revenue and is due for a 7% rental hike next year. Meanwhile, earnings upside could come from one-off accumulated arrears in rents from Toshin’s lease, if any, which we have yet to factor into our numbers. (3)

Longer term, the possible divestment of its Japanese properties could help to unlock values.

Strong balance sheet with no overhang from CPU. Balance sheet remains strong with gearing at 30% and no major refinancing due this year. In addition, we see limited downside risk from the convertible preferred units (CPU), with dilution estimated at c.0.4% to 1.2% to FY13-14 DPU assuming full conversion.

Compelling valuations with total return of 26%. We see strong organic growth outlook for SGReit’s portfolio, backed by stable income derived from master tenants. SGReit stands out for its compelling valuation of 0.7x P/NAV and attractive FY12/13F yields of 6.7-7.2% in the small mid cap REIT space. We have raised our DCF-backed TP by 5.6%and FY12/13 DPU slightly to account for Wisma Atria’s stronger performance. Our revised TP offers investors a total return of 26%.