Tax transparency for MBFC 1

Tax transparency for MBFC 1 should allow savings translating to 2-3% of DPU annually. We do not dismiss the possibility of similar conversions and structures for ORQ and MBFC 2, which could allow less tax leakages and potential simplification ofholding structures.

We raise DPUs and DDM-based target price (discount rate: 8.1%) factoring in tax savings from Suntec REIT’s one-third stake in MBFC Phase 1. Maintain Outperform on favourable risk-reward. We see catalysts from earlier bottoming ofoffice market and further tax savings.

What Happened

Suntec REIT has announced that BFC Development Pte Ltd, the entity which holds MBFC Phase 1 has been successfully converted to BFC Development Limited Liability Partnership. This will allow it to obtain tax transparency and not pay corporate tax on its income from its one-third stake in MBFC Phase 1.

What We Think

We expect this development to result in savings of about S$4m-5m (2-3%) for Suntec REIT annually. Savings are not retrospective, implying no claw-backs for previous taxes paid.

Management’s efforts on this are commendable. Previously, the tax leakage, income support and complex holding structures for ORQ and MBFC Phase 1were some of the key contentionpoints that some investors had when they compared K-REIT’s and Suntec REIT’s portfolios against CCT’s. We do not dismiss the possibility of a conversion for the holding company of ORQ and the use of a similar structure for a potential acquisition of MBFC Phase 2 for increased tax savings.

If these changes take place, not only will there be less tax leakages, but overall holding structures fortheportfolio could be less complex (e.g. unwinding of shareholders’ loan for tax shelter) to facilitate investors’ understanding and a potential narrowingin valuation gap against CCT.

What You Should Do

Overall, we view this news positively for both its tangible and intangible benefits. Maintain Outperform on favourable risk-reward from a potential bottoming of the office market and cheap valuations (0.7x P/BV and 6.9% yield).

Turning Point

1Q12 results within expectations. Suntec (SUN) released its 1Q12 results yesterday, posting gross revenue and distributable income of S$73.3m (+20.1% YoY) and S$54.9m (+3.8% YoY) respectively. DPU for the period came in at 2.45S¢, accounting for 25.3% of our FY12 DPU forecast. NPI increased by 5.0% YoY bringing it to S$49.0m on the back of high occupancy rates and additional income from Suntec Singapore. Going forward, we expect SUN’s DPU to drop slightly amid the loss in income from the divestment of CHIJMES and lower income contribution from Suntec City as a result of the AEI which will begin in June. Based on our DDM valuation (COE:8.9%; TGR:1.5%) we maintain BUY on this counter with a lowered TP of S$1.51. SUN is currently trading at 6.0% spread to 10-year bond yield which is 108bps and 363bps above its long term (4.9%) and pre-crisis mean spread (2.4%) respectively, our TP of S$1.51 translates to a spread of 4.9% and a potential upside of 17.5%.

Proceeds from CHIJMES used for AEI and mitigate dips in DPU. As part of the company’s proactive asset management strategies in maximising returns from the portfolio, Suntec divested CHIJMES for a price of S$177.0 million, 23.2% higher than valuation. According to management, the proceeds will be deployed to partially fund the AEI at Suntec Singapore and Suntec City Mall, and to mitigate any temporary dip in distribution per unit during the execution of the AEI from June onwards.

Gain in revenue offset by lost in income. Going forward, as ORQ and MBFC continue to outperform the general office market, together with additional income from Suntec Singapore in the 1H12, we expect SUN’s DPU to drop mildly by 2.8% in FY12. In our forecast, we expect most of the lost in income due to the divestment at CHIJMES and the AEI at Suntec City to be offset by the gain in income from the abovementioned. Given that this counter is currently trading at 0.65x P/B together with a forecasted yield of 7.5% for FY12, we believe our TP of S$1.51 which translates to a spread of 4.9% is undemanding.

A winner in the making

• Slightly ahead of expectations, 3MDPU representing 28% of our forecast

• First phase of Suntec City AEI to start, expect earnings to normalise

• Maintain BUY at an unchanged TP of S$1.45

Highlights

Slightly ahead of expectations. 1Q12 gross revenue and NPI rose by 20.1% and 5.0% y-o-y to S$73m and S$49m respectively, largely due to the consolidation of revenue from Suntec Singapore. Additional contribution from Marina Bay Financial Centre (MBFC) Phase 1 also helped to lift distributable income by 3.8% to S$54.9m. DPU was 2.453Scts representing 28% of our FY12 Forecast

Our View

Stable office portfolio. While this quarter marked the end of the income support for ORQ, we expect this income vacuum to be offset by positive rental reversions for its remaining portfolio, and the possible refund of the GST paid on the ORQ income support in the next three quarters. Meanwhile, monthly signing rents at Suntec City Office Towers remained firm at S$8.79 psf supported by high occupancy (99.5%).

First phase of Suntec retail mall’s AEI works starting. Approximately 193,000 sq ft, or 23% of the Suntec City retail space is expected to undergo AEI works from June 2012. While we expect some downtime in occupancy, the management will mitigate this by carrying out the works in phases. 4Q12 is likely to be the most intensive phase of its refurbishment exercises before occupancy starts trending up in 1Q13. On a positive note, NLA will be boosted to 380,000 sf upon the completion of AEI works in mid -2013, of which 45% has been pre-committed to popular tenants like H&M, GAP and La Senza. At the same time, some of the anchor tenants are expected to have new concept stores. This will boost the mall appeal and drive footfall in the medium term.

Recommendation

Maintain BUY. Suntec offers FY12-13F DPU yields of 6.7% and is trading at an undemanding 0.7 x P/BV. Gearing is at a healthy 37.4%. There is also minimum refinancing this year (7% of total debt). Our unchanged DCF-backed TP of S$1.45 offers a total return of close to 20%.

Due for a bounce

Positives were better rental reversions and stronger occupancy from Suntec City offices. An ROI of 10.1% from Suntec City Mall's AEI is within sight, based on >45%secured pre-commitments. Its risk-reward trade-off remains favourable at 0.65x P/BV.

1Q12 DPU matches consensus and our estimates at 28% of FY12. We expect a frontend-loaded year with Suntec City Mall's AEI contributing in 2H12. We factor in GST rebates for ORQ, adjusting our DPU by 1-2%. Maintain Outperform with a higher DDM target (discount rate: 8.1%).

Stronger offices

1Q12 DPU was up 4% yoy on higher contributions from ORQ, MBFC and Park Mall. Positives were slightly better rental reversions at Suntec City offices, aided by low expiring rents for certain leases like IDA's and UBS's. Renewal rents inched up to S$8.79psf (4Q11: S$8.72psf) while occupancy tightened to 99.5% (4Q11: 99.2%). 2012 lease expiries are down to 7.5% by NLA and management is working on those leases due in late 2012 and early 2013. ORQ and MBFC also contributed more yoy. Management is expecting GST returns from ORQ income support in the coming quarters.

AEI on track

Management appears increasingly confident of returns from Suntec City Mall's AEI, guiding that it is on track to hit its ROI target of 10.1%, judging from its >45% of secured pre-commitments. Chijmes' divestment proceeds will be used to mitigate a temporary DPU dip 'if necessary'. Phase 1 of the AEI will involve the closure of 193k sf (23% of Suntec City's retail NLA) in the Galleria zone and Fountain Terrace, with a most intensive phase expected between Oct and Dec 12, before completion in 2Q13. Mall rents and occupancy were stable before the AEI.

Valuations compelling

With limited DPU downside and at 0.65x P/BV, we reckon its risk-reward remains in favour of a positioning for a bottom and successful remake of Suntec City Mall.

Suntec Reit posts Q1 DPU of 2.453¢

SUNTEC real estate investment trust (Reit) yesterday posted a distribution per unit (DPU) of 2.453 cents for the first quarter of 2012, a 2.7 per cent year- on-year increase.

Based on the unit price of $1.27 on 23 April, this translates to an annualised distribution yield of 7.8 per cent.

For the quarter ended March, distributable income increased 3.8 per cent year-on-year to $54.9 million, on the back of stronger performance from its office portfolio and higher income contribution from its jointly controlled entities, One Raffles Quay and Marina Bay Financial Centre (MBFC) Towers 1 and 2, and the Marina Bay Link Mall.

For the quarter, gross revenue jumped 20.1 per cent year-on-year to $73.3 million, mainly due to the consolidation of $14.6 million in revenue from Suntec Singapore. For the same period, net property income of $49 million was 5 per cent higher year-on-year.