Lower retail revenue eats into 4Q10 results

4Q10 DPU of 2.316 S-cents. Suntec REIT’s 4Q10 gross revenue of S$61.41m fell 0.56% YoY and 2.9% QoQ. NPI was stagnant YoY but dropped 6.7% QoQ to S$47.2m. Office revenue contributed 47% of total 4Q10 gross revenue, while retail revenue constituted the rest. Gross office revenue was S$28.7m, comprising Suntec City office revenue of S$26.8m and Park Mall’s S$1.9m. Gross retail revenue was S$32.7m, comprising Suntec City retail revenue of S$26.8 and revenue from Park Mall and Chijmes of S$5.9 m. Distributable income declined 6% YoY and 2.8% QoQ to S$44.9m, amounting to a 4Q10 DPU of 2.316 S-cents. The declines were mainly due to lower retail revenue achieved for the quarter, which fell 0.9% YoY and 1.5% QoQ, reaffirming our initial concerns about the looming retail slide for Suntec properties, following the ‘rejuvenation of Orchard Road’ 1. Chijmes, Park Mall and Suntec City Mall all saw a drop in revenue of 11.8%, 6.5% and 1.5% QoQ respectively. The income contribution from One Raffles Quay (ORQ) also saw a decline because of lower income support and lower interest income, following the repayment of the ORQPL shareholder’s loan.

Portfolio Performance. Following the MBFC1 acquisition, which was completed on 9 Dec, Suntec has surpassed CCT as Singapore’s 2nd largest REIT, with total assets of S$6.7b. As of 31 Dec, its aggregate leverage stands at 40.4%, with total debt of S$2.58b and weighted average debt term-to-expiry of 3.3 years. Office portfolio occupancy rose to 98.8% from 96.8% a year ago. However, retail portfolio occupancy declined marginally by 0.1 pp to 98.0%.

Maintain HOLD. We are overall positive on the office sector recovery, and confident of the manager’s expectation that negative rental reversions for Suntec’s office portfolio will bottom out by end 2011. However, we continue to have lingering concerns about Suntec’s retail portfolio, given that we do not expect retail rents to pick up as much as office rents, and there may be more “hollowing out” of shoppers’ traffic (precluding its immediate office catchment and traffic from large convention shows, such as the IT Show, PC Show etc.) to Orchard road or even suburban malls, if there is no further traffic boost to Suntec properties. In addition, 25.5% of retail portfolio NLA is expiring in 2011, followed by 30.3% in 2012 and 27% in 2013. We still think that the MBFC1 acquisition will help to boost the proportion of office to retail mix for Suntec, and help mitigate some of the top-line effects of thinning retail traffic, but this is, nonetheless, still a temporary fix. Maintain HOLD with a revised fair value of S$1.60.

Multi-pronged strategy at work

• No surprises in results

• Growth from organic and inorganic means

• Maintain Buy, TP $1.69

Maiden contributions from MBFC. Suntec recorded distribution income of S$44.9m, -2.8% qoq and –6% yoy, dragged down by slightly lower contributions from both the retail and office properties. While portfolio occupancy improved to 98-99%, impact of negative office reversions impacted bottomline. It renewed/ contracted new leases of 127ksf of retail NLA in Q4 and another c304ksf of office NLA at an average of S$8.16psf/mth, including forward leasing a number of leases due FY11. MBFC1 contributed a maiden S$2.5m. DPU of 2.316Scts (FY10: 9.859Scts) was 20% lower yoy due to a recent placement exercise to partially fund the acquisition of MBFC1. The group took in a S$116.8m revaluation surplus, which lifted book NAV to S$1.78.

Managing organic growth, looking for new acquisitions. Looking ahead, the group will continue to benefit from the rising office market. It has proactively renewed c276ksf of leases expiring in FY11 and has a remaining 164ksf (6.8%) of office space (excl IDA’s 90ksf), and another 276ksf of retail area to be renewed this year. Negative rental reversions are likely to be felt but rising office rents will mean a narrowing of spread between expiring and re-contracted leases. In addition, it is proactively looking for new acquisitions. Its current gearing stands at a healthy 38.4%. In addition, earnings are likely to be boosted by a lower all-in financing cost of 2.8% (vs 3.77% previously).

Maintain Buy. Suntec offers FY11 and FY12 DPU yield of 5.7% or 310bps spread over the risk free rate. The target price of $1.69 translates to a total return of 13%. We believe potential further upside can be realized as he group executes on its organic growth or acquisition strategies.

One of the Highest-Leveraged S-REITs; Maintain HOLD

Performance in 2010. Suntec REIT has made a total distribution of 9.266 S-cents1 , for the period from 1 Jan 2010 to 8 Dec 2010, with an average DPU yield of 7.1%2 . It share price has also appreciated 11.9% YoY, from a low of S$1.23 on 25 May to a high of S$1.56 on 29 Oct. It has recently completed its acquisition of a one-third interest in MBFC1, which is financed 72% by a loan facility (S$1,105 m) and 25% by private placement of new units (S$428.2m). Its private placement was 3.1x oversubscribed on 29 Nov at an issue price of S$1.37, bearing testimony to investor’s confidence in its latest “Premium Grade A” assets acquisition.

Moody’s downgrade. Nonetheless, Moody downgraded Suntec’s corporate family-rating from Baa1 to Baa2 and its senior unsecured ratings from Baa2 to Baa3 on 15 Dec. The downgrade reflected the substantially debt-funded acquisition of the one-third stake in MBFC1, which will weaken Suntec’s financial profile, by increasing its aggregate leverage ratio from 33% to 41.5%3 . At the same time, Moody’s also expects Debt/EBITDA to increase to 9-10x, up from 8.3x, with EBITDA/Interest around 3-3.5x (from 4.3x) over the next two years

Retail slide looming. On the portfolio end, the completion of the Circle Line MRT asset enhancement works at Suntec City was less favorable than expected. We noticed that retail crowds have thinned considerably, especially in the evenings and weekends (when there are no major shows at Suntec Convention). It appears that the ‘rejuvenation of Orchard Road’ has stolen much of the traffic, and Suntec City Mall now relies heavily on its office-catchment during weekdays. If the trend persists, this may impact rental income, considering that Suntec derives some 53% of its total gross revenue from retail rentals and 47% from office leases. We think that the MBFC1 acquisition will help to boost the proportion of office to retail mix for Suntec, and help mitigate some of the topline effects of thinning traffic at Suntec City Mall, but this is, nonetheless, still a temporary fix.

Maintain HOLD. We recognize that the MBFC1 transaction has long-term strategic benefits, and provides Suntec with exposure to “Premium Grade A” properties in Singapore. The acquisition will also enable greater income diversification, with NPI contribution from Suntec City estimated to reduce from 75.9% to 58.9%. However, the initial NPI yield of 4% in FY11 provides little upside in comparison with its average distribution yield of 7.1%, in our opinion. At 41.5% gearing, it is also one of the highest leveraged S-REITs among the 25 listed on SGX, with little debt headroom for further acquisitions in 2011. Maintain HOLD with a revised fair value of S$1.55.

1 Computed based on summing the quarterly DPUs and Advanced DPU.

2 Computed based on Total DPU (Annualized) divided by Average Closing Price from 4 Jan to 8 Dec 2010.

3 Assuming that proceeds are not used for repaying the One Raffles Quay Pte Ltd (ORQPL) shareholder’s loan.

Financing details of MBFC Acquisition

• Advance distribution for period 1 Oct – 8Dec approx 1.677 cents

• Private placement priced at $1.37 per unit raised $428.8 million

• Maintain Hold, target price $1.37  

Suntec REIT announced the financing structure of the MBFC acquisition. Suntec REIT raised gross proceeds of $428.8 million through a private placement and according to the circular sent out, it will also draw down $1,105 million of debt to fund the balance of the acquisition cost. 313 million new units were to be issued pursuant to the private placement at a price of $1.37 per unit. The new units issued represent 16.9% of the total units before the private placement. The issue price was at a discount of 4% to the volume weighted average price of S$1.43 on 26 November 2010 and the issue was 3.1 times oversubscribed. In connection with the private placement, Suntec REIT will be paying out an advanced distribution to existing unitholders for the period 1 Oct – 8 Dec 2010, prior to the listing of the new units on 9 Dec. The REIT manager expects the advance distribution to be approximately 1.677 cents per unit. Post acquisition, we estimate Suntec REIT will have total debt of $2.8 billion which will bring gearing up to 42%.

The private placement was well oversubscribed at 3.1 times which reflects investor’s preference for downtown grade A properties. This we believe is also the catalyst for the stock. Minority unitholders may again feel disadvantaged by the inability to participate in the private placement, the first time being in Dec 2009. At the current price, Suntec REIT is trading at approximately 15% discount to book value and we are projecting 6.8% dividend yield for FY11E. However our concern with Suntec REIT lies mainly in its gearing. At 42%, it is one of the higher leveraged REITs and the gearing will also limit it on making further acquisition. Deleveraging will have to be carried out at some point. We raised our target price slightly from $1.34 to $1.37 and maintain our Hold recommendation.