3Q09 results: Better than expected on lower financing costs

• Suntec REIT announced 3Q09 results, with DPU at S$0.0292/unit, down 2% Q/Q but 8% higher than our estimate on the back of lower financing costs (2.88% all-in costs) as a result of a higher proportion of short-term debt. Distributions YTD amounted to S$0.0816/unit, giving a 9.9% annualized yield based on yesterday’s closing price. Book value stood at S$1.95/unit with gearing of 34%. Stock will trade ex-3Q09 distribution on 2 November.

• Occupancy rate has improved, but rents still under pressure: We note that the occupancy rate for the portfolio improved on a sequential basis, with that of Suntec City Office back up at 94.8% versus 92.5% in 2Q09. Renewal rents, however, continued to fall, declining 12% Q/Q to S$7.30 psf pm. Passing rents for the trust’s retail portfolio also saw a modest decline. We retain our view that substantial negative rental reversion will start to kick in only in 2H10 and distributions are likely to bottom out only in 2012.

• Calibrating our earnings estimates: We raise our distribution estimates for 2009-2011 by 2-7% to factor in lower financing costs, especially for this year. Our Jun-10 DDM-based price target remains unchanged at S$1.00/unit, assuming an 8.5% discount rate and a 2% long-term growth rate.

• We retain our Underweight rating on Suntec: Key upside risks to our rating and price target include: 1) a potential fundraising that is likely to remove the EFR overhang; 2) incrementally more positive news flow for the sector in the near term; and 3) a quicker-thanexpected bottoming out and recovery of the rental market. Key downside risks include a worse-than-expected rental reversion cycle and a return to illiquid capital markets as we had a year ago.

3Q09 Results

First look

SUN’s 3Q09 DPU came in above Nomura and street expectations, on better-thanexpected portfolio performance. In particular, portfolio occupancy held up better than expected. Considering the apparent 10.2% ex-ORQ office lease roll and 8.9% retail lease roll achieved in 3Q09, we find the occupancy resilience impressive. Rents were likely cut to achieve these, but the YTD correction in rents at the Suntec City assets appears milder than we were anticipating. Forecasts, PT under review.

Rents cut to secure occupancy

Positive rental reversion; BUY

Stable 3Q09 earnings; earnings in-line. Suntec REIT reported 3Q09 results DPU of 2.92¢ (+2.3% YoY; -1.9% QoQ). Annualised 9M09 DPU (including deferred units) came in at 10.9¢, broadly in-line with ours and consensus estimates. Net property income rose 3.1% YoY on the back of higher rental reversion. Suntec will trade ex-3Q09 distribution on 02 November 2009.

Maintain BUY, DDM-based TP of S$1.45. Achieved positive rental reversion and higher occupancy. Suntec achieved gross office revenue of S$28.7m for 3Q09, 7.9% higher than in 3Q08, driven mainly by higher rents achieved for the Suntec City and Park Mall offices. In 3Q09, committed occupancy for the overall retail portfolio stood at 99.1% (98.4% in 2Q) and 96.4% for office (94.8% in 2Q).

Healthy leasing activity. For 9M09, Suntec renewed and signed 513,000 sqft of office space. With this, the remaining office leases expiring in FY09 amounts to approximately 14,000 sq ft or 0.5% of the total office NLA. Suntec has seen healthy leasing activity, with eBay/PayPal taking a 28,000 sqft lease in Tower 5 (UBS’s former space). COSL Drilling, Interoil Singapore (oil & gas), Asia Green Capital (investment bank), Dan Bunkering (bunker trader) are among the new tenants at Suntec City.

Retail reprieve on overall earnings. Despite the economy being technically out of a recession, it is clearly still a tenants’ market and the focus on tenant retention remains paramount for all landlords. Nevertheless, with retail contributing to ~50% of overall income, we expect earnings prospects to remain favourable. We believe the spectre of higher retail footfall at Suntec City is likely to transpire when the Circle Line becomes fully operational in 2011. The opening of Esplanade and Promenade stations will materially enhance Suntec’s traffic footfall, a case that is currently seen in ION Orchard mall, given its connectivity with Orchard MRT. At current prices, Suntec offers investors an attractive dividend yield of 8.0% for FY10. Stock traded at 4.6% yield between 2005 and 2007. At our TP of S$1.45, stock still offers attractive yield of 6.5%.

3Q09 results ahead; improvement in occupancy rates

3Q09 DPU of 2.92cts (+2% YoY, -2% QoQ) came in ahead of our forecast with 9M09 DPU of 8.82cts making up 80% of our FY09E. Earnings were underpinned by organic growth from the Suntec City properties which made up 86% of total revenue.

Improvements in occupancy; retail relatively stable. While contracted office rents continued to trend down (leases secured in 3Q09 for Suntec City averaged S$7.30psf vs S$8.24psf in 2Q09 & avg passing rents of ~S $8psf), occupancy rate improved QoQ fr 94.8% to 96.4% for the office portfolio. Majority of the office leases maturing this yr have been renewed, with only 14,000sf (or 0.8%) left vs 527,000sf at the bgn of the yr. Mgmt has commenced work for leases exp.in FY10 with ~65,000sf or 14% of exp.space renewed.

Similar improvements in occupancy were seen for retail, with avg occupancy rates rising from 98.4% to 99.1% in 3Q. Avg rents for Suntec City Mall were relatively stable at S$10.96psf (S$10.98psf in 2Q). The proportion of retail leases exp. in FY09 has been reduced to 180,500sf (17.3% of total) with the lease with Carrefour (exp in Dec) constituting the bulk.

Balance sheet remains healthy with gearing at 34.3%, and financing cost is relatively low at 2.88%. With the refinancing of the S$700m CMBS completed, the next major refinancing due is the S$400m club loan due in June 2011.

Maintain Buy with TP of S$1.26 pegged to parity to DDM. While 4Q09E DPU is expected to be weaker on higher financing cost upon the drawdown of the S$825m club loan & issue of the deferred units, we believe Suntec is on track to meet our 11cts (flat YoY) FY09E DPU forecast. The office sector deterioration has been well reflected in our view, with the stock trading at 0.6 P/B and yielding 9.3% for FY09E implying a wide 667bps spread over the 10-yr bond.

Rebound In Occupancy

Quick Comment – 9M09A Ahead of Our Expectations at the Net Income and Distributable Level, with Net Income and Distributable 81% and 82% of our full-year estimates even though Gross revenue and Net property income was in-line with expectations. Variance due to lower than expected finance charges and higher than expected revenue from ORQ. We maintain our Overweight rating and price target of S$1.30.

Operating Conditions Improving At The Margin. Occupancy for both office and retail portfolio appear to have troughed in 2Q09, with both rebounding to 99.1% and 96.4% respectively (Exhibit 6). We estimate that every 10% decline in occupancy results in 17% decline in Net property income, and a rebound in occupancy is comforting. As expected, retail and office rents continue to soften in 3Q09. However, the rate of decline has improved, with office rents -11% in 3Q09 compared to -17% in 2Q09 and retail rents at Suntec City Mall -0.2% in 3Q09 compared to -0.6% in 2Q09. We continue to expect a softening of office rents in the next 3 years given the large upcoming supply, but maintain our view that retail rents will trough in 2009. With retail contributing ~55% of Suntec’s NPI, Suntec should benefit from this rebound in retail rents.

Unchallenging Valuations: Suntec is trading at an average dividend yield of 6.16% (FY10e and FY11e), a 354bp spread over the current 10yr SGS yield of 2.62%. Furthermore, current implied capital values of S$1,937 for retail and S$958 for office (based on S$1.18/share) look undemanding given 3Q09 prime Grade A office capital value S$1,700 psf and our expectation of S$1,500 psf capital value as we believe capital values will hold up better than rents in this office downcycle. We maintain our view that investors should look past the potential capital raising overhang as (1) capital raising is not necessarily negative for stock price performance based on other S-Reits performance (2) based on our estimates, gearing in FY11 is still manageable at 39.7% and with debt pushed back to FY11, there are no near term refinancing risks.