Retail kicker in 2010

• Above expectations. 2Q09 results exceeded both the Street and our expectations on a stronger topline, better net property income margins, and lower interest expense. Distributable income of S$47.7m (+14% yoy) and DPU of 2.98cts (+7% yoy) form 32% of our full-year forecasts. 1H09 DPU of 5.9cts also exceeded expectations at 64% of our FY09 forecast. Net property income of S$48.8m (+6% yoy) was boosted by positive reversions for Suntec City and Park Mall properties.

• Office occupancy down 2.6% pts qoq. Committed occupancy for the office portfolio was 94.8%, down from 97.4% as at Mar 09. This was mainly due to lower occupancy at Suntec Offices of 92.5% (from 96.3% in Mar 09) when major tenants IDA and UBS returned a total of 60,000sf of space during the quarter. Negotiations for part of the space with prospective tenants are ongoing. Leases secured for the quarter averaged S$8.24psf (-17% qoq).

• Retail occupancy stable. Committed occupancy for the retail component averaged 98.4%, down marginally from 98.8% in the last quarter. Leases secured for the quarter averaged S$10.98psf (-1%).

• Asset enhancement work for Suntec City. The manager has commenced asset enhancement work in Suntec City, including: 1) an upgrading of office lobbies for all five office towers; and 2) the construction of a glass external façade, a covered walkway linking the entrance of the Promenade MRT station to Suntec City Mall, and new retail units along the promenade. The work is expected to be completed by mid-2010, in conjunction with the opening of the Promenade station. The bulk of capital expenditure would be borne by the MCST of Suntec City.

• Maintain Outperform; target price raised to S$1.28 (from S$1.07). In view of the strong 1H, we have moderated our rental decline assumptions by 5-10%; assumed higher net property income margins of 75.5% (from 74.3%); and factored in higher amortisation costs for adding back to distributable income. Our DPU forecasts for FY09-11 rise by 8-20%. Our target price rises accordingly to S$1.28 (discount rate 9.4%), still based on DDM valuation.

Suntec REIT reported gross revenue for 2QFY09 of $64.5 million (+8.9% y-o-y, flat q-o-q)), net property income was $48.7 million(+6.2% y-o-y, flat q-o-q). Distributable income was $47.7 million(+13.5% y-o-y, +2.9% q-o-q). DPU for the quarter was 2.977 cents (+6.3% y-o-y, +2.0% q-o-q).

Office portfolio reversionary rent continues to show a downward trend. It has fallen 38.9% from a year ago at $13.50 to 8.24. Occupancy of the office portfolio has also been sliding down from 1Q08 at 99.8% to 94.8% in 2Q09. These reflect the office sector is still reeling from the effects of recession. The retail portfolio is more resilient with occupancy maintaining above 98%. The office portfolio accounts for 47% of total revenue while the retail portfolio contributes 53%.

As previously announced, Suntec has no near term refinancing concern. It has successfully secure $825 million of term loan in April 2009. The next loan maturity is in 2011 with loan amount of $532.5 million. The current gearing is 34%.

Valuation & recommendation. We believe that demand for office space will take time to pick up following the nation’s exit from recession in the last quarter. We make no changes to our assumptions and have a FY09F DPU forecast of 10.05 cents which translates to a dividend yield of 9.5%. Fair value remains unchanged at $0.94 and retain our Hold recommendation

Year of Stability

Retail catalysts

• Maintain Outperform. We believe there is room for upside surprises from SUN’s retail segment, from a higher catchment population after the opening of two new MRT stations at Suntec City, and direct linkage to the Marina Bay integrated resort. Additionally, Chinese and Indian tour agencies are starting to market Singapore as a single tour destination over their traditional marketing of Singapore as a stop-over destination. This change should have a significant impact on the length of visitors’ stay in Singapore, and hence retail spending.

• Supply overhang in office; but cost-competitiveness also increases. New office supply of 9.8m over the next five years as well as 400,000-600,000 sf of potential shadow space from 2010 is likely to depress a rental recovery. On the other hand, this development should also improve Singapore’s cost-competitiveness vs. its regional competitors, Hong Kong and Tokyo. We expect continued low rents to support occupancy. A pick-up in leasing volumes in recent months is a sign that occupancy could turn out less depressed than expected.

• DDM-derived target price of S$1.07 (discount 9.4%). We like Suntec REIT for its: 1) quality office and retail portfolio; 2) low leverage of 34.4%; 3) absence of refinancing concerns until 2011; and 4) severely discounted price for a possible fall in asset values. We believe that downside risks for the office sector have been factored into its share price while upside surprises from its retail segment have largely been neglected.

Retail catalysts

• First mixed commercial REIT in Singapore. Listed on the Singapore Exchange on 9 Dec 04, Suntec REIT owns almost 3m sf of prime commercial space in Singapore, consisting of retail and office properties in Suntec City, Park Mall, Chijmes and a one-third interest in One Raffle Quay.

• Weak office outlook, but retail has growth potential. Weighed down by large upcoming supply and increasing shadow space, the outlook for the office sector remains weak. In our view, there is more room for upside surprises from the retail segment, catalysed by an increased catchment population from two new MRT stations at Suntec City, and direct linkage to the Marina Bay integrated resort.

• Positives from ample liquidity and low interest rates. Our economists expect high liquidity and low interest rates to persist in a climate of weak global growth. This would be highly positive for REITs which should benefit from relatively easier and cheaper financing, as well as attractive spreads to government bond yields.

• Initiate coverage with Outperform and DDM-derived target price of S$1.07 (discount 9.4%). We like Suntec REIT for its: 1) quality office and retail portfolio; 2) low leverage of 34.4%; 3) absence of refinancing concerns until 2011; and 4) severely discounted price for a possible fall in asset values. We believe that downside risks for the office sector have been factored into its price while upside surprises from its retail segment have largely been neglected.