FY09 refinancing clouds clear

DPU up 2% QoQ. Suntec REIT recorded a 2.3% QoQ and 16% YoY increase in 1Q09 revenue to S$64.9m. Unitholders get 2.918 S cents for the quarter (up 2% QoQ and 15.9% YoY). Results were better than expected, with Suntec’s gross revenue and distributable income outperforming our 1Q estimates by about 4-7%.

Rents down but still incremental. An overhang of supply and uncertainty of demand are key concerns for the office sector. 3.7% of Suntec City office lies vacant, up from 1.8% a quarter ago. We understand that a couple of tenants are only renewing part of previously occupied space. The manager said maintaining occupancy above the 90% level is a key priority. Some 527k sf of office leases are up for renewal in FY09, with an average rent of S$5.33 psf pm. The manager has already renewed more than half of these, at around S$9.96 psf pm on average. The remaining 237.6k sf of office space expiring this year is currently earning an average rent of S$6.64 psf pm – we note the margin of safety between achieved rents (down 11% QoQ) and average rents on expiring leases (up 25%) has narrowed quite dramatically – but is still adequate, in our opinion.

S$825m facility in place. Suntec has secured a S$825m term loan facility to refinance the S$125m in MTN and S$700 in CMBS loans maturing this year. The deal, a seven-bank club loan facility, is structured as a S$725m 3-year loan and a S$100m 7-year fixed rate loan. The manager said the facility costs a blended all-in interest margin of less than 375 bps over the base rate (versus an all-in financing cost of 3.02% in 1Q09). The cost of debt is significantly higher, but a fair reflection of the current lending environment, in our view. This announcement clears one “elephant in the room” but it does not change our view on Suntec’s potential need for an equity issue to address falling capital values.

We still see some value. Our SOTP value for Suntec is S$0.91, down 4% from S$0.95 due to minor adjustments. Our fair value estimate is unchanged at S$0.80, a 12% discount to our SOTP value. This incorporates our assumption of a S$500m equity issue at the S$0.60 level. Suntec is up 31% since our last report in March. We still see some room on the upside, with current price levels 21% below our fair value, along with a 14% FY09F yield (35% total return). Maintain BUY.

Laying refinancing concerns to rest

At a Glance
• Refinances entire $825m debt, no more debt due till 2011
• Results in line with projections
• Outlook dampened by weak office outlook, but likely factored into share price
• Upgrade to Buy with TP of $0.82

Successfully refinances $825m loan. Suntec announced it has secured a club loan with 7 banks to refinance the entire $825m maturing this year, underlining the strength of its portfolio and credit standing. The deal comprise of $725m 3- year loan and $100m 7-yr fixed rate loan at a blended all-in interest spread of less than 375bps. With this, the group has no further existing debt due till 2011.

1Q09 results largely in line. Results came in largely in line with expectations as the group renewed 0.3msf of office space and 71000sf of retail space, representing 13% of its portfolio NLA. This was partially offset by lower office occupancy of 97.4%. Office rents achieved average $9.98psf, 11% lower qoq while retail rents remained largely stable. Looking forward, we expect office rents to remain weak owing to slowing demand. The group has a remaining 13% of office and 32% of retail NLA to be renewed in 2009. The office leases are likely to enjoy positive rental reversion, although much smaller than before, as the average level of the expiring contracts are at a low $6.64psf/mth.

Upgrade to Buy. Share price is likely to react positively to the removal of the refinancing overhang. The stock is currently trading at 0.34xP/bk NAV and gearing of 34%. Our 2009/10 DPU projections of 10.7cts and 9.3cts have assumed a 50% drop in peak/trough office rents and a vacancy level of up to 15%. Yield is at an attractive 16.2% and 14%. Upgrade to Buy with TP of $0.82.

Suntec REIT reported gross revenue for 1QFY09 of $64.9 million (+16.0% y-o-y), net property income was $49.2 million(+15.4% y-o-y). Distributable income was $46.4 million(+18.2% y-o-y). DPU for the quarter was 2.918 cents (+15.9% y-o-y).

Strains of recession showing. Occupancy came off slightly in 1QFY09 with office occupancy of 97.4%(-2.5% y-o-y) and retail occupancy of 98.8(-0.01% y-o-y)%. Average rent for leases secured in the quarter was also lower at $9.96 vs 4QFY08 average rent of $11.20. Meanwhile, average rent for expiring leases is $6.64 vs 4QFY08 average rent of $5.42. These indicate that while passing rents are playing catch-up to the spot rates, the gap between passing rent and spot rent is also converging much earlier due to falling spot rates. Retail portfolio average rent registered slight increase from $11.02 in 4QFY08 to $11.05 in 1QFY09.

Highlight of the day. Suntec REIT announced refinancing details of its $825 million debt that is maturing this year. $700 million would be refinanced with a 3-year term loan and the other $100 million with a 7-year term loan. All-in interest cost including upfront fees is at a margin of 3.75% on a floating basis. With the refinancing plan in place, the next loan maturity is in 2011 with loan amount of $532.5 million.

The announcement of the refinancing is definitely positive news for Suntec REIT. The ability to secure funding of $825 million at comparatively low interest margin demonstrates the lenders’ confidence in the REIT. Our next concern is the impact of the economy on Suntec REIT. As mentioned earlier, average rents for new leases fell 11% in 1QFY09 from 4QFY08. Approximately 46% of office leases are expiring in 2009 and 2010, which we feel could be subjected to greater rent pressure. We maintain our Hold recommendation with a fair value of $0.69.

Focus on cash calls and cash flows

New office asset value reality is already priced in. The Business Times reported on Friday that the entire 32nd floor of Suntec City Tower 1 has been sold for about S$1300 per square foot of strata area. This is about 40% lower than previous strata floor transactions completed about seven months ago (above the S$2000 psf level). We believe this new deal is important as it gives an indication of the current market value for office space. However, Suntec REIT’s current market value already reflects an implied asset value of S$885 psf for Suntec City Office (our estimate) – or a 32% discount to this latest transaction. Our valuation prices Suntec City Office at about S$1106 psf.

Potential risk of cash call. In our opinion, the refinancing of the S$825m in debt due this year is less of a problem than the potential need for an equity issue. In 4Q CY08, Suntec REIT saw property values fall 7% against its 3Q CY08 revaluation. We believe cap rates used by independent valuers still do not fully reflect downward trends in S-REIT capital values. For example, we understand that Suntec City Office was valued at S$1900 psf, or 46% higher than this latest transaction. This scepticism towards the accuracy of these valuations is creating downward pressure on share prices – Suntec’s current share price of S$0.505 is at a 75% discount to reported NAV. As capital values fall, we estimate that Suntec could eventually need up to S$480m in fresh equity to maintain gearing at 40% levels. In the current environment, rights issues may need to be underwritten in order to succeed. As a non-sponsored REIT, any rights issue by Suntec could require the backing of investment banks or sub-underwriting arrangements with substantial shareholders.

Focus on cash flows. There are inherent strengths in Suntec’s portfolio and we continue to believe in the merit of our BUY call on Suntec. The biggest concern today is how deeply earnings – and consequently distributions – will be affected by deteriorating economic conditions. We have adjusted our earnings and valuation assumptions, with a fairly conservative assessment of rents and occupancy levels. Our new DPU estimates for FY09-10 are 6-10% below consensus. This still translates to reasonable distribution yields of 18.6% and 16.1% in FY09F and FY10F respectively. Our SOTP value for Suntec falls 10% to S$0.95. Maintaining the 15% discount to SOTP, our fair value estimate falls from S$0.90 to S$0.80.

Results flat on QoQ basis

Results flat QoQ. Suntec REIT (Suntec) posted a 16.8% YoY and 3.3% QoQ gain in gross revenue to S$63.5m for the quarter ended 31 December. Suntec will pay out 2.858 S cents per unit for the quarter, up 25.4% YoY but flat QoQ, translating to an annualized yield of roughly 17%. We note that Suntec had enjoyed a marginal uptick during the property revaluation completed in the previous quarter. Just three months later, Suntec booked a revaluation deficit of S$328.7m driven by the valuers’ more conservative projection of rental rates.

Achieved office rentals slip, as expected. Office revenue contributed 45% to total gross revenue (ex One Raffles Quay revenue). For the quarter, Suntec City office replacement and renewal leases were secured at an average of S$11.20 psf per month – 11% lower compared to the S$12.57 psf pm achieved in the previous quarter but higher than preceding rents. The REIT will see about 65% of its office portfolio ex ORQ up for renewal in the next two years. We expect achieved rentals to continue softening down to high single digits this year. But the average passing rent at Suntec City Office of around S$6.50 psf pm (our estimate) gives an adequate margin of safety.

Uncertain retail landscape. Retail revenue contributed 55% to total gross revenue (ex ORQ). We expect that like its peers, Suntec will pass on the bulk of the savings from the recently announced property tax rebate to its tenants. Suntec’s manager said the “real test” for retailers will be the post- Christmas and Chinese New Year shopping landscape. The manager said that there isn’t a long queue, so far, looking for renegotiations but it was willing to work out something mutually satisfactory with its tenants. It said the main priority was to maintain occupancy levels. We understand that a typical response would be to restructure the lease (a lower rental today but a longer lease term, etc). We have priced in a 8-10% per annum decline in Suntec City Mall rentals over the next two years.

Refinancing key overhang. Suntec has about S$825m of debt, or about 44% of its total borrowings, up for refinancing in the next 12 months. The manager said Suntec is in the midst of engaging with several financial institutions. This is a lengthy process but the sooner Suntec can clear this overhang, which is weighing down valuations, the better. The REIT is currently leveraged at 0.34x debt-to-assets. Maintain BUY with S$0.90 fair value on valuation grounds.