Results in line

Suntec’s results were in line with expectations, with the reit still enjoying organic growth from positive rental reversions. Although we expect the group to continue to benefit from positive average rental revenue growth, the pace is moderated by the softer economic environment. While Suntec’s mixed portfolio of office and retail space offers investors relatively more resilience, there is unlikely to be near term catalyst to drive share price. Maintain Hold with DCF-backed TP of $0.79.

Low base effect. Suntec reported Oct –Dec 08 distribution income of $44.2m (DPU: 2.86cts), +32% yoy on a 16% higher revenue of $63.5m, thanks to organic growth across its portfolio. Retail revenue accounted for 55% of topline and benefited from higher renewal and replacement rents. Office income continued to enjoy positive rental reversions with quarterly transacted rents at Suntec Office averaging $11.20psf. Occupancy dipped slightly to 98.2% due to frictional issues. The group had changed its FY end to Dec and FY08 revenue and distribution income of $294m and $201m are based on 15-mth performance. Portfolio was revalued down by 7% over Sep 07 l evels, lowering bk NAV to $2.01 and lifting gearing to 34.3%.

Uncertain macro outlook. Weaker economic outlook going forward is likely to dampen demand for office space and moderate retail sales. Our current projections are for office rnts to dip 35% over this cycle with vacancies rising to 15% correspondingly. The group has 28% of its office portfolio and 39% of its retail NLA due for renewal in 09. While the group should enjoy positive rental reversions, owing to a low base, possible vacancy risks exist as demand for office space contracts. While occupancy level of its retail space is full, retail rents are likely to remain stable. Negotiations for refinancing its $700m CMBS due Dec 09 are already underway.

Lack of near term drivers. Suntec is offering FY09 and FY10 DPU yield of 13.6-15% and 0.3x P/bk NAV, in line with other office and retail S-reits. While valuation is compelling, given the lack of near term drivers, we maintain our Hold call with a target price of $0.79.

Suntec Reit distribution income surges

Jump of 31.7% to $44.1m for the Oct-Dec period; DPU for quarter also up at 2.858 cents

SUNTEC Real Estate Investment Trust (Suntec Reit) has reported a distribution income of $44.1 million for the quarter ended Dec 31, 2008, a jump of 31.7 per cent.

The distribution per unit (DPU) for the quarter came to 2.858 cents, up 25.4 per cent year-on-year. This works out to an annualised DPU of 11.339 cents, representing a yield of 17.4 per cent based on Suntec Reit’s closing unit price of 65 cents on Jan 21.

Suntec Reit has changed its financial year-end from Sept 30 to Dec 31, and for the 15 months ended Dec 31, achieved a DPU of 13.303 cents.

For the October-December 2008 quarter, gross revenue rose 16.8 per cent to $63.5 million and net property income jumped 28.1 per cent to $47.9 million.

Regarding Suntec Reit’s dividend payout ratio, CEO of ARA Suntec, Yeo See Kiat, said: ‘We’re giving 100 per cent. We’ve been giving 100 per cent since day one.’ ARA Suntec is the manager of Suntec Reit.

When asked about the request by some Reits to the government for a reduction in the minimum payout ratio to Reit unit-holders to as low as 50 per cent and yet still enjoy tax concessions, Mr Yeo said temporarily lowering the cap would give Reits a bit of flexibility in these tough times. However, Suntec Reit is not considering such a temporary measure, Mr Yeo noted, adding that if Suntec Reit had wanted to, it could have lowered its payout ratio to the currently-permissible cap of 90 per cent.

When asked whether Suntec Reit intends to pass the Budget’s tax rebates to retailers seeking to benefit from the government measure, Mr Yeo said that he might be willing to talk to the retailers on an individual basis but Suntec Reit had to go through the Budget concessions in detail before it could give a clear answer.

Asked about refinancing, Mr Yeo said: ‘We have worked very hard to maintain our credit rating.’ Suntec Reit’s average all-in financing cost for the quarter was 3.26 per cent and its gearing stood at 34.3 per cent as at Dec 31, 2008.

‘Whilst our next major refinancing is only due in December 2009, we are currently working on the refinancing ahead of its maturity,’ Mr Yeo added.

Sector news positive for Suntec

Sector news a positive… The recent news of two successful S-REIT refinancings bodes well for Suntec REIT (Suntec). Office-focused CapitaCommercial Trust has secured a 3-year term loan facility to refinance some S$580m due in March ’09, while Cambridge Industrial Trust has refinanced S$390.1m of loans. Some S$3.4b of S-REIT debt is still due for refinancing in the next 9 months but the news is overall a positive signal – especially that of Cambridge, a smaller and non-sponsored S-REIT, which was perceived as relatively higher risk. Please see our sector report out today for more details.

Waiting for the same from Suntec. Suntec has about S$825m of debt, or about 40% of its total borrowings, up for refinancing in the next 12 months. This is a lengthy process – we understand Suntec began talking to lenders late last year – and both the S-REITs mentioned here only announced done deals about two months prior to debt expiry. However, the sooner Suntec can clear this overhang, which is weighing down valuations, the better. Its cost of debt is likely to increase from the last reported all-in cost of 3.2%. The REIT is currently leveraged at 0.32x debt-to-assets.

Income outlook still bleak. Recent news reports suggest office rents fell 15-20% in 4Q CY081 . Suntec REIT, which will likely release FY08 results next week, should also register a decline in achieved rentals, in our view. The REIT will see almost 70% of its office portfolio ex One Raffles Quay up for renewal in the next two years. We are projecting Suntec City office rental rates to tumble down to single digits this year. We also expect vacancy rates to be on the rise. We estimate the average passing rent at Suntec City Office is currently in the S$6.50 ballpark, comfortably below our fairly bleak reversionary rent expectations for the next two years. On the retail side, we have priced in a conservative 8-10% per annum decline in Suntec City Mall rentals over the next two years.

Maintaining BUY. Our RNAV estimate of S$1.05 prices in a 38% decline in asset values. Our fair value estimate for Suntec is S$0.90, at a 15% discount to our RNAV estimate. We expect (non-cash) revaluation losses going forward, which could potentially stress the REIT’s tolerance for gearing. We believe our valuation reflects the risk of an equity recapitalization (which is not necessary, but possible). Suntec has seen a 21.5% increase in share price since our last report. Maintain BUY.

Back to Basics

Higher yield required as less superior to CCT: We are maintaining our Equal-weight rating on Suntec REIT on a lower price target of S$0.68 (from S$0.91). In addition to reducing our rental assumptions for its assets, our new price target attempts to capture the risk of our bear case scenario panning out, as the macro environment continues to deteriorate, by assigning a 20% probability to our bear case. A base case DCF-driven NAV suggest a value of S$0.77 for Suntec, on a fully diluted basis. In our view, the risk-reward offered by CapitaCommercial Trust, our new sector top pick with 14.5%-13.6% DPU yield, is more attractive than Suntec’s 13.3%-13.5% yield. We prefer CCT’s higher-quality asset portfolio, leasing track record and balance sheet, backed by its strong parent, CapitaLand.

Too early to ascertain refinancing risk, as its S$700m debt refinancing is only due in December 2009. According to management, banks remain keen to work with Suntec on its refinancing but are reluctant to commit to funding rates ahead of time. On a positive note, our economics team is currently expecting SIBOR to be 0.6% by 2009 year-end and 2.1% by 2010 year-end. If rates remain below 1% in 2009, this would be positive for S-REITs as further increases in required spreads from the current 200-250bp would be cushioned by the lower SIBOR or swap rates. At a current leverage of 33%, Suntec has room to absorb a 200bp to 320bp cap rate expansion before it hits the 50% and 60% marks. This translates to a 35% to 46% devaluation in its asset portfolio respectively. We believe this buffer is sufficient for the next 12 months at least.

Sector dependent on macro recovery: The market is likely to remain skeptical on the viability of the S-REIT business model given its heavy reliance on credit and will be keeping a watch on the ability and cost of the S-REIT debt refinancing in 2009. For now, we believe S-REITs are likely to trade in line with the STI Index.

Looking oversold

Focus on rentals and capital values. Suntec REIT (Suntec) will see almost 70% of its office portfolio ex One Raffles Quay up for renewal in the next two years. We are projecting Suntec City office rentals will tumble down to single digit next year. We also expect vacancy rates to be on the rise. We estimate the average passing rent at Suntec City Office is currently in the S$6.50 ballpark, comfortably below our fairly bleak reversionary rent expectations for the next two years. On the retail side, we have priced in a conservative 8-10% per annum decline in Suntec City Mall rentals over the next two years. We also feel capital values are at risk, especially for the REIT’s office portfolio. Suntec’s properties were revalued on 30th September, yielding a marginal surplus. According to management, implied cap rates were up 25 basis points (bps) from last year – which still feels a little low to us.

Some refinancing risk. Suntec has about S$825m of debt, or about 40% of its total borrowings, up for refinancing in the next 12 months. Its cost of debt is likely to increase from the last reported all-in cost of 3.2%. The REIT is currently leveraged at 0.32x debt-to-assets. We expect (non-cash) revaluation losses going forwards, which could potentially stress the REIT’s tolerance for gearing. We believe our valuation reflects the risk of an equity recapitalization (which is not necessary, but possible).

Looking oversold. We still think Suntec’s assets are a good long-term bet, and will be net beneficiaries of the revitalization of the Marina area and the completion of the Circle line. We have only two concerns with the REIT: historians will likely label the One Raffles Quay buy in 2007 as overexuberant; and the deferred equity payment structure on the IPO assets creates unnecessary stress on DPU in what are looking to be testing times. Still, our primary focus is on valuations – which are looking oversold. Value hunters have an opportunity to pick up some really good assets on the cheap, in our view. Back of the envelope, the current share price seems to be implying a 48% decline in capital values. We think our concerns have been more than priced in at this point. Our RNAV estimate of S$1.05 prices in a 38% decline in asset values. Our fair value estimate for Suntec is 90 S cents, at a 15% discount to our RNAV estimate. Maintain BUY.