Defensive focus

Steady 4Q, no surprises. Suntec REIT (Suntec) posted a 20.3% YoY and a 3.7% QoQ gain in 4Q gross revenue to S$61.4m. Results were as expected. The REIT will distribute 2.85 S cents per unit, up 2.2% QoQ1. Portfolio performance was largely stable with Suntec’s office and retail portfolios enjoying occupancy rates of 99.3% and 99.6% respectively. Leases at Suntec City office were secured at an average rent of S$12.57 psf per month in 4Q. Retail rentals edged up slightly QoQ. Suntec’s properties have been revalued, leading to a marginal revaluation surplus of S$11.9m for 4Q ex One Raffles Quay, which is classified separately. Implied cap rates (up around 25 basis points since last year according to management) still feel a little low to us. Due to the change in financial year end, Suntec will revalue its properties again in December.

Defensive focus. Suntec announced yesterday it acquired 12,023 square feet (sf) of strata space at Suntec City Office Towers for S$26.3m. The buy was funded with the proceeds from a Nov 2006 private placement earmarked for this purpose. Suntec has about S$40m in unused proceeds left. However, management guided it is taking a step back and has relaxed its ‘proactive’ acquisition strategy. Suntec also said that the major asset enhancement plans for Park Mall have been shelved for now.

Unknowns priced in. Suntec will see about S$825m of debt coming up for refinancing in the next 15 months (Exhibit 2). In our view, the cost of debt achieved (versus the current all-in cost of 3.19%) will be the key risk here. Our focus is primarily on the uncertainty from the rental and occupancy front. On the office side, about 30% of the tenant mix is from the financial services industry. Suntec sees 32.7% of its office portfolio up for renewal over the next 15 months. Industry data shows that office rentals have peaked, as we had expected, and we could see office rents back in single digits going forwards. Still, the average rent for expiring leases in 2009 is at a very low S$5.32 psf pm – which is a nice hedge even in the face of rental declines. We feel these risks have been more than factored in at current price levels. Our revised 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.

No surprises

Story: Suntec’s 20% yoy jump in topline to $61.4m was in line with street estimates, lifted by positive rental growth and contributions from ORQ. NPI grew by a stronger 25% thanks to a lower expense ratio of c26% during the quarter. As a result, distribution income surged to $43.9m (DPU: 2.85cts). The group revalued its properties up by 6.5%, translating to a book NAV of $2.26. Its 1/3 share in ORQ was also revised up to $2719psf.

Point: The group continued to enjoy positive rental reversions from its new and renewal office leases at Suntec and Park Mall as average passing rents are still significantly below current asking levels. Meanwhile, retail rents have also continued trending up on the back of AEIs and organic improvements. Going forward, the office leasing market has grown more challenging with moderating demand and slower economic growth. An estimated 30% and 24% of portfolio NLA is due to be renewed over FY09-10. While rents and occupancy are likely to come under pressure, the large gap between new and previous levels should partially offset the slack in income. With retail operations anticipated to be increasingly competitive and with c42% of retail leases up for renewal in FY09, we believe growth in retail revenue, which accounts for 57% of topline, is likely to decelerate. In tandem with the slower environment, plans to redevelop Park Mall are shelved in view of the dampened industry and credit environment, as is the move to acquire additional strata units at Suntec office. While gearing is not high at 32%, refinancing activities will be focused on with $825m of debt (44% of total) maturing next year, largely at Dec 2009.

Relevance: Suntec is offering FY09 and FY10 DPU yield of 14-16% and 0.3x P/bk NAV, in line with other office and retail S-reits. While valuations are compelling, given the lack of near term drivers, we maintain our Hold call with a target price of $0.88, based on a 20% discount to RNAV of $1.10.

Refinancing tops Suntec Reit agenda

Q4 distribution income surges 44.5% to $43.9m

WITH credit concerns looming over the market, refinancing is now top of the agenda for Suntec Real Estate Investment Trust (Reit).

‘While we have no major financing needs in the next 12 months, we are keenly aware of the current global financing crisis and liquidity crunch,’ said Yeo See Kiat, CEO of Suntec Reit manager ARA Trust Management (Suntec).

‘Refinancing of our $700 million CMBS loan due in December 2009 is one of our key priorities.’

For FY2009, Suntec Reit has debts of $40 million, $85 million and $700 million maturing in April, May and December respectively. Its gearing ratio at Sept 30 was 31.9 per cent.

But refinancing should not pose a major problem, Mr Yeo said. ‘We have got a good partner in Cheung Kong. The financial institutions know who we are.’

ARA Trust Management (Suntec) is linked to Cheung Kong Group, a major Hong Kong conglomerate.

Mr Yeo was addressing financing concerns at a briefing on Suntec Reit’s results for its fourth quarter ended Sept 30.

It reported a 44.5 per cent year-on-year surge in distribution income to $43.9 million. This drove a 34.6 per cent jump in distribution per unit (DPU) to 2.854 cents.

With an annualised DPU of 11.353 cents, Suntec Reit’s distribution yield was 17.6 per cent based on the closing unit price of 64.5 cents on Oct 29.

According to Suntec Reit, its office portfolio continued to enjoy positive rental reversion during the quarter. The committed occupancy rate at Sept 30 was 99.3 per cent.

Suntec Reit has acquired about 61,500 sq ft of Suntec City strata-titled office space, but is likely to put such growth on hold given today’s business climate, Mr Yeo said.

Also shelved is the redevelopment of Park Mall, he added.

The project could be postponed for one to two years and reviewed when conditions change.

Suntec Reit’s retail portfolio enjoyed an occupancy rate of 99.6 per cent at Sept 30.

Suntec City Mall, Park Mall and Chijmes all saw higher committed passing rents compared with a year earlier.

Investors pushed Suntec Reit’s unit price up 4.5 cents yesterday to close at 69 cents.

Lehman Issue a Non-Issue

Lehman occupies minimal amount of office space. In the wake of Lehman Brothers’ (Lehman) debacle and subsequent Chapter 11 bankruptcy filing, its Singapore operations has also ceased after SGX suspended it from taking new securities and derivatives positions. As such, it is inevitable that we examine the implications for its present office landlord – Suntec REIT (SRT). We note that Lehman presently takes up approximately 40,000 sf of office space in Suntec City Office Tower Five. This represents a mere 3.1% of SRT’s total Suntec City Offices portfolio of 1.29m sf, and an even smaller 1.4% of its entire portfolio of 2.90m sf. Although Lehman employees have not vacated and talks over any possible settlement have yet to commence, we predict a minimal 0.9% dip in FY09 DPU in the event of a termination by end-Sep 08 and a replacement tenant cannot be found within the next six months. As such, exposure to the Lehman collapse is not a major issue. In any case, Lehman is legally obligated to fulfil its remaining lease tenure (renewed early last year) if termination occurs.

Staying on course for positive rental reversions. As Lehman’s lease agreement was only renewed in early-07 at the prevailing market rents then, SRT does stand to benefit from positive rental reversions if a new tenant were to step in. Most importantly, the organic drivers underlying Suntec City Office Towers remain intact, with a considerable 42.7% of the leases due in FY09 still paying at significantly below market rents, coupled with high occupancy levels. Other banking & financial services tenants within SRT’s portfolio, such as Deutsche Bank and UBS (Suntec City Office Towers), as well as Deutsche Bank, Credit Suisse, UBS, ABN Amro and Barclays (One Raffles Quay) have either remained relatively unscathed or managed to remain solvent.

Medium-term office story still stands. The recent signing of new leases at Marina Bay Financial Centre Phase 1, as well as new leases and renewals at Capital Tower and One George Street, provide positive reminders of Singapore’s growing position as a regional financial hub. At a time when the global investment climate is severely weakened, this implies that demand for office space remains and that the medium-term office story is still thriving.

Maintain BUY at S$1.87. Of late, office landlords, particularly office REITs, have been absorbing a sizable amount of flak on the back of global macroeconomic uncertainty, as well as expected falls in occupancy levels, dips in capital values and rental rates. The creeping up of unemployment rate (from 4Q07’s 1.7% to 2Q08’s 2.3%) has not contributed positively. Given the historically low P/B levels of office REITs at 0.5x currently, share prices appear to have factored in these negativities. Although we are not expecting the weakened sentiments to cool off anytime soon, we continue to believe that SRT will be able to grow organically. On a YTD comparison, it has also outperformed the other office REITs. Since the Street first got wind of Lehman’s highly possible collapse, SRT has slipped 15.0%. We believe any remaining overhang should evaporate with SRT’s limited exposure to Lehman. At present levels, the stock is trading at a FY08-09 yield of 7.2 – 8.7%, implying a 430 – 580 bps premium over the 10-year SGS bond yield of 2.9%. Maintain BUY at S$1.87.