Making hay while the sun shines

Story: We believe Suntec’s depressed share price performance in recent months could be due to concerns about the refinancing of its bridging loan that is due Oct 2008 and is already priced in. Its current yields of 6.2- 6.7% are already higher than industry peers’ 5.3-5.8%. To put things into perspective, funding is unlikely to be a problem given its “Baa1” rating and low gearing, the
S$421m to be refinanced represents only 23% of total debt, and any incremental funding costs would have a marginal impact on total average interest cost and earnings.

Point: More importantly, investors should focus on the strong recurrent income stream from the group’s properties. Positive office rental reversions thanks to the sharp surge in rentals in the past 12 months should underpin earnings growth. There is further room for upward earnings revision when the group rejuvenates Park Mall, including developing two adjoining land parcels it bought recently. With gearing at 31%, funding these activities should not stretch its balance sheet significantly.

Relevance: The investment case for Suntec is its strong organic growth amid a positive office rental reversion cycle as well as attractive FY08F and FY09F yields of 6.2-6.7%. There is also room for earnings expansion as Park Mall has not been factored into our estimates. At the current price, valuations are undemanding vis-à-vis its sector peers. Our price target of S$1.98 is adjusted to reflect higher funding cost for the bridging loan, higher terminal cap rate of
4.5% (vs 4% previously), and dilution from CB conversion. Maintain Buy.

Solid defensive play

From here to uncertainty. The “REIT as growth” story was birthed by benevolent circumstances. Markets were strong, credit was easy, and the Singapore economy was flying. The property market was booming and the REITs became a surrogate for riding the wave. Suntec REIT (Suntec) itself saw a whopping cumulative S$2.1b in fair value gains on its property assets since its inception. Its share price hit S$2.13 last summer, a 213% gain over its 2004 IPO price. Circumstances are no longer so accommodating. Share prices of retail/office S-REITs have fallen more than 20% since July, reflecting the breakdown in the credit markets and uncertainty about future growth prospects.

Revising our expectations. We are factoring in this uncertainty into our expectations for Suntec. The deteriorating US economy will likely cause Singapore GDP growth to ease. We expect expansion in the financial sector, a key driver for office rentals, to also ease. The property market seems to have already hit a plateau. Our forecasts assume office rentals will peak by 2009. However, the downward correction should be marginal as the rally has been prematurely arrested.

Strongly positioned for DPU growth. What sets Suntec apart is that over 60% of its Park Mall and Suntec office assets are up for renewal in FY08-09. Currently rented at around S$5 psf per month, these assets offer a huge potential for rental upside. Suntec also has other avenues for improving yield via floor space additions to Park Mall and asset enhancements at its retail locations. Suntec City itself is finally set to realize its true potential as the Marina area blossoms with the completion of the Circle Line and the Integrated Resorts in 2010.

Solid defensive play. The de-rating of S-REITs has given investors another opportunity to take a fresh look at Suntec as a defensive vehicle offering stable cash flows and high yields. It is trading at a 34% discount to its 1Q NAV of S$2.2. There is some concern over the expiry of the two bridge loans in 2009 relating to its One Raffles Quay acquisition, which we think is overdone. We estimate Suntec’s DPU at about 9 S cents in FY08, yielding more than 6% or 400bps over 2-yr Singapore government bond. Maintain BUY at fair value S$1.71.