Lower dividends for lower gearing

SUN announced that it has placed out 218m new units at an issue price of S$1.605 per unit. According to its manager, the gross proceeds will be used to pay down debt. Although gearing will be lowered to 35%, DPU for FY14-15 is expected to drop correspondingly, by 6.8%. We maintain our Add rating with a lower DDM-based (discount rate: 8.0%) target price after incorporating the DPU dilution. Catalysts are still expected from strong earnings from the Phase 1 and 2 of the completed AEI at Suntec City and additional earnings from Leighton Tower in the more long term scenario.

What Happened

SUN just announced a placement of 218m new units (c.9.6% of its share base) at an issue price of S$1.605 apiece to a consortium of institutional and other investors. Gross proceeds will approximate S$350m with net proceeds of S$341.4m, after deducting underwriting, selling, management-fee and other expenses. The issue price represents a 5.3% discount to its last closing price. According to SUN’s manager, the gross proceeds (S$341.4m) will be used to repay debt.

What We Think

An estimated S$780m of SUN’s debt (c.24% of total debt) is due for refinancing this year. Using gross proceeds from this placement and from a recent issue of S$310m medium-term notes (at 3.35% due in 2020), it can repay more than 83% of its debt due in FY14. With the paydown, its FY14 leverage is expected to dip to 35% from its last reported 38% in 4Q13. Although we are mildly surprised by this placement, particularly since interest costs are still low (SUN’s all-in cost was estimated at 2.5% in 4Q13), we believe that the purpose of the placement is to diversify SUN’s sources of funding, while lowering its gearing, before any hike in interest rates. However, as a result of this placement, DPU could be diluted by 6.8% for FY14-15. Accordingly, we lower our DDM-based target price to S$1.83.

What You Should Do

Although we did not expect the placement, we maintain our Add rating, in view of SUN’s bright earnings prospects over the next few years, supported by completed AEI at Suntec City and additional income from Leighton Tower in 2016.

Cash call for strength and growth

• To raise S$341.4m in net proceeds
  
• Intention to repay existing debt
  
• Advanced distribution of ~2.096 S cents
  

Private placement of 218.1m new units

Suntec REIT announced yesterday that it will be issuing 218.1m new units at S$1.605 apiece following the close of the private placement to institutional and other investors. The issue price is nearer to the upper end of the range of S$1.575-S$1.615 proposed during the launch of placement, and represents a discount of 4.7% to the VWAP on 18 Mar (before placement announcement). ~S$341.4m in net proceeds will be raised, after deducting the expenses relating to the cash call, while the unit base is expected to increase by 9.6% with the issue of new units (expected on 27 Mar).

Strengthen balance sheet and position for growth

The move came as a surprise to us as Suntec REIT had explicitly expressed that it has sufficient resources to fund its growth plans just a quarter ago, and that it was trading at a 21% discount to book value. According to management, the current intention is to use the proceeds to repay its existing debt, which is likely to reduce its debt burden and aggregate leverage from 39.1% as at 31 Dec 2013 to 35.0%. However, given the change in stance, we believe that Suntec REIT may possibly be beefing up its financial strength for potential growth opportunities in the near term. In any case, we note that Suntec REIT will no longer have any refinancing needs until 2015 after the completion of the placement and refinancing of the loan due in Jun 2014, and that the weighted average debt duration will improve from 2.4 years to 3.6 years.

Maintain BUY with lower fair value of S$1.85

In connection with the placement, Suntec REIT also intends to make an advanced distribution of ~2.096 S cents/unit for the period from 1 Jan to 26 Mar 2014 (being the day prior to the issue of new units). With just five days to the quarter close, this seems to show that Suntec REIT’s performance is only moderately affected by the concurrent close of Phases 2 and 3 spaces of Suntec City in 1Q14. We lower our fair value slightly from

S$1.90 to S$1.85 after factoring the enlarged unit base and lower finance costs due to debt repayment. Maintain BUY on Suntec REIT as upside potential remains attractive.

SUNTEC REIT RAISING $341M TO REPAY DEBT

Suntec Reit is issuing 218.1 million new units at $1.605 apiece in a private placement. The move will increase the unit base by 9.7 per cent, and could dilute distributions per unit by 3.9‐8.4 per cent from FY14 to FY16.

Suntec Reit said the issue is likely to reduce its gearing from 38 percent to 33.8 per cent. Its aggregate leverage will also improve from 39.1 to 35 per cent. Noting that the issuance will improve capital structure and credit profile, it added that the fund‐raising exercise will “provide Suntec Reit with greater financial capacity and competitive advantage to capitalise on potential growth opportunities”.

The issue price per unit, a

En route to sustainable recovery

• Suntec City AEI a success
  
• Recent acquisition to boost earnings
  
• Potential risks addressed
  

Poised for multi-year growth

Suntec REIT has essentially locked in robust growth over the next few years with its strong asset management and execution. First started its Phase 1 rejuvenation works at Suntec City in Jun 2012, Suntec REIT has recently reopened Suntec Singapore and the retail space in 2Q13 with a strong committed occupancy of 99.6%. In addition, passing rent of S$13.09 for Phase 1 space was significantly above the rent of S$10.34 achieved at the rest of the mall, proving the success of the asset enhancement initiative (AEI). We understand that Phase 2 AEI is on track for completion in 4Q13, and that leasing interest has been equally optimistic (pre-commitment of 83.7% in 3Q13). While we may potentially see some weakness as Suntec REIT prepares for Phase 3 AEI in the immediate term, we believe it has laid the foundation for sustainable growth in the years ahead.

Overseas foray likely to be earnings accretive

In mid-Nov, Suntec REIT also made its first overseas investment with the acquisition of 177-199 Pacific Highway, a Grade A freehold office tower under development in Australia. We see several strong merits in the transaction. First, the deal is expected to be earnings-accretive, as Suntec REIT will receive coupon payments at a yield of 6.32% p.a. during the construction, and a NPI yield of 6.89% upon completion of the property. Second, the property is 100% pre-committed, and Suntec REIT will enjoy an annual rental escalation of c. 3.5% for its head lease and rental guarantee for four years for any vacant space upon completion. Thirdly, all-in borrowing cost (including interest rate hedge) is expected to be below 3%, hence giving Suntec REIT a positive yield spread.

Maintain BUY

While we have earlier voiced our concerns on Suntec REIT’s gearing and exposure to forex following the acquisition, management said that it will perform currency hedge on the property’s income stream, and that gearing is not expected to breach 40% even if expected revaluation gain on its existing portfolio does not materialize. In view of Suntec REIT’s growth potential and current compelling valuation, we maintain our BUY rating and S$1.90 fair value.

A display of growth potential

SUN ended FY13 on a high note, with 4Q13 revenue and net property income (NPI) posting a +30.2% yoy and +10.2% yoy jump, respectively. FY13 DPU was 3% above our forecast. The strong growth in earnings was mainly attributed to the opening of Phase 1 of Suntec City following the completion of AEI works. We maintain an Add rating with an unchanged DDM-based (discount rate: 8.0%) target price of S$1.96 on the back of further income

contribution from the near-to-completion Phase 2 of Suntec mall in 1Q14.

Strong quarter

Suntec REIT (SUN) posted a respectable 4Q13 revenue of S$71.6m (+30.2%) and NPI of S$49.8m (+62.9%). The strong growth was mainly attributed to the completed Phase 1 AEI at Suntec mall. Currently, these area boasts a high 99.6% committed occupancy, while the areas unaffected by the AEI reported an occupancy of 91.3%. Together with Park Mall, SUN’s retail malls have achieved a high occupancy of 97.3% while its office portfolio remained at 99.6%.

AEI to bring near-term growth

Phase 2 of the AEI has achieved an impressive pre-commitment of 97.0%, scheduled to be completed in 1Q14, SUN is expected to benefit from the additional income contribution in 3Q14 (assuming 2-3 months of a fitting out period). However, earnings in 1H14 are expected to remain weak as SUN begins Phase 3 of the AEI in early Feb, which is scheduled to be completed in 4Q14. During the results briefing, management indicated that the AEI continues to remain on track for a 10.1% ROI, securing an average rental rate of S$10.10–S$12.59 psf/mth (based on stabilised rent).

Well-poised for future growth

With 12.5% of office space up for renewal in FY14 and asking leases secured at S$8.65 psf/mth last quarter, we expect SUN to continue to achieve positive rental reversions in FY14 – particularly on the back of a recovering office market. In addition, the recent acquisition of Leighton Tower is expected to bring the next stage of growth for the REIT in FY16 when the construction is completed. On the basis of clear growth prospects, we maintain an Add rating with an unchanged target price of S$1.96.