Starting to shine brightly

• Strong contribution from Phase 1 AEI
  
• Recent acquisition to boost earnings
  
• Expect continued improvement ahead
  

Significant recovery post Phase 1 AEI

Suntec REIT’s 4Q13 results exceeded both market and our expectations. NPI came in at S$49.8m, representing a 62.9% jump YoY, due to the opening of Phase 1 retail space of Suntec City Mall (SCM) and Suntec Singapore post AEI. Distributable income from operations also saw a 3.4% increase YoY to S$54.2m. Amid the recovery in performance, management utilized a smaller amount of S$4.0m from CHIJMES sale proceeds for capital distribution (3Q13: S$4.5m, FY13: S$19.0m). Nevertheless, this helped to boost the quarterly DPU up by 10.1% YoY to 2.562 S cents. As such, FY13 DPU amounted to 9.328 S cents, just a tad lower than FY12 DPU of 9.49 S cents but ahead of both ours and consensus forecast of 9.1 S cents.

Continued improvement in operational metrics

Contribution from the retail segment continued to climb, reaching 39% of gross revenue in 4Q13 versus 34% seen a quarter ago. However, the retail revenue was still 10.2% lower YoY due to the ongoing AEI of Phase 2 SCM. Suntec Singapore, we note, contributed S$18.2m from just S$0.5m in 4Q12. In addition, office segment registered a sustained growth of 3.8% YoY due to positive rental reversions, consistent with our positive view on the office market. Notably, rental rate for leases secured at Suntec City Office again improved QoQ at S$8.65 psf pm (3Q: S$8.55). Going forward, we understand that management will continue to focus on forward renewal of its office leases. With only 12.5% of its office leases due to expire in 2014, we thus believe the office segment will remain robust.

Maintain BUY

Suntec REIT also updated that Phase 2 AEI is

on track for completion in 1Q14, and that pre-commitment for the retail space has reached 97.0%, up from 83.7% in 3Q. While bottomline may experience a dip in 1Q as Phase 3 tenants vacate for the last phase of AEI, we continue to be overall positive on its longer-term potential, arising from 1) strong rental uplift at Suntec City, 2) earnings accretion from 177-199 Pacific Highway acquisition and 3) potential interest savings post refinancing of its S$773.5m club loan due in 2014. We maintain BUY with unchanged fair value of S$1.90 on Suntec REIT.

Suntec continues to deliver

• FY13 results in line with our and market expectations. Highest quarterly DPU since 4Q09.
  
• FY13 DPU of 9.328 SGD cts includes a 0.839 SGD cts top-up (total SGD19m) from the sales proceeds of CHIJMES for capital distribution.
  
• Pre-commitments for Phase 2 leases for Suntec City AEI hit 97% and opens in early 2Q14. Phase 3 works will start next month.
  

Results in line with expectations

Following the massive SGD410m AEI on Suntec City, Suntec’s FY13 revenue contracted by a modest 10.6% YoY to SGD234m, forming 96.5% of our and 98% of consensus estimates. Full-year DPU declined 1.7% YoY to 9.328 SGD cts, constituting 101% of our and 102.5% of consensus forecasts. The amount included a top-up of 0.839 SGD cts (total SGD19m) from the sales proceeds of CHIJMES for capital distribution. Stripping out the top-up, FY13 DPU would have been 8.489 SGD cts (-10.5% YoY). Aggregate leverage inched up to 39.1% from 38.6% last quarter following new borrowings. Net financing costs for FY13 averaged 2.5% with an average term of 2.44 years.

AEI making good progress

Committed occupancy for Phase 1 leases hit 99.6% with average passing rent of SGD13.09 psf per month. Suntec also said that 97% of Phase 2 NLA has been pre-committed (previous quarter: 83.7%). Among the brands that have signed up are Marche, McDonald’s, Andersen and Etude House. Phase 2 works will complete in April while Phase 3 AEI will commence next month. Our investment thesis on Suntec remains intact. In this growth-limited environment, Suntec is one of the very few S-REITs that has a DPU CAGR of 4.2% from 2013-2016 (13.3% over three years), following the rental reversions from the major overhaul at Suntec City. Maintain BUY with an unchanged DDM-derived TP of SGD1.75 (discount rate of 8%).

Post-results luncheon feedback

We recently hosted a post 3Q13 results investor luncheon for SUN. Key issues discussed were 1) progress of the Suntec City AEI , 2) the long-term competitiveness of the mall, 3) office outlook and 4) acquisitions. We came away with our positive view on the stock intact.

We maintain our Outperform rating with an unchanged target price of S$1.91. Targeted returns from the Suntec City AEI continues to show incremental progress and we expect successful execution to underpin a DPU CAGR of 6.5% in FY14-16. At a FY15 DPU yield of 6.3% and P/BV of 0.85x (widest discount among peers), we think the market has yet to fully appreciate this potential.

What Happened

We hosted a post-results investor luncheon with SUN. Several main issues discussed include: 1) Suntec City’s Phase 2 AEI and its progress; 2) its plans in the repositioning of the Suntec City Mall; 3) Suntec’s office occupancy and room for the possibility of further positive rental reversions and 4) its plans to conduct further acquisitions amid a compressed cap rate market.

What We Think

The discussion reaffirms our belief that although Phase 2 of the AEI is on track to be completed by 4Q13, Phase 2 areas could potentially command less than its guided S$12.59 psf/month as 40-45% of the total NLA in Phase 2 is taken up by anchor tenants. In Phase 1, the general trade occupancy currently varies between a healthy 16% and 18%. Although Suntec City is still largely a ‘weekday mall’ that is highly dependent on the office crowd, with the completion of Phase 2, anchor tenants such as Golden Village and Toys ‘r’ Us are expected to draw crowds from both the family and young adult segments which could potentially boost weekend traffic.

Suntec’s office is currently generating positive rental reversions with 3Q13 at S$8.55 psf/mth (+1.5% qoq). With FY14 expiring leases at below S$8.55 psf/mth, management indicated its confidence in recording a positive rental reversion. Given the challenging acquisition environment in Singapore, we expect SUN to consider seeking acquisitions overseas. Timely of this prospect is still unclear and is unlikely to drive SUN’s share price in the near-mid term, in our view.

What You Should Do

SUN remains our top pick within the SREIT space. Maintain Outperform.

One step back, two steps forward

Although earnings continued to be weak in 3Q13, we remain confident of the smooth execution of Phase 2 of the AEI which is slated for completion by 4Q13. A drop in earnings is expected to be mitigated by a full quarter’s contribution from Phase 1 in the near term.

3Q13 results were largely in line with our and consensus estimates. 3Q DPU accounted for 25% of our FY13 forecast while 9M13 DPU met 75% of our forecast. We roll forward our DDM-based target price (discount rate of 7.9%), raising it by 14%. We reiterate our Outperform rating in view of the stellar execution of the AEI at Suntec City as we anticipate respectable growth through it.

AEI continues to affect earnings

Suntec REIT’s 3Q13 DPU dropped by 2.6% yoy, mainly because of Phase 2 of the asset enhancement initiative (AEI) at Suntec City. This includes a DPU top-up of 0.199 S¢ (S$4.5m total) from the Chijmes proceeds. During 3Q, Suntec Singapore began contributing to earnings. The bulk of earnings from Phase 1 AEI is expected to come through only in 4Q13. However, by then, c.249,000 sq ft of retail space will be closed in preparation for Phase 3 of the AEI which is scheduled to start in 1Q14.

Phase 2 AEI on track

Phase 2 AEI remains on track for completion by 4Q13. Pre-commitment stands at an impressive 83.7% though achieved rents for this phase are expected to be a tad lower than in Phase 1 as a result of fewer fashion anchors. We continue to anticipate double-digit growth from Phase 2 as Suntec REIT targets to achieve 10.1% ROI, which translates into S$12.59 psf/mth.

Maintain Outperform

We continue to favour the REIT for its stable portfolio occupancy (99.8% for office, 98.3% for retail) and strong rental reversion post AEI. In addition, with leases secured during the quarter at S$8.55 psf vs. S$8.42 psf in 2Q13, we are confident that Suntec REIT will be able to achieve positive rental reversion when 17.6% of its office NLA comes up for renewal in FY14.

Poised for strong harvest

• 3Q13 DPU up 1.8% QoQ
  
• Assets high on demand
  
• ROI for Suntec City AEI on track
  

Firm recovery as expected

Suntec REIT posted an encouraging set of 3Q13 results last evening. As we have previously expected, NPI saw a strong recovery of 44.0% QoQ (+4.7% YoY) to S$40.3m following the opening of Phase 1 retail space and Suntec Singapore post enhancement works. Distributable income was also lifted up by 10.0% QoQ (-10.4% YoY) to S$47.3m. As a result, a smaller capital distribution of S$4.5m (S$7.8m in 2Q) from CHIJMES sales proceeds was needed to mitigate the dip in distribution payout. This led to a DPU of 2.289 S cents, up 1.8% QoQ (-2.6% YoY). Consequently, 9M13 DPU amounted to 6.766 S cents (-5.6%), meeting 73.4% of both consensus and our FY13F DPU.

Positive portfolio performance

The retail segment contributed ~34% of gross revenue, marking a rise from 2Q level of ~28%. However, on a YoY basis, retail revenue was still down 30.1% due to Phase 2 asset enhancement initiatives (AEI) at Suntec City Mall. Suntec Singapore was the top performer in 3Q, raking up 125.3% growth to S$16.5m. In addition, the office segment continued to perform, delivering a growth of 4.1% YoY on the back of positive rental reversions. We understand that ~160,000 sqft of leases was signed in 3Q, leaving only a balance of 1.7% of office NLA due for renewal in 2013. At Suntec City office, average signing rent also improved from S$8.42 psf pm to S$8.55. As at 30 Sep, both the office and retail portfolio occupancy rates were maintained at high levels of 99.8% and 98.3%, respectively. As such, its portfolio performance is expected to stay relatively steady, despite potential weakness in 4Q13/1Q14 as Suntec REIT prepares for Phase 3 AEI.

Maintain BUY

Management also updated that precommitment at Phase 2 retail space has improved from 70.1% in 2Q to 83.7%. While there are a few anchor tenants (which may command lower rents), Suntec REIT reiterated that ROI of 10.1% remains on track. In 4Q, we can reasonably expect revaluation gains of the portfolio assets, which may improve Suntec REIT’s gearing and P/B ratios (currently at 37.2% and 0.84x respectively). Maintain BUY with higher fair value of S$1.85 (S$1.80 previously) as we roll our valuation to FY14.