Patience Is Bitter, But Its Fruit Is Sweet.

3Q13 DPU to fare better. The worst distribution drag by Suntec City Mall’s (SCM) ongoing renovation works is likely over in 1H13, when Phase 1 new tenants have yet to start paying rentals and Phase 2 old tenants are being vacated for the AEI. Nonetheless, we noted that many Phase 1 tenants (H&M, Uniqlo, Giant, Breadtalk Café , Hans etc.) have begun operations in Jun-Sep, but they are likely to be still on rentfree periods (1-2 mths). We thus foresee modest rental uplift last quarter and forecast 3Q13 DPU at 2.28 SG-cts (+1.5% QoQ; -2.8% YoY) and FY13 DPU at 9.23 SG-cts. (-2.7% YoY).

Look out for progress update on AEI. Pre-commitments for Phase 1 leases in 2Q13 hit 99.6% (96.7% in 1Q13), with average passing rent of SGD13.09 psf/mth. Suntec also reported that 70.1% of Phase 2 NLA in 2Q13 has been pre-committed (prev. qtr 53%). We think pre-commitments for Phase 2 should hit at least 85% in 3Q13. Looking at the intensity of the refurbishment works, overall AEI is making good progress and works should wrap up as scheduled by 4Q14.

Retail Sales holding up. The Singapore Retail Sales Index (excluding motor vehicles) went up 2.5% YoY in both Jun and July. The Food and Beverage Services Index was also up 4% and 2.1% YoY in Jun and Jul respectively. The largest dip in Jul came from recreational goods (-3% YoY) and telecommunications apparatus/computers (-7%). Fast food outlets also suffer a slight dent (-0.2% YoY). We expect retail sales to fare better in Aug-Sep period following the success of the F1 race, with a total of 262,527 visitors at the Marina Bay Street Circuit over the three-day sell-out race weekend (highest attendance since the inaugural 2008 race.) We also noted that turnover rents for Retail REITs constitute only about 2-10% of overall FY11-FY12 gross revenue, which should provide some reprieve in the event of a persistent sales slump, as retails rentals are typically contracted for three years.

DPU top-up possible. Suntec received cash proceeds of ~SGD147m from the sale of Chijmes in 1Q12. So far, it has topped-up SGD2.7m in 1Q13 and SGD7.8m in 2Q13. Looking at the conservative SGD10.5m payout this far, we do not rule out another top-up in 3Q13.

Reiterate BUY. Our investment thesis on Suntec remains in-tact. In this growth-limited environment, Suntec is one of the very few S-REITs that has a DPU CAGR growth of 4% from 2012-2015 (12.7% over three years), following the rental reversions from the major overhaul at Suntec City. Suntec is now trading at forward-yield spreads of 3.2% and P/B of 0.80x Maintain BUY with an unchanged TP of SGD1.90.

New city taking shape

• Further progress on refinancing
  
• Performance likely to improve
  
• Valuations remain compelling
  

Establishment of Euro MTN programme

Suntec REIT announced on 15 Aug that it has established a US$1.5b Euro Medium Term Note programme, with ANZ Bank, Citigroup Global Markets, DBS Bank and Standard Chartered Bank as arrangers and dealers for the exercise. This comes promptly after Suntec REIT has secured a S$500m five-year unsecured loan facility in Jul to refinance all its borrowings maturing in Oct 2013. We believe that Suntec REIT may possibly make use of the programme to issue longer-term unsecured notes to address (part of) its refinancing needs (S$773.5m club loan) due in 2014. This will be a positive development in our view, as Suntec REIT will not only be able to lock in part of its debts into fixed rates, enhance its debt maturity profile but also improve its unencumbered asset ratio. The programme has been assigned a “Baa2” rating by Moody’s Investors Service.

Worst may be over

Looking ahead, we remain positive on Suntec REIT’s performance. While its 2Q13 NPI and distributable income were down 38.5% and 18.7% YoY respectively due to the concurrent execution of Phases 1 and 2 of the remaking of Suntec City, we believe that the worst is likely over given that Phase 1 enhancement works were completed in Jun and the retail space there has since become operational. Committed occupancy for Phase 1 has improved to 99.6% from the precommitment of 96.7% achieved in 1Q, whereas passing rent of S$13.99 psf pm was also significantly higher than the rate of S$11.31 for the rest of Suntec City Mall and S$12.59 projected for the whole project. Together with the continued strength and active lease management at its office segment, we are hopeful that any volatility in Suntec REIT’s financial performance is likely to be cushioned as it commences its Phase 3 (last phase) next year.

Maintain BUY

At current price, Suntec REIT trades at one of the lowest P/B in the S-REITs sector at 0.73x, while offering a compelling FY14F yield of 6.9%. We are revising our fair value from S$1.85 to S$1.80 due to higher riskfree rate. However, as valuations remain attractive and outlook is positive, we maintain BUY on Suntec REIT.

A New Dawn

As previously indicated by its management, the pre-commitment rate for Suntec City Mall’s Phase 1 AEI reached 83% in 4Q12. We speculate that the rate is now over 90%, as Phase 1 of the AEI is near to completion and prepares to commence operations in about 1.5 months. On the back of a well-executed AEI, we have upgraded our rating on SUN to BUY, with a revised TP of SGD2.10.

Value enhancements through AEI at Suntec City. At its last results briefing, SUN’s management indicated that 83% and 37% of Suntec City’s Phase 1 and Phase 2 AEI space respectively have been pre-committed. With a forecasted average rental rate of SGD12.59 per sq ft per month (+25%) and a higher NPI of SGD7.8m per month (+33%) post-Phase 1 AEI, we expect SUN to benefit from this project when the majority of works are completed in 4Q13.

Bright prospects despite weak performances in 1Q13 and 2Q13. While we speculate Phase 1 pre-commitment rate to have exceeded 90%, we expect the earnings for SUN to be the weakest between 1Q13 and 2Q13, a period when the Phase 1 has not commenced operations while Phase 2 is closed in preparation for the upcoming AEI. However, as we approach the end of Phase 1 AEI, we expect SUN to re-rate as its outlook brightens on the back of a well executed AEI.

Trading at steeper discount than appeared. SUN, which is currently trading at 0.9x P/B is one of the few S-REITs that are still trading at a discount to book value. In addition, given that Suntec retail mall (which accounts for c.33% of the total portfolio value) is valued at c.SGD2,100-SGD2,200 per sq ft, we believe SUN is trading at a steeper discount than it appears on book; if the ‘true value’ of the mall is taken into consideration.

SUN trading at higher yield versus peers. Currently, SUN is trading at a dividend yield of 5.2% and 5.7% of FY13’s and FY14’s forecasted yields respectively. Concurrently, given a lower average dividend yield of 5.0% (4.8% if Keppel REIT is stripped out) among the Grade A office and retail REITs space, we believe SUN is due to re-rate once positive income starts flowing in when Phase 1 AEI is completed in about 1.5months. On this basis, we have upgraded our rating on SUN to a BUY with a TP of SGD2.10 on the back of a clearer outlook, positive rental reversion and high pre-commitment rates for the new space.

AEI growth priced in

• Results in line
  
• Focusing on delivering AEI, strong precommitment.
  
• Positives from AEI priced in, downgrade to HOLD at an unchanged TP of S$1.70
  

Suntec 4Q results are in line. NPI on a year-on-year and qo-q basis recorded a decline of 41.3% and 20.5%, respectively, which is in line with expectations. The was largely led by the lower contribution from Suntec Mall as the reit executed its AEI plans, as well as the income vacuum from the divestment of CHIMJES, which was partly mitigated by the strong office occupancy (99.7%) and positive rental reversions at Suntec offices (rents secured at $8.98 psf). Accounting for the higher contribution from MBFC phase 1, DPU came in at 2.326cts, representing a slight 6.2% drop. Full-year DPU of 9.49 cts is in line with our forecast. NAV rose by 5% to S$2.044 on the back of a revaluation gain of c.S$117m.

Executing Suntec retail AEI. Looking forward, AEI at its Suntec retail mall is likely to be its main focus on the back of a subdued acquisition outlook. Execution of Phase 1 AEI at Suntec City Mall is on track for completion in 1Q. Precommitments came in strong at 83% and 37% for Phase 1 and 2, respectively. While Phase 2 AEI spanning over 380,000 sf will commence by end-Feb, we expect the rental vacuum to be partly mitigated by (i) the incremental income from the completion of P1 AEI work; (ii) the additional 125,000 sf of space created at L1/2 of the conventional centre; (iii) positive rental reversions at Suntec offices.

Downgrade to HOLD on valuations. While we like the reit for its proactive leasing strategies, we believe the positives of the Suntec Mall AEI work have already been priced in. Given the lack of positive catalysts in the near term, we downgrade our rating for Suntec Reit to HOLD, but maintain the target price at S$1.70. Upside risks to our call will hinge on better-than-expected execution of its enhancement initiatives and the topping up of distribution from the sale proceeds of CHIJMES, which we have not yet factored in.

POSITIONING WELL FOR GROWTH

• 4Q12 DPU exceeded expectations
  
• Office segment stayed resilient
  
• Good progress on Suntec City AEI
  

4Q12 DPU above expectations

Suntec REIT posted an encouraging set of 4Q12 results last evening. Despite registering a 41.3% YoY decline in NPI to S$30.6m, DPU for the quarter came in at 2.326 S cents, down only 6.2%. This brings the FY12 to 9.49 S cents (-4.5%), ahead of our full year DPU forecast of 9.28 S cents (consensus: 9.4 S cents). Notably, no proceeds from the divestment of Chijmes were needed to achieve the quarterly performance, which in our view reflects the strong execution by management.

Office segment continues to perform

The drop in 4Q NPI was mainly attributable to the closure of Suntec Singapore in Oct 2012 and Suntec City Mall (Phase 1) in Jun for the asset enhancement works (AEI) and the sales of Chijmes. In particular, Suntec Singapore saw a loss of S$10.9m vs. S$5.8m in 4Q11. However, the office segment continued to perform, raking up 11.1% growth in revenue amid positive rental reversions and consistently high occupancy of 99.7% (99.9% in 3Q). This helped to cushion the softness at its retail segment, which experienced a 27.6% decline in revenue.

More details on Suntec City AEI

Suntec REIT also shed more light on the Suntec City AEI, saying that its Phase 1 AEI is on track for completion by 2Q13 and that its 83% of its NLA had been pre-committed (71.2% in 3Q). For the first time, management disclosed that the Phase 2 AEI will commence on Mar and that 37% pre-commitment had already been secured. Based on the timeline, we believe that 2Q may face the largest impact on its rental income, thereby prompting the REIT to utilise Chijmes sales proceeds to mitigate the fall in DPU. We now tweak our model assumptions to factor in the better-than-expected results and a possible S$10m distribution from the divestment proceeds in FY13. Our fair value in turn is raised from S$1.70 to S$1.94. Maintain BUY.