Equity Fund Raising Overhang Removed

MBFC Twr 3 acquisition. DBS announced on 10 Dec that it has entered into an agreement with Choicewide Group Limited, a JV of Cheung Kong (Holdings) Ltd and Hutchison Whampoa Limited, to purchase 30% equity stake (and its associated loan) in Marina Bay Financial Centre (MBFC) Twr 3 for an aggregate consideration of SGD1.035b (SGD2,555 psf). DBS is the anchor tenant at MBFC Twr 3, occupying over 600,000 sq ft or 18 floors. Both parties also entered into a conditional put option agreement for DBS to take up Choicewide’s remaining 3.33% equity stake and its associated loan for an estimated aggregate price of SGD115m. The remaining stake on MBFC Twr 3 (66.66%) is held by Hong Kong Land and Keppel Land.

A little bit of history. DBS sold its Shenton Way office buildings (Twrs 1 & 2, about 875k sq ft net lettable area at Shenton Way) to funds managed by Goldman Sachs fo SGD690m (SGD800 psf) end-2005, with a leaseback agreement for an initial period of 8 years. The logic back then was that the sale to enhance the efficiency of its balance sheet. Goldman Sachs later sold the buildings to Overseas Union Enterprise for

SGD871m (SGD970 psf) in 2010, whose upgrade plans prompted DBS’ shift to Marina Bay Financial Centre (MBFC). In Oct 2012, DBS moved into its new headquarters at MBFC Twr 3, occupying over 600,000 sq ft or 18 floors of the 46-storey building. Some of the support functions were relocated to Changi Business Park. Recall also that Suntec REIT purchased MBFC Phase 1 (33.33% stake) from the same vendor on 9 Dec 2010 for SGD1.495.8b, including rental support of SGD113.9m over a 60-month period. This works out to SGD2,568 psf with income support and SGD2400 psf excluding income support. The latest FY11 valuation for MBFC Twr 3 (as of 31 Dec 2011) was SGD1.523b (SGD2,615 psf).

Positive for Suntec. We view this acquisition positively for Suntec REIT as it removes the EFR overhang of MBFC Twr 3 being injected into the REIT. It can henceforth focus more on its organic AEI on Suntec City. In addition, Suntec REIT has, over the weekend, also appointed the CEO of APM Property Management Pte Ltd as its Deputy CEO with effect from 1 Jan 2013. We think this shows Suntec REIT’s commitment to making the

Suntec City revamp a success. We reiterate a BUY rating for Suntec REIT. Our TP of SGD1.70 is unchanged for now, but we believe there is upside potential after FY12 results as pre-commitments for phase 1 Suntec City Mall (complete by 2Q12) are likely to be secured above Suntec’s post-AEI target of SGD12.59 psf/mth.

Delivering consistently

• 9M DPU 5% higher than our FY12F
  
• Suntec’s retail mall’s AEI (Phase 1) is proceeding at full steam, pre-commitment levels healthy at 71%
  
• Maintain BUY at a higher S$1.70 TP
  

Highlights

Results slightly ahead of our forecast. 3Q12 gross revenue and NPI declined 8% y-o-y and 20% y-o-y respectively to S$62.6m and $38.4m. The drop was largely due to AEI works at Suntec’s retail mall, as well as the income vacuum from the divestment of CHIJMES, which was partly mitigated by higher contributions from ORQ and MBFC Phase 1. Consequently, distributable income came in at S$52.8m translating to a DPU of 2.35 Scts. 9M DPU came in 5% higher than our FY12F but is in line with street estimates.

Our View

Head start in FY13 renewals. Occupancy for its office portfolio held up at 99.9%. The group renewed about c.70,000 sf at a slightly higher monthly rent of S$8.96 psf pm vs S$8.71. For 4Q12, only 38,505 sf NLA (c.1.6% of total) will expire in 2012 with a chunkier 476,560 sf NLA (c.19.7% of total) in FY13. However, the group’s continuous pro-active efforts in forward renewing its leases should help mitigate leasing risk going forward

Suntec’s retail mall Phase 1 AEI going at full steam. As at end 3Q12, almost 50% of the F&B outlets at The Fountain, as well as the Food Republic at Suntec Convention Centre have vacated. Occupancy excluding the AEI works held at 98.6%; we estimate that on a see through basis, occupancy as at end of Sept was closer to c.80%.Meanwhile, the space vacated by Carrefour will be temporarily taken over by Giant from Nov 12 to Feb 13 before it relocates to B1. Pre-commitment of Phase 1 AEI space remained healthy moving up from 58% a quarter ago 71.2%. We estimate that occupancy is likely to trough in the 3Q13 but revenue for the mall should start to see sequential improvement upon the completion of Phase 1 AEI works in 2Q13.

Financial metrics remain healthy. All refinancing has been done for the year with gearing at 37.8%.

Recommendation

Maintain BUY. We continue to like the Suntec REIT for its pro-active leasing strategies and revenue for the mall should start to improve sequentially from 2Q13 onwards post the completion of Phase 1 AEI works. We have nudged up FY12/13F DPU by 4% each to account for better than expected rentals for its offices at Suntec City. We maintain our BUY call at a slightly higher DCF-backed TP of S$1.70.

The cloud is clearing

3Q12 results within expectations. Suntec (SUN) reported its 3Q12 results, posting gross revenue and distributable income of S$62.6m (-7.8% YoY) and S$52.8m (-6.3% YoY) respectively. DPU for the period came in at 2.35S¢; together with 1H12 DPU of 4.81S¢, total DPU delivered thus far accounted for 77.0% of our FY12 DPU forecast. During 3Q12, NPI dropped by 19.5% YoY bringing it to S$38.4m; this is mainly attributable to the loss in income from the divestment of CHIJMES and the commencement of the AEI work at Suntec City since June 2012. Going forward, given a clearer outlook on the effect of Suntec City’s AEI on the trust’s income coupled with a higher than expected pre-commitment rate of 71.2% of the upcoming space at Suntec City, we are positive on the future of SUN and upgraded our rating to BUY with a revised TP of S$1.80. SUN is currently trading at 4.8% spread to 10-year bond yield which is 246bps above its pre-crisis mean spread of 2.4%, our DDM based (COE: 8.0%; TGR: 1.0%) TP of S$1.80 translates to a spread of 4.2%.

Drop in NPI and DPU in 3Q12 due to loss in income and AEI. During 3Q12, both the DPU and NPI fall by 7.2% and 19.5% respectively, mainly attributed to the lost in income due to the divestment of CHIJMES and the commencement of the AEI at Suntec City since June. Going forward, management indicated the proceeds from the divestment of CHIJMES could be deployed to partially fund the AEI at Suntec Singapore and Suntec City Mall; though this is unlikely to happen in FY12.

Value enhancements at Suntec City’s AEI. To date, management indicated that 71.2% of Suntec City’s phase 1 AEI space has been pre-committed. With a forecasted average rental rate of S$12.59 psf/mth (+25%) and a higher NPI of S$7.8m/mth (+33%) post AEI, we expect SUN to benefit greatly from this project when it is completed in 2Q13.

Upgraded to BUY with higher TP of S$1.80. Although the earnings of SUN is likely to remain flattish in the coming two quarters, given a high portfolio occupancy rate (office -100%, retail – 98.2%), together with a clearer outlook of the trust and a strong commitment rate to the new space, we believe SUN will benefit greatly upon the completion of its AEI of Suntec City. With a forecasted FY12/FY13 dividend yield of 5.9% and 6.3% respectively, we are positive on SUN and has upgraded our rating to BUY with a revised TP of S$1.80.

The Sun shines brighter here

DPU top-up unlikely in 3Q12. As a result of Phase 1 AEI work, which started in Jun 2012, we expect revenue from Suntec Mall to slide from SGD103m in FY11 to SGD86m (16% decline) in FY12F. Occupancy rate is likely to fall to 75-78% by year-end (excluding the space vacated by Carrefour). Carrefour takes up some 137k sq ft of NLA and will likely depress occupancy rate to ~60% when its lease tenure expires 31 Dec 2012. Nonetheless, we are confident that Suntec REIT should be able to pay out DPU of at least 2.15 Singapore cents for 3Q12 and at least 9.0 Singapore cents for the full year. We also do not think that Suntec will use its Chijmes divestment proceeds to top up its 3Q12 DPU. It may want to keep this flexibility for 4Q12 when there is greater clarity on its full-year distributable income.

AEI making good progress. From our observation, refurbishment works have been progressing well, with Suntec Convention and the Galleria/Fountain Terrace zones proceeding full steam ahead. Food Republic has ceased operations and tenants at Fountain Food Terrace are expected to vacate by end Oct. We think pre-commitments for Phase 1 leases should hit at least 65% presently and Phase 2 AEI should commence on time by Apr-May 2013. We estimate that the largest dip in mall occupancy should occur in FY13F at ~59%, but this will improve in FY14F to ~70%.

Office portfolio in good shape. Against a background of office supply glut (Pipeline supply of 24% of available Downtown Core stock by 2012-2016) and high vacancy rates (Downtown Core vacancy at 13% in 2Q12), we are heartened that Suntec has secured 100% occupancy for Suntec Office, Park Mall Office, One Raffles Quay and 99.5% for MBFC1. With less than 22% of office leases NLA expiring per annum for the next three years, we remain positive that Suntec’s proactive leasing management will tread cautiously to optimise its office portfolio.

Upgrade to BUY on brighter prospects. There are only a handful of S-REITs that offer yields of more than 6% but are trading at discounts to book. Suntec is one of them, with a yield-spread of 463bps compared to the sector average of 436bps. With all its assets and income contribution from Singapore, we believe investors will continue to favour Suntec in the absence of forex risk (all SGD), highly-liquid S-REIT counters (ADTV >USD8m) and investable alternatives. In addition, in this inflationary and yield-chasing climate, yields for Suntec could be compressed further to 5.5% in our view. Upgrade to BUY with a higher target price of SGD1.66.

Execution is the key

• 2Q12 results sequentially lower but within expectations

• Leasing activities strong for Suntec Offices, precommitments for phase 1 of the new retail mall at 58%

• BUY, TP raised slightly to S$1.61

Highlights

Results in line. Suntec’s gross revenues and net revenue declined by 3-7% q-o-q as the AEI at Suntec retail mall commenced, as well as an income vacuum from the sale of CHIJMES. The loss of income from the expiry of One Raffles Quay’s (ORQ) income support was partly mitigated by the GST rebates and positive rental reversions. Distributable income was S$53m or 2.631cts DPU (-6.8 y-o-y, -3.7% q-o-q), bringing 1H DPU to 4.814 cents or 54% of FY12 forecast.

Our View

Leasing activities for Suntec offices still strong. Despite weaker market sentiment, office rents at Suntec City held steady at S$8.71/psf/mth vs S$8.79 a quarter ago supported by full occupancy. In total, the trust renewed an impressive 146,456 sf of office space in the quarter, leaving only 2.5% of space to be renewed in 2H12 and is now forward leasing FY13 space.

AEI at Suntec City mall has commenced. As expected, average monthly passing rent for the retail space at Suntec City dropped 8% q-o-q to S$9.35 psf. This was largely due to the closure of Galleria, given its more prime location and we expect further dips as the F&B restaurants and retail space around The Fountain close progressively in the 2H. In total, the affected c.193,000 sf of retail space will reopen in Apr-May 2013 and rents should moved up subsequently. As of 2Q12, c58% of the space has been pre-committed vs 45% a quarter ago and makeover for the whole mall is expected to be completed by 2014 vs the earlier guidance of 2015.

Sufficient funding for Phase 1 and 2. Gearing is at 37.5% and the group has sufficient cash resources from the sale of CHIJMES to fund the capex for the AEI in Phase 1 and 2. Meanwhile, refinancing for its S$200m loan due in Oct should be completed soon.

Recommendation

Maintain BUY. We have nudged up our FY12/13F DPU by c.3.0% and TP by 2.0% to S$1.61 as we lowered discount rate (risk free pegged to 1.8%) while also taking into account higher renewal assumptions for its offices at Suntec City. FY12/13F yields remain attractive at c.6.0%. Upside risks to earnings estimates hinge on the topping up of distributions from the sale proceeds of CHIJMES which we have not factored in at this moment.