Suntec REIT

Embarking on the enhancement journey

1H12 results inline but higher expenses from Suntec Singapore. 1H12 revenue at SGD144m, up 18% YoY, was 57% of our FY12 forecast and 55% of consensus estimate. 1H12 DPU at 4.184 SG-cts, down 2% YoY, was 52% of ours and consensus estimate.

High expenditure from Suntec Singapore. Operating expenses (consolidated basis) for Suntec Singapore escalated 12% QoQ to SGD12.6m from SGD11.3m last quarter. 1H12 expenses was SGD23.9m, vis-à-vis 1H12 revenue of SGD27.8m (representing a low NPI margin of 14% from previous 28%-29%). This resulted partly in Suntec’s overall 1H12 operating expenses escalating 74% YoY despite 1H12 revenue inching up only 18% YoY. We reckon that this may due to preparation costs incurred for getting the convention area ready for phase 1 refurbishment.

Portfolio review – Suntec City Office achieve 100% occupancy. Suntec City office occupancy improved from 99.5% last quarter to full occupancy at an average rent of SGD8.71 psf/mth. The last time the office area was fully leased out was in Mar 2008. Due to phase 1 AEI works, Suntec City Mall occupancy was dragged down to 75%-78%, according to our estimate. This caused average passing rent to inch down 8.5% QoQ to SGD9.35. One Raffles Quay achieved full occupancy, whilst occupancy for the MBFC1 stood at 99.5%.

Suntec City AEI expedited. Completion in end 2014. Phase 1 AEI (~193k sqft), which encompasses Suntec Singapore and the Galleria section commenced on 1 Jun 2012 and will complete by ~Apr 2013. 58.5% of Phase 1 leases has been precommited so far. We understand that Carrefour will be shifting down to the basement and the existing food court will close in Dec 2012; a new food court will open in 1Q13. The refurbishment schedule has also been brought forward, with Phase 2 (~383k sqft) completing in 4Q13 and Phase 3 & 4 (249k sqft) to be done by end 2014.

Adjustments to our estimates. We lower our FY12-14F DPU by 0.8%-1.8% due to (1) higher-than-expected occupancy drops for Suntec City Mall (2) catering rent-free periods (1-2 mths) for existing tenants that are relocating in the interim and (3) higher financing costs. However, FY15 DPU is boosted up 2% due to the earlier completion of the asset enhancement works. Reiterate HOLD with TP of SGD1.42.

Fillip from LLP conversion

Tax transparency. Suntec REIT recently announced that it has successfully converted the vehicle which holds Marina Bay Financial Centre Phase 1 (MBFC1) from a private limited to a LLP (limited liability partnership) structure, which grants it tax transparent status. Previously, Suntec had to pay 17% corporate tax rate on rental income generated by MBFC1. The new tax structure took effect from 16 Jun 2012.

FY12-15F DPU up by 0.8-1.5%. Based on our estimates, Suntec will enjoy tax savings of SGD2.8-5.2m for FY12-15F, adding 0.8-1.5% to our forecasted DPU. We understand that the restructuring of One Raffles Quay (ORQ) into a similar tax-efficient LLP structure may not happen in the near term and has not factored this into our estimates (estimate boost of another SGD1.7-3.3m if allowed).

Remaking of SSICEC. Suntec will be closing the Suntec Singapore International Convention and Exhibition Centre (SSICEC) for a major overhaul in October this year. The six-month closure, the first major renovation since 1997, aims to bring the 17-year-old venue up to date and will cost SGD180m. All seven floors will be spruced up, with a grand entrance added on Level Three, and restaurants and shops on Levels One and Two. The number of meeting rooms will increase from 31 to 46, and all will be fitted with Wi-Fi connection.

Remaking of SCM. Suntec will spend another SGD230m to remake Suntec City Mall (SCM). Work is scheduled to start in mid-2012 and will wrap up by mid-2015. It will increase SCM’s NLA to 980,000 sq ft from the current 855,000 sq ft. Tenant mix will also be revitalised with more higher-yield mini-anchor stores and F&B outlets. Upon completion, we expect the annual rental income of SCM to be uplifed by SGD32m, boosting from FY11’s SGD103m to SGD135m.

TP increased by ~6% to SGD1.37, maintain HOLD. After factoring in the tax savings, our target price for Suntec goes up by ~6% to SGD1.37. The stock currently trades at 0.7x FY12F book and 7% FY12F yield. Downside risks include worse-than-expected average rentals for SCM and concentration risk on Suntec City. Reiterate HOLD.

Saving on taxes

Suntec REIT (SUN) recently announced the successful conversion of BFC Development Pte. Ltd. (BFCD) – a company which holds Marina Bay Financial Centre Towers 1 & 2 and the Marina Bay Link Mall, from a private limited company to a limited liability partnership with the name “BFC Development LLP”. SUN currently holds one-third interest in the MBFC properties through its interest in one-third of the issued share capital of BFCD. Following the conversion, although SUN’s interest will remain unchanged, going forward we expect the trust to save an estimated annualized tax of S$3.2-3.7m, as BFCD will no longer be subjected to corporate income tax. We expect this savings in taxes to contribute an additional 0.14S¢ and 0.18S¢ to FY12 and FY13 DPU respectively. Based on our DDM valuation (COE: 9.5%; TGR:1.5%) we maintain BUY on this counter with a revised TP of S$1.52. SUN is currently trading at 6.0% spread to 10-year bond yield which is 108bps and 366bps above its long term (5.0%) and pre-crisis mean spread (2.4%) respectively, our TP of S$1.52 translates to a spread of 5.1% and a potential upside of 13.8%.

Enjoy tax savings by converting to limited liability partnership. By converting to a limited liability partnership (LLP), unitholders of SUN will be able to enjoy tax transparency on the income it receives from the MBFC properties. This is consistent with the tax-free income from other properties held directly by most REITs in Singapore.

Possible conversion of ORQ into LLP in the future. Given the success of converting BFCD into a LLP, we believe SUN and its partners in One Raffles Quay (ORQ) will move forward to convert their holding company into another LLP. However, as the conversions of private limited companies into LLPs are subjected to the approval of IRAS on a case by case basis, we currently do not forecast this factor into our model. Additionally, even if the conversion is successful, we expect to see minimal impact on the earnings of FY12.

HIGHER DPU FROM TAX TRANSPARENCY STATUS

•Conversion of BFC Development Pte Ltd

•Income from LLP tax transparent

•Unitholders to enjoy higher DPU

MBFC properties holding company obtains LLP status

Suntec REIT announced last Friday that BFC Development Pte Ltd (BFCD PL), which owns MBFC Properties, had been successfully converted from a private limited company to a limited liability partnership with the name BFC Development LLP (BFCD LLP). Suntec REIT had held one-third interest in BFCD PL. Following the conversion, the REIT now holds one-third interest in BFCD LLP as a partner.

Positive impact from the conversion

As a limited liability partnership is tax transparent for Singapore tax purposes, this means that Suntec REIT will enjoy tax transparency on its share of income from MBFC Properties going forward (adjustments are not retrospective). This is positive for unitholders as the distributable income is likely to be higher now that the income generated will no longer be subject to corporate tax. We understand that dividend income (cash flow) and share of profits will benefit from the conversion, whereas income tax for income support will still be ongoing. Based on our estimates, FY12-13F DPU may get a boost of 0.11-0.17 S cents, or 1.2-1.9% increase. This, together with the GST refund from income support expected in the coming quarters, will likely cushion a temporary dip in DPU from the asset enhancement works at Suntec City, which began at the start of Jun.

Maintain HOLD on valuation grounds

We factor in the DPU uplift from higher contribution from MBFC Properties. This in turn raises our DDM-based fair value to S$1.23 from S$1.20 previously. We note that Suntec REIT’s unit price has outshone both the STI (+6.7%) and S-REIT Index (+12.7%) with a 23.3% gain YTD as a result of better-than-expected financial performance and excellent execution by management. At current level, however, we believe that Suntec REIT is fairly priced on a total return basis. As such, we retain our HOLD rating.