Suntec REIT - DBS Research 2017-08-16: Wait For A Better Entry Point

Suntec REIT - DBS Vickers 2017-08-16: Wait For A Better Entry Point SUNTEC REAL ESTATE INV TRUST T82U.SI

Suntec REIT - Wait For A Better Entry Point

  • Suntec REIT's 2Q17 DPU of 2.493 Scts (+0.3% y-o-y) in line with expectations.
  • Positive momentum at Suntec Mall with 1H17 foot traffic and tenant sales up 11% and 5% y-o-y.
  • Acquisition of 477 Collins Street for A$414m on an initial yield of 4.8%.
  • No immediate need to raise equity to fund Suntec’s expansion plans.

Not without execution risk. 

  • We maintain our HOLD call with a revised TP of S$1.95. 
  • Consensus and DBS did not correctly anticipate the 15% rally in Suntec’s share price year-to-date. However, we believe it is too late to chase the stock as
    1. the expected turnaround in Suntec’s operations is not without execution risks despite the impressive gains made by new CEO, Mr Chan Kong Leong, and
    2. a large portion of the “good news” has been priced in, given that Suntec’s current yield is close to -1 SD yield of 5.2%.

Where we differ – Consensus too bearish. 

  • Consensus’ target price of around S$1.74, implies close to 10% downside to Suntec’s current share price. We believe this view is too bearish as Suntec’s share is likely to remain well supported, given
  • an expected recovery in the Singapore office market next year, which typically results in REITs trading closer to book value, and 
  • increased investor interest on the back of continued positive foot-fall and tenant sales data from Suntec Mall, which incidentally grew 11% and 5.3% y-o-y for 1H17, likely to the best retail mall performance from any REIT this reporting season.

Data points to turn more positive. 

  • Beyond a pullback in Suntec’s share price, we would turn more bullish on Suntec, if the REIT is able to achieve a faster-than-expected improvement in rents, given its plans to reduce the number of large stores at Suntec Mall and increase the variety of retailers in the mall. 
  • Other data points include a stronger-than-expected AUD, given 10-15% of Suntec’s earnings are sourced from Australia, and Suntec executing on more DPU-accretive acquisitions.

Key Risks to Our View

  • The key risks to our neutral view include failure to drive footfall and tenant sales at Suntec Mall, which curtails the ability to attract prospective tenants and drive rents higher.


Flat DPU as expected; 2Q17 DPU of 2.493 Scts (+0.3% y-o-y) 

  • 2Q17 DPU fell marginally by 0.3% to 2.493 Scts. This took 1H17 DPU to 4.918 Scts (+0.9% y-o-y), which represents 50.1% of our FY17 and is line with our expectations.
  • Excluding capital distribution of S$8m, underlying 2Q17 DPU would have been 2.191 Scts (+0.3% y-o-y) and 1H17 underlying DPU 4.498 Scts (+2.3% y-o-y).
  • Underpinning the improvement in underlying 2Q17 DPU was a 13% y-o-y increase in NPI, driven by higher contributions from Suntec office (+8%) and income from 177 Pacific Highway which was absent in 2Q16.
  • The uplift in Suntec office income was mainly driven by higher in-place rents as it benefited from higher signing rents over the last few years despite committed occupancy falling to 97.9% from 98.1%. Over the quarter, Suntec office was able to sign rent at S$8.79 in 2Q17 up from S$8.66 in 1Q17 and S$8.58 in 2Q16.
  • The results were also boosted by the acquisition of the Southgate Complex last year, income which is captured in the associate income line. This offset the lower contributions from Suntec Mall (-10% drop in NPI), which was affected by the negative rental reversions over the prior quarters. 
  • Despite the drop in income from Suntec Mall, the property continues to show good progress in terms of foot traffic and tenants sales, which have risen 11% and 5.3% y-o-y for 1H17. This is higher than the 7.3% and 4.3% increase in foot traffic and tenant sales reported for 1Q17. Committed occupancy at Suntec Mall has also increased to 99.3% from 97.5% at end 2Q16 and 98.4% at end 1Q17.
  • Meanwhile, occupancy at the office component of the Southgate Complex has increased to 93.5% from 89.7% at end 1Q17. This, combined with rising spot rents in Melbourne, points to an increase in NPI over the next few quarters.

Negative rental reversions likely to continue in the near term 

  • Over the quarter, we understand Suntec reported negative rental reversions across its Singapore office and retail portfolio.
  • While there are expectations for a recovery in the Singapore office market next year, pressure on rents remain. For example, Suntec is in the final negotiations for 23.3% of leases expiring in 2018. We understand while expiring rent for some of these leases range from S$8.00-8.50, with Suntec prioritising occupancy rather than maximising rents, negative rental reversions are likely to occur.
  • Meanwhile, management guided that it will still take at least another 6 months to stabilise rents at Suntec Mall. While there is pressure on rents as occupancy costs stand at around 20%, Suntec has been able to mitigate the decline in rents by reducing the number of large stores and carving up the space for small tenants with a resultant higher effective rent. 
  • We had originally anticipated that Suntec would have to drive tenant sales first and bring down occupancy costs to a more sustainable level of around 16-18% from 20% and wait for tenant sales to increase further before it could raise rents at Suntec Mall. Around 20% of Suntec mall are currently allocated to tenants who have too much space to achieve the right sales efficiency.
  • With 21.9% and 32% of retail leases up for renewal over FY18 and FY19, if the tenant sales momentum continues, Suntec is well placed to change its tenant mix and increase rents over the next couple of years.

Acquisition of 50% interest in 477 Collins Street 

  • In conjunction with its 2Q17 results, Suntec also announced the acquisition of a 50% interest of Olderfleet at 477 Collins Street for A$414.17m. The developer and co-owner of the property is Mirvac Group.
  • The 40-storey freehold property which is under construction with a practical completion by mid-2020 has an estimated total NLA of 58,000 sqm comprising 56,000 sqm of premium office space and 2,000 sqm of retail space. The building is located on Melbourne’s premier business street and is near the Southern Cross Station.
  • 39.1% of the building has been pre-committed by Deloitte, who will use the building as its Melbourne headquarters. Deloitte has signed a 12-year lease and will take over 22,000 sqm of office space, spanning 12 floors.
  • The building also provides exposure to a market where rents are projected to increase, given favourable demand and supply outlook.
  • Mirvac as part of the acquisition agreement, will also provide a rental guarantee on any unlet space for the first five years. Thus, the initial yield is 4.8%, with annual rental escalation of between 3.50-3.75%. his appears fair in comparison to recent transactions in Melbourne of around the high 4% to 5% yield level.
  • The acquisition is expected to fully funded with Singapore dollar debt. Suntec will receive 4.8% coupon p.a. on the progress payments it will make during the construction period.
  • Taking account of the rental guarantee, the WALE of the property is approximately 7.74 years.
  • Further based on Suntec’s estimates, the trust expects a c.1.8% accretion to proforma FY16 DPU once the building is completed. DPU is projected to increase to 10.180 Scts from 10.003 Scts.

No equity-raising required near term 

  • Aggregate leverage dipped marginally to 36.1% from 37.7% at end 1Q17, mainly due to the early conversion of S$212m worth of convertible bonds over the quarter. There remains around S$88m worth of convertible bonds outstanding which mature in 2021.
  • Post the acquisition of 477 Collins Street, assuming the funding of the Penang Road development and acquisition of another 25% interest in the Southgate complex, Suntec guided that gearing would approach the 42% level by 2021.
  • While the market will likely speculate that Suntec may raise equity, we would like to highlight that capital needs for the 477 Collins Street and Penang Road will not come in one lump sum but rather progressively, in line with the construction schedule.
  • Furthermore, we anticipate Suntec to report an uplift in property values at year-end to better reflect recent market transactions. CapitaLand Commercial Trust (CCT) and CapitaLand Mall Trust (CMT) both achieved around 15bps and up to 50bps compression in cap rates for their office and retail malls, respectively.
  • With Suntec Office and Suntec Mall currently valued on Suntec’s books on a cap rate of 4% and 5% respectively, we anticipate at least a 10bps compression at year-end. This compares to CCT office properties, which are on a cap rate of 3.60-4.10% (4.10% for CapitaGreen with remaining leasehold of 56 years versus Suntec at 71 years) and recent market transactions at 3.0-3.3%. Meanwhile, CMT’s Grade A office and retail malls are being valued on a cap rate of 4.75-5.05% and Jurong Point was transacted at 4.2%.
  • After imputing a revaluation gain of around S$122m, assuming 10bps cap rate compression and conversion of the in the money convertible bonds in 2021, we anticipate gearing to stabilise at around the 40%, with a temporary increase in gearing to around 41% in 2020. Therefore, based on our analysis, there is no imminent need for Suntec to raise equity.
  • As a consequence of additional units on issue from the conversion of the convertible bonds in 2Q17, NAV per unit and adjusted NAV per unit (excluding distributions) fell to S$2.119 and S$2.094 from S$2.145 and S$2.120, respectively.
  • Meanwhile, the all-in financing costs and proportion of fixed-rate debt was stable at 2.41% and 65%.

TP raised to S$1.95 

  • We have raised our DCF-based TP to S$1.95 from SS$1.75, after rolling forward to FY18 as well as incorporating the acquisition of 477 Collins Street and more optimal capital structure (target gearing of 38% versus 36% previously). 
  • In addition, given the strength of the AUD, we now assume an AUDSGD rate of 1.05- 1.08 in the near term versus 1.01 previously.
  • However, we still expect Suntec’s annual DPU to remain at 10 Scts for the foreseeable future, given that underlying earnings, while improving, are still not sufficient to support a DPU of 10 Scts. We expect Suntec to continue to supplement its DPU with capital distributions.

Maintain HOLD with revised TP of S$1.95 

  • While we are positive on the DPU accretion arising from the 477 Collins Street acquisition and tailwinds from a recovery in the Singapore market as well as the turnaround at Suntec Mall, with limited upside to our revised TP of S$1.95, we maintain our HOLD recommendation.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | 2017-08-16
DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 1.95 Up 1.750