Suntec REIT (SUN SP) - DBS Research 2017-10-30: Limited Share Price Upside For Now

SUNTEC REAL ESTATE INV TRUST T82U.SI

Suntec REIT (SUN SP) - Limited Share Price Upside For Now

Suntec REIT 3Q17 DPU down 2.1% y-o-y to 2.483 Scts, in line with expectations.
Tenant sales and foot traffic at Suntec mall pointing in the right direction.
Pressure on the Singapore office portfolio to ease as spot office rents have recovered.

3Q17 DPU fell by 2.1% y-o-y to 2.483 Scts. This represents 25% of our FY17F DPU, and was in line with our expectations.
Underlying 3Q17 DPU excluding S$8m in capital distributions was 2.181 Scts, down 8.2% y-o-y, mainly due to 5% y-o-y increase in the number of units on issue as well as lower contribution from associates (-12% due to absence of one-off pretermination income from Marina Bay Financial Centre and One Raffles Quay). However, this was marginally ahead of expectations with underlying 3Q17 DPU representing c.26% of our original operating FY17 DPU. The slight outperformance was due to stronger than expected performance from the convention centre (NPI up 4.2% y-o-y) and contribution from 177 Pacific Highway stronger AUD).

3Q17 NPI was up 11.6% y-o-y, predominantly attributed to the full quarter contribution from 177 Pacific Highway versus a partial contribution in 3Q16 (NPI up 100% y-o-y). In addition, NPI from Suntec Office rose 3.4% y-o-y, on better cost control and higher effective occupancy.
However, signing rents at Suntec Office fell q-o-q to S$8.35 per sqft per month from S$8.79 in 2Q17 (S$8.78 in 3Q16). We understand the drop in signing rents was impacted by leasing of larger office space (which typically command a discount) compared to prior quarters.
Meanwhile, Southgate office had a soft quarter with committed occupancy falling to 89.6% from 93.5% in 2Q17. We understand occupancy should climb higher over the new few quarters, with 3.2% of leases with heads of agreements signed.
Going forward, for the remainder of the year, only 2% of office leases remain with 18% of office leases up for renewal in FY18. For Suntec office itself, FY18 lease expiries have been reduced to less than 30% of NLA and the REIT is in final negotiations for 9.8% of leases expiring in FY18.

3Q17 NPI for Suntec Mall increased marginally (+1.4% y-o-y). The improvement was attributed to a y-o-y improvement in occupancy (99.3% versus 96.8% in 3Q16). Occupancy also improved q-o-q from 96.8%. This offset the impact from prior quarters negative rental reversions.
In addition, footfall and tenants have maintained their upward trend, rising 12.2% and 4.9% for the first nine months of the year respectively. This compares to 11% and 5.3% increase in foot traffic and tenant sales in 1H17 respectively.
Further signs of improvement can also be seen with flattish rental reversions for Suntec Mall leases that were renewed or re-let in the quarter.

Aggregate leverage was steady at 36.8% (36.1% at end 2Q17). However, the all-in financing costs rose to 2.55% from 2.41% on the back of increase in floating rates.
The proportion of fixed rate debt was stable at 65%.
Owing to an increase in the units on issue, NAV per unit and adjusted NAV per unit (excluding distributions) fell to S$2.115 and S$2.090 from S$2.119 and S$2.094 respectively.

As we expect Suntec Mall to continue to register a steady increase in tenant sales as the awareness of the property and offering improves, we believe the negative drag on earnings from the mall may end soon. Aiding the bottoming of Suntec Mall’s earnings is management’s decision to proactively right size certain stores to improve sales efficiency and occupancy costs for the mall. We understand occupancy costs for Suntec Mall is above the 20% level.
Furthermore, with spot office rents having bottomed and expected to recover next year, we believe the downward pressure on Suntec’s office portfolio should ease. Nevertheless, Suntec may still report negative rental reversion especially in 1H18.
Thus, going into FY18 and beyond, we expect Suntec’s underlying earnings to improve especially with the anticipated acquisition of another 25% stake in the Southgate Complex in Melbourne, which we have penciled in to occur in early 2018.
This should reduce the payment of capital distributions over time, with overall headline DPU steady at 10 Scts per annum.

With 3Q17 DPU in line with expectations and limited upside to our TP of S$1.95, we maintain our HOLD call.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2017-10-30

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 1.950 Same 1.950