Suntec REIT - DBS Research 2017-12-15: There For The Taking

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SUNTEC REAL ESTATE INV TRUST T82U.SI

Suntec REIT - There For The Taking

• Our deep dives into Suntec Mall’s tenant mix identifies significant opportunities which should translate to the closing of the rental gap to other Singapore malls.
• Takeover threat hangs over Suntec should Suntec’s share price not re-rate sufficiently.
• Increased confidence in CEO, Mr Chan Kong Leong to engineer a turnaround leads us to raise our TP to S$2.30.

Upgrade to BUY. 

• We upgrade Suntec REIT from HOLD to non-consensus BUY call with a revised TP of S$2.30. 
• We, like all sellside analysts, were blind-sided by Suntec’s past performance and missed the 30% share price rally in 2017. However, we believe the rally can be sustained from current levels, as we now have greater confidence in CEO, Mr Chan Kong Leong’s ability to engineer a turnaround at Suntec mall having done a deep dive into the property and identified easy wins to improve the mall’s performance. 
• With a multi-year upturn in the Singapore office rents on the horizon, we also argue that REITs with office exposure should trade above book value, as seen historically.

Where we differ –

Takeover potential. 

• Over the years, there has been speculation of Suntec being by privatised by Suntec’s sponsor, ARA Asset Management and its partners. While we are not privy to ARA’s intentions, we believe with ARA now having the backing of Warburg Pincus/Avic Trust, ARA has the resources to privatise Suntec if the market undervalues Suntec. 
• Based on an offer price at our TP of S$2.30, we estimate ARA could generate an IRR of 10%. Thus, we believe the public market needs to re-rate Suntec; otherwise it is vulnerable to a takeover.

WHAT’S NEW - The bullish case for Suntec

Wrong to be blind-sided by past performance 

• Over the past year, Suntec REIT’s share price has increased by 30% despite us and consensus being cautious on the stock. In hindsight, we all had been blind-sided by Suntec’s past performance, specifically the inability to significantly improve rents at Suntec Mall post its S$410m AEI which commenced in 2012 and which was completed in 2015. 
• The underperformance was also partially due to the downturn in the retail market due to a combination of a sluggish Singapore economy, competition from e-commerce, Singaporean progressively spending overseas and new mall supply.

Prospects of more buoyant retail scene in 2H18 

• However, while the retail environment is expected to remain challenging in the near term due to the known headwinds, there remains a potential for a recovery towards 2H18 as our DBS economists expects Singapore to register strong GDP growth of 3% in 2018, up from their previous forecasts of 2.5% growth. 
• In addition, with our expectations for a rise in residential property prices and cash injection into the economy following the large enbloc sales in late 2017, we believe a firmer consumer sentiment should translate to a better retail spend towards the latter half of 2018.

Suntec’s new CEO the catalyst for change and improvement 

• More importantly, we believe Suntec’s CEO, Mr Chan Kong Leong, who became CEO in January 2017 is the catalyst to transform Suntec Mall and close the rental gap between Suntec Mall and other suburban malls. Mr Chan was formerly with CapitaLand and has extensive experience in retail malls. 
• Passing rents at Suntec Mall stand at S$10-11 psf/mth versus other suburban malls of S$15-18 psf/mth. Thus, far we have seen greenshoots under his tenure with both foot traffic (+12.2% yo-y for 9M17) and tenant sales (+4.9%) improving. The growth in foot traffic and tenant sales is the highest among the SGX listed retail REITs and has also outperformed the overall retail sales index, albeit off a low base. 
• He has also announced a clear and coherent strategy to turn around the performance of the mall, including: 
  1. improving the signage at the mall.
  2. boosting awareness of the mall by increasing the number of events such as car shows and movie launches.
  3. adding a loyalty programme.
  4. right sizing the size of certain stores at the mall which were too big for certain tenants, resulting in a more sustainable occupancy costs but higher effective rents. 
• We understand around 20% of Suntec Mall is currently allocated to tenants who have too much space to achieve the right sales efficiency.

Lack of awareness of the strong attributes of Suntec 

• In the early 2000s, Suntec Mall was a popular location for Singapore shoppers but during its AEI and the emergence of other retail options in suburban locations, shoppers had lost interest in Suntec and there had been a lack of awareness of the mall’s strong attributes for both shoppers and prospective tenants which have yet to be fully leveraged on. These include: 
  1. The unparalleled connectivity with two MRT stations that are within four minutes of walking time 
  2. Proximity to the expressway with ample parking compared to other shopping malls in Singapore 
  3. Part of an integrated development with five office towers and a convention centre, thus generating a large number of foot traffic from the nearby office workers and conference delegates 
  4. Immediate catchment from neighbouring office buildings and hotels 

Deep dive into tenant mix identifies upside opportunities 

• To identify the opportunities and whether it possible to turn around Suntec Mall, we took a deep dive into the malls’ tenant mix and curation. We also benchmarked the property against Vivo City which is owned by Mapletree Commercial Trust. Vivo City is deemed by many investors as one of the best managed malls in Singapore.
• In order to achieve an optimal curation, we believe two principles need to be followed: 
  1. the layout design needs to be convenient to its shoppers, if not intuitive - It should not take long for shoppers to find a store. We believe this implies stores of similar nature of related categories should be grouped closer to one another. While having a few clusters (as opposed to a single group) is acceptable, scattering the same trade mix all over a mall is generally not ideal.
  2. leveraging on the impact of its anchor space - Anchor space usually commands lower rents with bigger space, it completes the offerings of a shopping mall and meanwhile should be used a traffic puller to provide more cross-selling opportunities to the stores nearby.
• Looking at the store curation of VivoCity, it appears to be more strategic than Suntec’s. Taking four trade categories as examples, namely Sportswear, Electronics & Telecommunications, Bags/Shoes & Accessories and Kids & Maternity, we found the following three distinctive design advantages of VivoCity over Suntec City.
  1. Stores of the same trade categories tend to be on the same floor for VivoCity, whereas they are spread around at least two different floors for Suntec City.
  2. Stores of the same trade categories tend to be clustered in one area for VivoCity. At Suntec City, such clustering is not easily observed.
  3. VivoCity strategically utilises anchor space to leverage shopper traffic. For instance, Best Denki is an anchor tenant located on level 2, VivoCity has also placed other electronics-related stores around Best Denki. In contrast, Harvey Norman, an anchor tenant of the similar nature, is on level one at Suntec City, but most of the other electronic-related stores are on a different level. Another example is kids & maternity category.
• VivoCity has its playground, a facility it offers for free, surrounded by these shops to derive the benefits of cross-selling opportunities. Suntec City, on the other hand, has two playgrounds – a bigger one that charges and a smaller one that is free of charge – but most of its kids & maternity related shops are located at a different end of the mall. This largely limits any cross-selling opportunities.
• While we have identified “flaws” at Suntec, we believe these are not insurmountable and the new CEO is aware of these issues. Thus, we believe as Suntec changes the tenant mix as the leases expire over the next few years, not only should an improved tenant mix drive increased tenant sales and foot traffic (thus increasing the attractiveness of tenants to the mall), we believe rents, should also rise over time. Thus, we have conservatively projected asking rents to rise from $10-11 towards S$15-16 over the next five years, still below rents at other suburban retail malls in Singapore.

Suntec Office more resilient than expected 

• We had previously been sceptical on the resilience of the offices at Suntec City in the face of the large jump in new office supply. However, thus far we have been proven wrong with office rents being relatively stable. 
• The key attributes of Suntec City Office are the ample car parking lots, the large amount of amenities at the nearby Suntec Mall and access to two MRT stations within short walking distance.

Upturn in office rents and heightened demand for office assets 

• With new office supply easing from 2018 and CBD Grade A office rents increasing q-o-q for the first time in 10 quarters according to CBRE in 3Q17, we believe we are at the start of multi-year upturn in the Singapore office market until the next jump in supply in 2022. In addition, with ample global liquidity, Singapore office buildings and land for the development of office towers are in high demand, leading to elevated prices or record land bid prices even for CBD fringe locations. 
• In line with the historical experience for office REITs in a sustained upturn, we believe there is potential for the Singapore office component of Suntec’s book value to trade at a premium to book value.

Retail assets in Singapore and office buildings in Australia are in high demand too.

• Similar to office assets in Singapore, retail assets are also in hot demand as reflected by record-low cap rate of 4.2% for Jurong Point which was sold for S$2.2bn. While some investors would argue this is just a single data point, we believe this transaction highlights to us the premium that retail assets in Singapore should command given that most retail malls are tightly held and there is a dearth of large retail assets that are ever put up for sale. This bodes well for the holding power of Suntec Mall but upside to valuations given its current cap rate only stands at only 5%. 
• Likewise, Suntec’s Australia office buildings 177 Pacific Highway and Southgate complex which are valued at cap rates of 5.5% and 6.25%, respectively, should also see valuation upside given heightened demand for office assets in Australia. For example, recent office assets with long leases have been bought in Melbourne with an initial yield around 5% by KREIT and Suntec itself.

Takeover potential.

• In the past few years, there had been occasional speculation of Suntec’s sponsor, ARA Asset Management privatising the REIT given that Suntec was trading at a significant discount to book value. While this valuation discount has closed somewhat given the rally in Suntec’s share price, we believe there may still be a financial incentive to pursue this option given the potential gains should Suntec be owned under a private fund structure.
• Based on our estimates, assuming that the Suntec portfolio is geared up to 60% and the assets are sold individually to the highest bidder, ARA and its consortium partners could potentially generate an IRR of 10% over a 5-year period. 
• While we had previously dismissed such rumours in the past given the large quantum involved in buying out Suntec and we are not privy to ARA’s current intentions, given that ARA has now been privatised and has the backing of Warburg Pincus and Avic Trust, we believe that ARA would have the financial resources to mount a takeover. Thus, we think that if the public markets continue to undervalue Suntec, it remains vulnerable to a takeover.

TP raised to S$2.30 

• To better reflect our confidence in the Suntec Mall, upside risk to the REITs property values and potential takeover threat, we raise our TP to S$2.30 from S$1.95 after lowering our beta assumptions from 0.85 to 0.75. 
• Our TP implies a P/BV of 1.1x which we think is conservative at the early stage of a recovery in the Singapore office market.

Upgrade to BUY 

• Given 12-month total expected return of c.16%, we upgrade our recommendation on Suntec REIT to BUY from HOLD with a revised TP of S$2.30. 
• We believe the turnaround of Suntec Mall and the upturn in the Singapore office market will trigger a rerating of the stock with further upside risk should its sponsor mount a takeover offer. 
• While we anticipate there will be some pushback to our non-consensus BUY call given Suntec’s flattish DPU profile and its DPU is supported by capital distributions – we think this is not an obstacle to a share price rally as other office REITs such as CapitaLand Commercial Trust and Keppel REIT with similar DPU characteristics have also rallied in 2017. 
• In addition, we believe investors will increasingly focus on the improving quality of Suntec’s underlying DPU with progressively lower capital support over time. We have projected Suntec’s underlying DPU to grow at a CAGR of 6% from 2017 to 2020.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | Singapore Research Team DBS Vickers | http://www.dbsvickers.com/ 2017-12-15

DBS Vickers SGX Stock Analyst Report BUY Upgrade HOLD 2.30 Up 1.950