Suntec REIT - DBS Research 2018-01-25: Still There For The Taking

Suntec REIT - DBS Vickers 2018-01-25: Still There For The Taking SUNTEC REAL ESTATE INV TRUST T82U.SI

Suntec REIT - Still There For The Taking

  • Suntec REIT's 4Q17 and FY17 DPU of 2.6 Scts and 10.0 Scts flat y-o-y, in line with expectations.
  • Office portfolio ends the year on a soft note.
  • But turnaround at Suntec Mall evident with robust growth in foot traffic and tenant sales; 4Q17 net property income up 3% y-o-y.

Re-rating not over. 

  • We maintain our non-consensus BUY call on Suntec REIT with a Target Price of S$2.30. We, like most sell-side analysts, were blind-sided by Suntec’s past performance and missed the 30% share price rally in 2017. However, we believe the rally has more to go from current level 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 Singapore office rents on the horizon, we also argue that REITs with office exposure should trade above book value, as seen in the past.

Where we differ –

Takeover potential. 

  • Over the years, there has been speculation of Suntec being 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 backed by Warburg Pincus/Avic Trust, has the resources to privatise Suntec if the market undervalues Suntec. 
  • Assuming an offer price at our Target Price of S$2.30, we estimate ARA could generate an IRR of 10%. Thus, we believe this takeover risk should result in a firm Suntec share price going forward.

Closing the rental gap. 

  • Passing rents at Suntec Mall of S$10-11 psf/mth are at a significant discount to other suburban malls of up to S$17-18 psf/mth. 
  • We believe as Suntec remixes its tenant mix and picks the low hanging fruits such as placing children stores next to the playground rather than opposite ends of the mall, the resultant higher foot traffic, tenant sales and improving rents should act as re-rating catalysts.

WHAT’S NEW - Continued signs of a turnaround

Stable DPU on a full year basis

  • Suntec REIT's 4Q17 DPU came in at 2.604 Scts, flat y-o-y, resulting in FY17 DPU of 10.005 Scts (flat y-o-y). This was in line with our expectations.
  • Excluding S$10m worth of capital distributions, underlying 4Q17 DPU stood at 2.228 Scts (-2.4% y-o-y) mainly attributed to a 2% dip in net property income (NPI) on the back of prior negative rental reversions. 
  • The main drag in 4Q17 was the Suntec offices which reported a 3% and 2% fall in revenue and NPI respectively.
  • Pleasingly, Suntec Mall shows some signs of recovery with 4Q17 revenue and NPI rising 2% and 3% y-o-y respectively.

Turnaround at Suntec Mall

  • Driving the improvement in Suntec Mall appears to be the tenant remixing exercise over the last few quarters but also an improvement in the mall’s operating statistics.
  • With the acceleration in footfall in 4Q17, footfall for the whole of 2017 rose 12.8% y-o-y to 45m, up from 12.2% y-o-y growth achieved for 9M17.
  • More importantly tenant sales continued its upward trend, increasing 4.8% y-o-y for FY17. 9M17 tenant sales growth was 4.9%. The F&B and sports categories were their strongest performers. While a large proportion of the growth in tenant sales was driven by new tenants, we understand existing tenants on a same store basis grew their sales by c.2%.
  • Occupancy at Suntec Mall remains healthy at 99.0%, up from 97.9% in 4Q16.
  • In terms of occupancy costs for the mall, it currently stands in the low 20’s. While appearing high, management guided that this is not a concern. This is due to its ability to cut up larger stores into smaller stores and/or remove underperforming tenants with better ones, which automatically adjusts occupancy costs to a more sustainable level for the particular tenant while still being able to increase rents compared with that paid by the vacating tenant. 
  • Going forward, with 20-30% of stores at Suntec still too large, the REIT will continue to right size the stores and endeavour to bring new brands or stronger brands to further improve the value proposition of the mall. This is on top of management’s intention to add more events and increase marketing to drive additional foot traffic to the mall.

Pressure on Singapore office rents

  • Over 4Q17, Suntec Office secured average rents of S$8.03 psf/mth, down from the S$8.35-8.66 range in 9M17. We understand the fall in signing rents was due to the renewal of 2 anchor tenants. This resulted in Suntec reporting c.5% negative rental reversions.
  • Nevertheless, occupancy at Suntec Office continues to be robust, standing at 99.5% up from 98.4% in 3Q17 and 98.9% in 4Q17. 
  • Due to forward renewals over the quarter, another 11.3% of leases are up for renewal for the remainder of FY18, down from 18%. In addition, Suntec is in final negotiations for c.20% of leases expiring in FY18.
  • Finally, while Suntec office has suffered due to the downturn in office rents, with the recent recovery in spot office rents and business confidence returning, Suntec office has seen more enquiries for office space and tenants are more eager to forward renew leases. This bodes well for signing rents should spot rents continue its upward trajectory over FY18 resulting in potentially flattish rental reversions.

Mixed contribution from Australia

  • Earnings contribution from Suntec’s Australian portfolio was mixed with Southgate flat y-o-y while 177 Pacific Highway’s NPI dipped 3.6% y-o-y largely due to lower average AUD in 4Q17 versus 4Q16.
  • For Southgate, it continues to make steady progress in improving occupancy. Occupancy as at end December was 90.7% up from 89.6% as at end September. Post balance date, Suntec has signed a Heads of Agreement for an additional 1.1% of NLA. Steady progress was also made on the refurbishment of the building, with 9 floors already completed. 
  • 177 Pacific Highway remains fully occupied.
  • Meanwhile, Olderfleet at 477 Collins Street, which is under construction and where Suntec has a 50% interest has achieved 39.1% pre-committed occupancy, with an extra 9% of NLA signed under Heads of Agreement.
  • Going into 2018, given the healthy Australian economy and modest new supply growth, we expect increased contribution from Suntec’s Australian portfolio on the back of rising rents.
  • Earnings should also be boosted by the expected acquisition of an additional 25% interest in Southgate. Under the original agreement to purchase Suntec’s original 25% stake, vendor Dexus had the right to put the property to Suntec and its JV partner at the same initial purchase price. Furthermore, Suntec and its JV partner have the right to purchase the property at the original purchase price subject to expiry of the put period.

Increase in values for Australian properties with the Singapore portfolio stable

  • Suntec REIT reported c.S$55m revaluation gains in 4Q17. This was mainly attributed to compression of cap rates in its Australian portfolio. Cap rate for Southgate office has fallen to 5.75% from 6.25%, while cap rate compressed to 5.25% from 5.5% for 177 Pacific Highway.
  • Valuation for Suntec’s portfolio was stable as there was no change in cap rates. The cap rate used for Suntec Mall stands at 5%.
  • As a consequence of the revaluation gains which offset an increase in issued units, NAV per unit (excluding distributions) stood at S$2.09, flat q-o-q.
  • Gearing dipped slightly to 36.4% from 36.8% at end September 2017. However, we expect gearing to increase to 39-40% as it debt is used to fund the acquisition of an extra 25% interest in Southgate and its equity contribution for the construction of 477 Collins Street.
  • Meanwhile, average cost of debt rose to 2.62% from 2.55% at end 4Q17.

Maintain BUY

  • With more than 10% total return expected in the coming 12 months, we reiterate our BUY call with a Target Price of S$2.30. 
  • We believe the turnaround of Suntec Mall and the upturn in the Singapore office market will trigger a re-rating of the stock with further upside risk should its sponsor mount a takeover offer if Suntec continues to be undervalued by the equity markets.

Key Risks to Our View

  • The key risks to our bullish view are a downturn in the office market and management’s inability to revitalise Suntec Mall.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | Singapore Research Team DBS Vickers | 2018-01-25
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 2.300 Same 2.300