Suntec REIT - DBS Research 2019-07-29: Resetting For The Future

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SUNTEC REAL ESTATE INV TRUST (SGX:T82U)

Suntec REIT - Resetting For The Future

• Suntec REIT (SGX:T82U)'s 2Q19 DPU of 2.361 Scts (-4.6% y-o-y) was marginally below expectations on lower capital distributions. 2Q19 underlying DPU up 1.4% y-o-y.
• Suntec Office posted +7.9% rental reversions; maintain positive rental reversions outlook.
• Maintain BUY but lower Target Price to S$2.15.

Market turning around to our expectations.

• We maintain our BUY call on Suntec REIT (SGX:T82U) but lower our Target Price to S$2.15 on lower capital distributions ahead.
• While there may be near-term share price overhang due to a surprise cut in dividend support, we believe that investors will over time focus on mounting evidence of a sustained turnaround at Suntec City Mall and offices, which will drive core DPUs higher. We expect underlying DPU to improve by 3.4% CAGR between 2018-21.

Where we differ – Street-high target price.

• We have a street-high Target Price of S$2.15 compared to consensus’ Target Price of S$1.92. We believe Suntec REIT deserves to trade towards our Target Price, given office buildings and shopping malls in Singapore have been recently been transacted at 1.7-2.7% and 3-4% exit yields respectively, below the cap rates of 3.65-3.90% and 4.75% used to value Suntec REIT’s office and retail properties.
• Furthermore, with office rents expected to be on a multi-year upturn, we believe Suntec REIT should at least trade closer to its book value.

Closing the rental gap to drive investors’ confidence on its resiliency.

• Suntec City Mall’s passing rents at S$11-12 psf/mth are at a significant discount to S$17-18 psf/mth at other suburban malls. Suntec REIT is remixing its tenant mix and picking the low-hanging fruits such as placing children stores next to the playground rather than at opposite ends of the mall. The resultant higher foot traffic, tenant sales and improving rents should be re-rating catalysts.

WHAT’S NEW - Resetting for the future

(-/+) 2Q19 DPU down 4.6% y-o-y; underlying DPU +1.4% y-o-y

• Suntec REIT's 2Q19 DPU came in at 2.361 Scts, down 4.6% y-o-y with 1H19 DPU at 4.795 (-2.3% y-o-y), accounting for 48% of our FY19F DPU of 9.93 Scts.
• The lower DPU was mainly due to lower capital distributions (2Q19: -35% y-o-y; 1H19: -21.2% y-o-y) and enlarged unit base.
• Excluding S$6.5m worth of capital distributions in 2Q19 vs S$10m in 2Q18, underlying 2Q19 DPU grew 1.4% y-o-y to 2.129 Scts.
• Meanwhile, underlying 1H19 DPU was 4.321 Scts, up 0.8% y-o-y after stripping out S$13m worth of capital distributions (S$16.5m in 1H18).
• Suntec REIT's 2Q19 revenue and NPI fell 2.3% and 7.2% y-o-y to S$88.4m and S$56.4m respectively, mainly impacted by lower contributions from Suntec Convention (revenue: -23% y-o-y; NPI: -61% y-o-y) as there were fewer major conferences. Despite the increase in number of corporate events, the average size of events has reduced.
• Both its office and retail segments recorded improvements, mainly led by Suntec Office and Suntec Retail with 2Q19 revenue up 2.2% y-o-y and 4.6% y-o-y respectively and 2Q19 NPI (ex-sinking fund) 0.4% y-o-y and +2.7% higher y-o-y. The sinking fund contributions have no impact on DPU.
• The improved property income was attributed to the sustained turnaround of Suntec City Mall and steady performance from Suntec City Office. While the underlying performance for 177 Pacific Highway improved, it was offset by the depreciation of the AUD.
• The results were also boosted by higher contribution from JVs (+14% y-o-y) mainly led by:
  1. the acquisition of an additional 25% interest in Southgate Complex in May18 with underlying income from Southgate Complex up 8% y-o-y owing to better office occupancy (99.5% vs 92.7%), and
  2. higher contributions from MBFC properties (+13% y-o-y) from one-off compensation of early termination and positive rental reversions.
• This was offset by lower contribution from One Raffles Quay (ORQ) which fell 6.7% y-o-y. The weaker performance was due to a drop in occupancy to 97% from 100.0% in the prior year.

Suntec City Mall recovery on track

• The turnaround at Suntec City Mall continued, with 2Q19 revenue and NPI (excluding S$1.4m sinking fund contribution) increasing by 4.6% and 2.7% y-o-y to S$31.7m and S$23.0m respectively.
• The stronger financial performance was due to better occupancy (98.3% versus 97.7% in 2Q19 and 98.6% in 2Q18) as well as higher signing rents achieved in prior quarters.
• Operating metrics for the mall also improved, with foot traffic up 3.9% y-o-y in 1H19 (+3.3% y-o-y for 1Q19) and higher tenant sales increasing by 1.7% y-o-y in 1H19 (+1.3% y-o-y for 1Q19). Tenants’ sales (ex-SuperPark) was 4.4% y-o-y higher led by F&B and electronic sales.
• We understand Suntec Mall continues to achieve positive rental reversions. Management expects to achieve c.5% rental reversions in general except for 15k sqft in basement 1 which is undergoing AEI works, which could see double digit rental reversions upon completion. We believe this bodes well for continued improvement in earnings in the next few years.

Steady Suntec City Office performance

• 2Q19 revenue and NPI (ex-sinking fund) for Suntec City Office grew 2.2% and 0.4% y-o-y to S$33.1m and S$25.7m respectively.
• The steady performance at Suntec City Office was credible and committed occupancy was steady at 99.1% versus 98.9% in 1Q19 and 98.7% in 2Q18.
• Given Suntec REIT achieved signing rents of S$8.92 to S$11.00 psf/mth compared to average expired rents of S$8.52 psf/mth, we understand Suntec City Office achieved c.7.9% positive rental reversions over the quarter.
• On the back of forward renewals, only 1.5% of office leases by NLA are up for renewal in FY19 as the bulk (23.4%) of the expiring leases has been renewed. For FY20, 22.3% of leases are up for renewal, of which 1.5% has been completed. Contrary to market expectations, management expects to achieve double digit positive rental reversions in 2H19 and possibly FY20 as expiring rents are still on the lower end at less than S$9psf/mth, assuming spot office rents maintain an upward trajectory.

Completion of 9 Penang Road and 477 Collins Street remain on track

• Around 91% of the 9 Penang Road development has been completed with construction on schedule for completed in 4Q19. UBS, which has pre-leased 100% of the office component, is expected to start the fit-out in 3Q19. Pre-leasing for the 15k sqft of retail NLA has commenced.
• Meanwhile, construction of 477 Collins Street remains on track for completion by mid-2020 with 71% of the building now completed. Pre-leasing commitment has increased to 82.5% from 76% in 1Q19, and 8.4% vs 13.1% in 1Q19 with heads of agreement, taking overall pre-committed occupancy to 90.9% from 89.1% in 1Q19.

Lower capital distributions with acquisitions to potentially supplement capital management strategy

• As in 2Q19, management said it will reduce its capital distributions from this year onwards and lower DPU expectations to 9-9.5 Scts from its previous target of 10 Scts. This will help preserve its remaining capital distribution of S$60m to ensure sustainable DPU in the next few years.
• As the underlying performance continues to improve, management believes that its operations will eventually support its DPU as capital distributions diminish in the next 2 to 3 years.
• Suntec REIT continues to look for acquisition opportunities to drive growth. Management plans to expand its overseas exposure from 16% of total assets currently to 30-40% in the next 5 years.
• On its overseas expansion plans, Suntec REIT would focus on deepening its presence in Australia and explore major cities developed countries with similar risk profile as its Singapore assets. These include London, Frankfurt, Paris and Munich.
• As its overseas exposure increases, Suntec REIT will consider hedging its balance sheet forex risks.

Maintain BUY, lower Target Price to S$2.15

• With 2Q19 underlying earnings expected to improve on the back of higher spot office rents in Singapore and continued turnaround of Suntec City Mall, we maintain our BUY call. However, we lower our Target Price to S$2.15 from S$2.20 previously and reduced our FY19F-21F DPU by 4% to 10% on lower capital distributions.
• While lowering capital distribution and DPU expectations may see some near-term overhang in share price performance, we believe with more evidence of improving underlying performance and sustainable growth trajectory, Suntec REIT will be able to deliver DPU growth in the future.

Derek TAN DBS Group Research | Rachel TAN DBS Research | https://www.dbsvickers.com/ 2019-07-29

SGX Stock Analyst Report BUY MAINTAIN BUY 2.15 DOWN 2.200