Suntec Reit - No refinancing concern till FY11F

Suntec REIT’s (SUN) 1Q09 DPU of 2.9Scts (+15% y-y, +2% q-q) met 30% of our previous FY09F forecast of 9.9Scts and 31% of the previous consensus forecast for FY09F of 9.5Scts. Core operating performance in 1Q09 was ahead of our expectation — gross rental revenue of S$64.9mn (+16% y-y, +2% q-q) and NPI of S$49.2mn (+15% y-y, +3% q-q) met 28% of our respective full-year forecasts. Net financing expenses in 1Q09 were also lower than our expectation. Interest on borrowings of S$10.7mn met just 17% of our full-year projection of S$64.4mn. The average financing cost of SUN at end-1Q09 was 3.0%, compared with 3.3% at end-FY08 and our previous full-year estimate of 3.4%.

While committed occupancy declining sequentially for office and retail properties in 1Q09, we believe management’s ability to contain office vacancy at just 2.6% and retail vacancy at 1.2% is commendable in the current context. We think this is especially so for office properties, where the relatively low vacancy was achieved as some 55% of office leases, excluding One Raffles Quay (ORQ), originally due for renewal this year were negotiated in 1Q09. While our assumption of 8% vacancy through FY09F appears conservative, with the bulk of the office leases expiring this year rolled over, we retain our assumption pending further guidance from SUN’s 2Q09 results update.

Together with the 1Q09 results announcement, SUN announced that it has secured from seven banks S$725mn three-year fixed rate and S$100mn seven-year floating rate term loan facilities, with a blended all-in interest margin of less than 375bps to refinance all S$825mn worth of debt maturing this year. The term loan facilities are secured against Suntec City Mall and parts of Suntec City Office. While the cost appears to be above our expectation, this announcement has removed a major stock overhang, on our reading.

Based on the current average financing cost of 3.0% and assuming a base rate of 1%, the implied financing cost of SUN immediately post-refinancing would be circa 3.8%, versus our projection of 3.6%. Following the full drawdown of the S$825mn new term loan facilities by the end of this year, SUN will not have any more debt due for refinancing until February 2011, when S$32.5mn of MTN loan matures.

We roll over our intrinsic NAV estimate to reflect FY10F valuation and raise our gross asset value estimate from S$3.35bn to S$3.7bn (+10.4%), as well as our core net asset value estimate from S$0.85/unit to S$1.02/unit (+20%). On our numbers, a noncash revaluation deficit of S$1.71bn (our gross asset estimate of S$3.7bn versus the latest portfolio valuation of S$5.4bn) could potentially be booked over the cycle and, consequently, SUN’s gearing could rise from the current 36.9% to 52%. Our valuation methodology assumes new equity of S$447.9mn to be raised at the current share price to ensure gearing stays within 40% in order to quantify the fair discount to core NAV that reflects the potential dilution. Accordingly, we raise our price target from S$0.82 to S$1.00 (+22%). Our price target implies a potential total return of 9.2%, including our projected FY10F dividend yield of 8.2%, at the current share price.

On a total return basis, the stock has performed well YTD, up 51.3% versus the S-REITs universe’s weighted average gain of 39% and the benchmark FSSTI index’s gain of 32.5% in the same period. Accordingly, we downgrade our rating to NEUTRAL on valuation grounds.

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