Starhill Global REIT - 2Q09: Positioned for expansion and acquisitions

Starhill Global REIT (SGREIT) reported distributable income of S$18.8m (+9.5% yoy) and DPU of 1.90 cents (+6.7% yoy) for 2Q09. The results were in line with expectations.

Sustainable and resilient earnings. Contribution from retail properties in Singapore was bolstered by long-term retail master lease structure at Ngee Ann City and doubling of shopper traffic at Wisma Atria basement after the linkway to Orchard MRT station was reopened. Renewed and new office leases for 6,250sf were signed at 28.0% higher than the preceding rates.

Write-down in asset values. Independent valuers had valued SGREIT’s portfolio of investment properties at S$1,954.6m as at 15 Jun 09, a decline of 7.1% from the valuation conducted on 31 Dec 08. The company's gearing has therefore increased from 31.1% to 33.4%. The 1-for-1 rights issue will reduce the gearing to 20.7%, thus providing financial flexibility. However, NAV/share will be reduced by 37% from S$1.27 to S$0.80.

Embarking on campaign for regional expansion. SGREIT intends to pare down its existing debts, pursue acquisitions and embark on asset enhancement initiatives. It is scouting for opportunities to invest in distressed assets in Singapore, Malaysia, China, Japan and Australia, particularly from distressed sellers having difficulties in refinancing debt. In Malaysia, SGREIT could potentially acquire retail assets from Starhill REIT listed on Bursa Malaysia. The company targets an asset size of S$3b within two years.

SGREIT plans to invest S$100m for an asset enhancement initiative at Wisma Atria (plan not finalised yet), which will add 40,000sf of retail space fronting Orchard Road. Reducing debt will also help it to attain a lower cost of borrowing when refinancing S$617m of debt facilities due next year.

Our target price is S$0.52 based on the Dividend Discount Model (required rate of return: 7.7%, terminal growth: 2.0%).

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Starhill Global REIT - Fairly valued

In past notes we have flagged that while Starhill Global REIT’s 1Q09 results were broadly in line with our expectations, the weakening economic environment is likely to bring lower retail and office rents in 2H09F, and heightened occupancy risk, as new supply comes on stream. According to Jones Lang LaSalle, some 2.5mn sf of new retail supply is due for completion in 2009F and 2.3mn sf in 2010F.

The distribution of new supply is relatively evenly spread over the next two years, with 33.4% scheduled to be completed in the prime shopping districts, 33.8% in secondary shopping districts, and 32.9% in suburban locations. Approximately 1.4mn sf of new and refurbished malls will be opened in Orchard in 2H09F, including ION Orchard (663,000 sf), 313 Somerset (294,000sf), Orchard Central (250,000sf) and Meritus Mandarin (215,000sf), directly competing with Starhill’s prime Orchard Rd properties Wisma Atria and Ngee Ann City.

Amid rapid deterioration in the economy, we have seen a faster contraction in occupancy and greater decline in office rents than previously anticipated. According to JLL, office demand in the CBD contracted by 558,418sf, resulting in CBD vacancy rising to 6.9% in the CBD Core. In the past six quarters, net demand in the Singapore CBD has contracted by 813,008 sf, with Orchard Rd rents falling 21.6% q-q in 1Q09 and now 35.0% down from the peak, impacting reversions in the REITs office towers in Ngee Ann City. While the supply/demand outlook has deteriorated, we have maintained our office rent assumptions — rents falling by 57.0% from peak to trough — as incremental increases in vacancy are likely to have less impact on overall rents, with an improvement in the quality of stock underpinning a marginal rise in rents late in the cycle, notwithstanding higher vacancy, which is likely to be concentrated in poorer quality buildings. That said, we caution that the recovery is likely to be slower than in past cyclical corrections. Expectations of a lower growth profile in rents, in part, are reflected in our expectations for capitalisation rates to move out by 50bps over the cycle.

We have revisited our valuation for Starhill Global REIT, rolling forward our intrinsic NAV to FY10F, from FY09. Our adjustments to earnings forecasts reflect expectations of marginally weaker office occupancy following weaker-than-expected 1Q09 demand estimates. We peg our new price target to our FY10F intrinsic value of S$0.74/unit (previously: FY09, S$0.70/unit), with the rise in NAV underpinned by a lower dilutive impact of a possible capital raising on our expectations of possible revaluation deficits. We assume circa S$115mn of new capital is raised at the current share price of S$0.73/share; previously we assumed capital was raised at S$0.47/unit, the unit price at the time. While we see inherent value in the Orchard Rd assets, valuations prompt us to cut our rating to NEUTRAL, from Buy.

Starhill Global REIT - Embarking On Campaign For Regional Expansion

Surprised by sudden rights issue. Starhill Global REIT (SGREIT) has announced a fully underwritten renounceable 1-for-1 rights issue at S$0.35 per rights unit to raise S$337.3m. The rights units are priced at a 45.3% discount to the last closing price of S$0.64. Rights units are entitled to distribution accruing starting 1 Jul 09. The joint lead managers and underwriters of the rights issue are DBS, Merrill Lynch and Credit Suisse. YTL Corporation has undertaken to subunderwrite up to 75% of the total rights issue. An EGM will be held on 13 Jul 09 to seek approval from unitholders for a whitewash resolution to waive their rights to receive a mandatory offer from YTL.

Embarking on campaign for regional expansion. SGREIT intends to pursue acquisitions, embark on asset enhancement initiatives and pare down its debts. It is scouting for opportunities to invest in distressed assets in Singapore, Malaysia, China, Japan and Australia, particularly from distressed sellers having difficulties in refinancing debt. In Malaysia, SGREIT could potentially acquire retail assets from Starhill REIT which is listed on Bursa Malaysia. The company targets an asset size of S$3b within two years.

SGREIT plans to invest S$100m for an asset enhancement initiative at Wisma Atria (plans not finalised yet), which will add 40,000sf of retail space fronting Orchard Road. Reducing debt will also help it attain a lower cost of borrowing when refinancing S$617m of debt facilities due next year.

Cut target price. We have cut our 2010 DPU forecast by 40.7% to 3.5 cents due to dilution from the rights issue and trimmed our assumptions for office rentals at Ngee Ann City and Wisma Atria. We cut our target price by 25.2% to S$0.80 based on the Dividend Discount Model (required rate of return: 7.7%, terminal growth: 2.0%).

Starhill Global REIT briefing

1) Rationale for Rights issue

a) Repayment of borrowings
The bulk of SGREIT's borrowings (~S$617m) is due for refinancing in FY10. SGREIT will prepay some of these borrowings with proceeds from the Rights issue in order to strengthen its balance sheet and put itself in a better position to renegotiate for better refinancing terms when the other borrowings are due in FY10. There will be no prepayment penalty for the borrowings.

b) Asset enhancement initiatives
Part of the proceeds may be utilized for asset enhancement initiatives at Wisma Atria. The plot ratio of Wisma has not yet been fully utilized. Management is planning to increase the GFA by 40,000 sq ft which will cost approximately S$100m.

c) Acquisition
SGREIT sees acquisition opportunities in mature markets such as Singapore, Australia and Japan that could arise as credit market remains tight.

2) Property Valuation

- The decline in property valuation was largely due to its office assets. This situation was similar to CapitaCommercial Trust, where independent valuers have assumed higher cap rate (15 bp increase for SGREIT's Singapore office assets) and steeper decline in office rents in the valuations.
- Valuations of retail properties remain largely unchanged.

3) Credit market condition remains challenging

Local lenders have been filling the lending void that has been left behind by foreign banks that have either pulled out or scaled back their operations in Singapore. Demand for real estate loan may be too much for the local lenders to absorb and thus leading to the tight credit market condition. The CMBS market remains shut.

Starhill Global REIT - 1-for-1 rights issue at S$0.35 per rights unit

Starhill Global REIT has announced a fully underwritten renounceable 1-for-1 rights issue at S$0.35 per rights unit to raise S$337.3m. The rights units are priced at a 45.3% discount to last closing price of S$0.64. The company intends to pare down existing debts, pursue acquisitions and embark on asset enhancement initiatives. Rights units are entitled to distribution accruing starting 1 Jul 09.

The joint lead managers and underwriters of the rights issue are DBS, Merrill Lynch and Credit Suisse. YTL Corporation has undertaken to sub-underwrite up to 75% of the total rights issue. EGM will be held on 13 Jul 09 to seek approval from unitholders for whitewash resolution to waive the rights to receive mandatory offer from YTL.

Starhill Global valued its portfolio of investment properties at S$1,954.6m as at 15 Jun 09, a decline of 7.1% from valuation conducted on 31 Dec 08. The company's gearing has therefore increase from 31.1% to 33.4%. The 1-for-1 rights issue will reduce gearing to 20.7%.