1H22: Held Back By Higher Interest Rates
Operationally, management has done a superb job by generating positive rental reversion of 5.7% for the Singapore office portfolio and 3.2% for Suntec City Mall. Income from its JVs (MBFC, ORQ and Nova Properties) grew 5.5% yoy. Management intends to maintain capital distribution at S$23m per year for two years. Although 2022 distribution yield of 6.3% and P/NAV of 0.75x are attractive, we await a more opportune time to re-enter the stock. Maintain HOLD. Target price: S$1.72.
• Suntec REIT (SUN) reported DPU of 4.81 S cents for 1H22 (+15.8% yoy), which is below our expectations due to higher interest expense. The results included capital distribution from past divestment gains of S$11.5m.
• Singapore office: Benefitting from office upcycle. NPI increased 9.5% yoy in 1H22. The Singapore office portfolio maintained positive rental reversion at 5.7% in 2Q22, its 16th consecutive quarter of positive reversion. It completed 316,100sf of new leases and renewals. New tenants were mainly from banking & financial services (27%), technology, media & telecommunications (19%) and manufacturing & distribution (16%). Occupancy for the Singapore office portfolio was stable at 97.8%. Occupancy for Suntec City Office improved 0.8ppt qoq to 99.4%, while occupancy for One Raffles Quay (ORQ) eased 2.0ppt qoq to 93.8%. Positive rental reversion could moderate in 2H22 due to higher expiry rents of S$9.59psf/month.
• Suntec City Mall: Traffic begets sales. Gross revenue increased 21% yoy in 1H22. Shopper traffic and tenant sales have recovered since the easing of COVID-19-related restrictions in Apr 22. Tenant sales were 15% above pre-pandemic levels in Jun 22. Rental reversion turned around to a positive 3.2% in 2Q22. Occupancy inched marginally higher by 0.1ppt qoq to 96.1%. Management focuses on activity-based concepts and dining offerings and has introduced seven new brands in 2Q22. Management expects footfall to improve with atrium events, workers returning to their offices and the return of convention and tourist crowds. Occupancy is expected to maintain at above 95%.
• Suntec Convention: Long-awaited recovery has arrived. Revenue more than tripled yoy to S$12.4m. NPI turned positive in 2Q22 and was S$2.9m in 1H22. There were 300 events in 1H22 and management expects a similar volume of activities in 2H22. International MICE events are returning but on a smaller scale.
• Australia: Resiliency from long WALE of 5.2 years. Occupancy at 21 Harris Street and 477 Collins Street improved 1.7ppt and 0.4ppt yoy respectively to 92.7% and 98.7%. Effective rents for prime office space in Sydney and Melbourne are expected to improve due to flight to quality. SUN will create fully-fitted office suites to attract new tenants.
• UK: Resiliency from long WALE of 10.1 years. Occupancy at Minster Building is stable at 96.7%. Nova Properties remains fully occupied. Occupancy for the office market at Central London is expected to maintain stable occupancy at 92.2% due to limited supply. Management plans to enhance the patio and lobby area by adding a cafe.
• Mid-year revaluation. Valuation for the Singapore office portfolio increased S$119.1m or 2% to S$5,944.1m. Valuation for the UK portfolio increased £1.2m or 0.2% to £799.4m. SUN recognised revaluation gains of S$54.2m. NAV per unit has increased 1% to S$2.13.
• Office recovery has strengthened and broadened in Singapore. According to CBRE, rents for Grade A core CBD offices increased 7.6% yoy and 3.2% qoq to S$11.30psf/month in 2Q22. Strength in the office market was driven by the reopening with all employees allowed back to their workplaces since 26 Apr 22. AXA Tower commenced demolition. Vacancy for Grade A office space within core CBD tightened 0.1ppt qoq to 4.4%. Thus, office landlords have raised their rental expectations. Leasing activities are dominated by renewals. There were also new setups from the legal sector and non-bank financial institutions.
• Enhancing Suntec City Mall. SUN plans to enhance East Wing Level 2 of Suntec City Mall to improve tenant mix and traffic flow. The asset enhancement initiative will add NLA of 7,000sf and is expected to be completed by Nov 22. Capex is estimated at S$2m.
• Completed refinancing. Aggregate leverage eased slightly by 0.6ppt qoq to 43.1% in 2Q22 due to the revaluation gains. SUN secured new sustainability-linked loans of S$500m maturing in 2027/29 at interest rate of 3.5% in Apr 22. It does not have any borrowings maturing in 2H22. SUN has a healthy average term to maturity of three years.
• Sensitivity to higher interest rates. All-in financing cost rose 16bp qoq to 2.51% in 2Q22. Interest expenses increased by 8.4% yoy in 1H22. SUN has increased the proportion of borrowings hedged to fixed interest rates from 53% to 56%. Management expects financing cost to reach near 3% by end-22. Every 50bp increase in base rates is expected to reduce distributable income by 4.7%.
• We have trimmed our 2022 DPU forecasts by 1.2% due to higher financing cost.
• Maintain HOLD. Our target price of S$1.72 is based on DDM (cost of equity: 7.0%, terminal growth: 1.8%). SUN trades at a discount of 25% to NAV per unit of S$2.13.
SHARE PRICE CATALYST
• Positive rent reversion at Suntec City Office in 2022.
• Employees returning to work at Suntec City Office and resumption of events at Suntec Convention to trigger recovery in shopper traffic and tenant sales at Suntec City Mall.
• Full-year contributions from Minster Building in London, UK in 2022.