1H23: Singapore Stable But Overseas Contribution Craters
Distributable income dropped 29.7% yoy in 1H23 if we exclude capital distribution of S$11.5m. SUN achieved positive rental reversion of 10.5% for Singapore Office and 18.2% for Suntec City Mall in 2Q23. Contributions from overseas markets are affected by the depreciation of 6.1% for the Australian dollar against the Singapore dollar. 2023 distribution yield is fair at 6.0%, although P/NAV of 0.62x is attractive. Maintain HOLD. Target price: S$1.37.
RESULTS
• Suntec REIT (SUN) reported 1H23 DPU of 3.476 cents (-27.7% yoy), which is broadly in line with our expectations.
• Singapore Office: 20th consecutive quarter of positive reversion. Occupancy for the Singapore Office portfolio inched higher by 0.4ppt qoq to reach 99.3% and achieved positive rental reversion of 10.5% in 2Q23 (1Q23: +11.2%). Tenant mix is skewed towards banking, insurance & financial services (31%) and technology, media & telecommunications (29%). Suntec City Office and One Raffles Quay (ORQ) were fully occupied at 100%.
• Suntec City Mall: 5th consecutive quarter of positive reversion. Occupancy was stable at 98.3% in 2Q23. Rental reversion has picked up to +18.2% (1Q23: +16.5%), driven by new leases (34%) and renewal leases (66%). SUN introduced four new-to-market and 10 new-to Suntec brands in 1H23 and more exciting offerings will be added in 2H23. Tenant sales were 8% above pre-pandemic levels in 1H23.
• Contributions from Australia hit by weak Australian dollar. NPI from Australia dropped
6.7% yoy due to lower occupancy and higher interest expense for Southgate Complex in
Melbourne. Management plans to invest S$20m on asset enhancement initiatives to spruce
up 177 Pacific Highway, Southgate Complex and 55 Currie Street. The Australian dollar
depreciated by 6.1% yoy against the Singapore dollar.
• United Kingdom: Resilient performance despite weaker Pound sterling. NPI from Minster Building increased 7.8% due to break penalty of £1m received from one tenant. NPI from Nova Properties dropped 8.9% yoy due to the weaker Pound sterling. Management plans to enhance the outdoor retail area at Nova Properties. The UK portfolio has long WALE weighted by NLA of 9.3 years.
• Hurt by higher interest rates. Financing costs increased S$25.7m or 54% yoy in 1H23. Allin financing cost was stable at 3.64% in 2Q23. Aggregate leverage is elevated at 42.6%. The proportion of borrowings on hedged to fixed rates is 58%.
STOCK IMPACT
• Competition from new office supply. According to CBRE, rents for Grade A office space in core CBD has increased 4.4% yoy and 0.4% qoq to S$11.80psf/month in 2Q23 as vacancy tightened 0.2ppt yoy to 4.0%. Most tenants prefer to renew existing leases at higher rents to avoid incurring additional expenses for relocating. There was healthy demand from private wealth and asset management companies, legal firms, professional services, government agencies and flexible workspace providers. Going forward, rents could come under pressure due to the completion of IOI Central Boulevard Towers. CBRE expects rents for Grade A office space in core CBD to be flat for 2H23.
• Retail market has picked up. Leasing activities were boosted by new mall openings, such as Woodleigh Mall and Komo Shoppes. Demand was driven by F&B operators, especially cafes, fashion and beauty & health. Retailers have gained confidence due to tourism recovery and the return of office crowds. Rents at Orchard Road increased by 2.9% yoy, while rents at Suburban malls jumped by 3.1% yoy. CBRE expects a recovery of retail rents in 2023 due to continued tourism recovery and below-average new retail supply. Retailers are willing to pay higher rents to secure prime retail spaces.
• Mixed outlook. Management expects office demand to be muted with rents likely to plateau. Rental reversion for Singapore Office portfolio is expected to remain positive at high single digits. Revenue contribution is enhanced by the past 20 consecutive quarters of positive rent reversions. MICE events and the return of tourists would boost shopper traffic and tenant sales at Suntec City Mall. Tenant sales are expected to maintain above pre-pandemic levels. Suntec Convention benefits from the return of international events but full recovery is expected in 2024.
• Occupancy Down Under to slip slightly. Office vacancy in Sydney and Melbourne CBD is expected to increase from slowing demand and new supply hitting the market. In particular, Adelaide will be impacted by significant new supply in 2H23. Occupancy at 55 Currie Street in Adelaide is expected to drop from 100% to 59% in 4Q23 due to non-renewal for a government tenant. Contribution will be affected by leasing downtime and higher incentives. Management intends to build fully fitted office suites to attract prospective tenants who are cost-conscious.
• Working on divestments. SUN has divested three units with total NLA of 10,000sf at Suntec City Office at above S$3,000psf. Management will continue to explore potential divestment of mature assets and strata units at Suntec City Office to deleverage.
EARNINGS REVISION/RISK
• We trimmed our 2024 DPU forecasts by 3% due to higher vacancies at 55 Currie Street in Australia and Minster Building in the UK.
VALUATION/RECOMMENDATION
• Maintain HOLD. Our target price of S$1.37 is based on DDM (cost of equity: 7.0%, terminal growth: 1.5%). SUN trades at a discount of 38% to NAV per unit of S$2.08.
SHARE PRICE CATALYST
• Positive rent reversion at Suntec City Office and Suntec City Mall in 2023.
• Employees returning to work at Suntec City Office and resumption of events at Suntec Convention could trigger recovery in shopper traffic and tenant sales at Suntec City Mall.
