• BUY, new TP of SGD1.95 from SGD2.00, 24% upside with c.6% FY22F yield). Suntec REIT’s price has dropped by 15% from the peak in April, mostly on concerns over the increase in financing costs from the sharp spike in interest rates. We still think upside from organic income growth on its office and retail portfolio should more than offset the negative impact of its low debt hedge profile. It is trading at 0.7x P/BV – a stark contrast from the high premium paid in Singapore office transactions in the market.

• Office rental still rising, offsetting rate hike impact. Its Singapore office assets (almost half of its income) has had positive rental reversions for the last 15 quarters. Rent reversion was at 5.3% in 1Q, and should grow by low- to-mid single digits this year, amid continued strength in Singapore office sector rental rates. Its overseas office assets (c.35% of income) are typically on long leases, with annual rate escalation clauses (2-3% pa in Australia) and rent review (typically pegged to inflation index) in the UK. The positive rent growth mitigates the impact of rising interest rates. It has among the lowest hedges of the REITs – c.51% of debt is hedged, and every +50bps will have a c.-4.7% impact on DPU. Note that its floating rates are pegged to the SGD Swap Offered Rate or Singapore Overnight Rate Average, which typically lags US Fed rates, and does not rise by an equal proportion.

• Suntec City Office strata unit sales indicates huge valuation gap. In June, an entire office floor (30th storey) in Suntec City Tower 2 was sold at a record SGD38.8m, or SGD3,300psf. Based on media reports (Suntec Office Sale) another floor has been put on the market at SGD36m (SGD3,600psf). The indicative psf sale price is c.50% higher than Suntec City’s office area’s end-2021 valuation of SGD2,415psf. This indicates Suntec City’s BV/share of SGD2.13 is very conservative, and the current traded price of 30% below its BV seems to be a bargain.

• Retail and convention showing good improvement. Suntec City mall registered flattish rent reversion in 1Q, after seven straight quarters of negative rent reversions, with the occupancy rate up 1.3ppt QoQ to 96% and a positive outlook for the rest of the year. Its convention segment – in the red for the past two years – is also expected to turn profitable in 2H22.

• Divestment still on the cards. Management is still evaluating other divestment opportunities in its portfolio (possibly 177 Pacific Highway) and revaluating its redevelopment plans for Southgate Complex (50% stake), to take into consideration changing work-from-home trends and micro market demand. A potential divestment at a premium to BV could further enhance BV and address its gearing (43.3% currently) and hedging concerns.

• We trim FY22-24F DPU by 1-3% post tweaking interest cost assumptions. Suntec has an ESG score to 3.1 out of 4.0 – so we applied a 2% premium to its fair value to derive our TP.

Source: RHB Research - 18 Jul 2022