• Starhill Global REIT renewed its master lease contract in Malaysia with a higher rental rate but with the condition that Starhill Gallery will undergo an AEI.
• Income disruption from AEI will be supplemented by manager’s management fee. But we trim our forecasts as we had earlier factored in growth for Starhill Gallery.
• Maintain ADD on attractive dividend yield, with a lower DDM-based Target Price.

Entered Into New Master Tenancy Agreements With Katagreen

• STARHILL GLOBAL REIT (SGX:P40U) announced that it has entered into new conditional master tenancy agreements for Starhill Gallery and Lot 10 Property in Malaysia with the current master tenant, Katagreen Development Sdn Bhd. The existing agreements will expire in Jun 2018. The new master tenancy agreement is conditional upon unitholders’ approval.

Secured Higher Rent But Contingent Upon An AEI at Starhill Gallery

• Under the new agreements,
  • Lot 10’s lease tenure will be nine years with a step-up of 6% every three years which will take effect on 28 Jun 2019, immediately upon the expiry of the existing agreement.
  • Starhill Gallery’s lease tenure will be 19.5 years with a 4.75% step-up every three years. The renewal of the agreements is contingent upon an RM175m (S$58.1m) AEI in Starhill Gallery which is expected to take two years. Due to the AEI, the rent step-up of Starhill Gallery will only take effect in the 4th year after the renewal. Starhill Gallery will be renovated in phases, so Starhill Global REIT will still receive a rent of RM26m (S$8.6m) during the AEI period in FY20-21.

Neutral Impact on DPU, Offset by Management’s Fee Paid in Units

• The AEI will be funded by borrowings. Assuming a total borrowings of RM193m (including capex for AEI and other transaction fees) at an assumed interest rate of 3.5% p.a., its gearing will increase marginally from 35.5% as at 30 Jun 2018 to 36.7%.
• Despite the income disruption at Starhill Gallery and higher interest expense which will commence after the completion of the AEI, impact on Starhill Global REIT's DPU from the AEI is expected to be neutral as the shortfall will be supplemented by manager’s management fee paid in units.

Timely Proposal to Ensure Income Stability

• Retail supply within a 10km radius from the two properties is expected to increase by a high 31% from 2018 to 2023 which is likely to exert pressure on rental and occupancy rate of its malls, especially Starhill Gallery which had its last major renovation in 2005. As such, we think that the proposal is timely as it will help to ensure income stability as competition intensifies.
• The new master lease agreement essentially lengthens Starhill Global REIT's gross rent weighted average lease expiry (WALE) from 4.2 years as at 31 Dec 2018 to 6.4 years.

Maintain ADD With a Slightly Lower DDM-based TP

• Even after factoring in management’s fee paid in units, we trim our FY20-21 DPU forecasts by 0.7-0.8% as we had factored in growth for Starhill Gallery previously. While this reduces our Target Price, we maintain ADD on Starhill Global REIT for its attractive yield.
• Re-rating catalyst includes eviews; downside risk includes weaker Singapore retail segment.

Source: CGS-CIMB Research - 19 Mar 2019