• Suntec REIT's share 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 Suntec REIT's 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.
• Maintain BUY rating on Suntec REIT (SGX:T82U) with new target price of S$1.95 from S$2.00, 24% upside with ~6% FY22F yield).

Office Rental Still Rising, Offsetting Rate Hike Impact

• Suntec REIT's 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 1Q22, and should grow by low-to-mid single digits this year, amid continued strength in Singapore office sector rental rates.
• Suntec REIT's overseas office assets (~35% of income) are typically on long leases, with annual rate escalation clauses (2-3% per year in Australia) and rent review (typically pegged to inflation index) in the UK. The positive rent growth mitigates the impact of rising interest rates.
• Suntec REIT has among the lowest hedges of the REITs – ~51% of debt is hedged, and every +50bps will have a ~-4.7% impact on DPU. Note that its floating rates are pegged to the S$ Swap Offered Rate or Singapore Overnight Rate Average (SORA), 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 S$38.8m, or S$3,300psf. Based on media reports (Suntec Office Sale) another floor has been put on the market at S$36m (S$3,600psf). The indicative psf sale price is ~50% higher than Suntec City’s office area’s end-2021 valuation of S$2,415psf.
• This indicates Suntec REIT’s book value per share of S$2.13 is very conservative, and the current Suntec REIT's share price traded 30% below its book value seems to be a bargain.

Suntec City's Retail and Convention Showing Good Improvement

• Suntec City mall registered flattish rent reversion in 1Q, after 7 straight quarters of negative rent reversions, with the occupancy rate up 1.3ppt q-o-q to 96% and a positive outlook for the rest of the year. Its convention segment – in the red for the past 2 years – is also expected to turn profitable in 2H22.

Divestment Still on the Cards

• Suntec REIT's 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 book value could further enhance Suntec REIT's book value and address its gearing (43.3% currently) and hedging concerns.

We Trim Suntec REIT's FY22-24F DPU by 1-3%

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

• Suntec REIT will release its financial results for FY2022 1H on 2022-07-27. For SGX listed companies' earnings release schedule, see Earnings Calendar.

Source: RHB Invest Research - 18 Jul 2022