Suntec REIT: Upgrade on One Raffles Quay acquisition

Results are in line. Suntec REIT reported 3Q07 revenue of S$46.7m;
+6% YoY but flat QoQ. Distributable income was equally strong at S$30.m;
+23% YoY and +7% QoQ. At the DPU level, growth was more moderate at
+12% YoY and +7% QoQ to 2.1 cents. Growth was mainly due to the
increase in office revenue at Suntec City and Park Mall as well as the
newly acquired strata space from Suntec City. However, higher property
expenses eroded much of the better revenue. This led to cost to income
ratio rising from 24.4% (2Q07) to 26.9% (3Q07). The results are broadly in
line with our estimates.
Buys One Raffles Quay. Separately, Suntec's manager ARA Trust
Management (ARA) announced that it has acquired a one-third stake in
One Raffles Quay (ORQ) for S$941.5m from Cheung Kong. The acquisition
includes a rental top up of S$103.48m. In our opinion, the best way to view
this rental top up is in the form of a discount. ORQ's actual value net of the
income support is thus S$838m or a reasonable S$1,877 psf. No rental
details were provided; however, assuming an average rental of say S$10
psf/mth, this translates to an NPI of S$40.2m or a capitalized rate of 4.8%.
Presently Suntec is trading at a yield of 4.4%, so ORQ should be marginally
accretive. However, allowing for the rental top-up, an extra S$17.0m NPI
could be recognized. This in turn will boost ORQ's yield to 6.1% making
the acquisition very accretive. Even though this scheme is innovative to the
office sector, it has been used previously in the industrial REIT sector. In
light of this acquisition, we have adjusted our FY08F from 8.70 cents to
8.84 cents.
Upgrade to BUY with revised fair value of S$2.18. Over the last quarter,
Suntec has corrected from a peak of about S$2.10 to the current level of
S$1.86 or by about 11%, which is close to our fair value of S$1.82 (based
on asset size of S$4.5bn). However, in light of the ORQ acquisition, Suntec
has reached our target asset size. We thus revised up our target size to
S$5.5bn and hence our fair value to S$2.18. With over 17% potential upside
to our fair value and a FY08F trading yield of 4.75%, the investment case
for Suntec is looking compelling. We thus upgrade our rating from HOLD
to BUY.