Despite a strong finish for FY2022 ended Dec 31, 2022, Suntec REIT faces a challenging outlook ahead, say analysts.
Suntec REIT (Suntec) has a portfolio of office and retail properties in Singapore and Australia. Its most prominent asset is Suntec City, which comprises four office towers, a retail mall and a convention centre.
On Jan 20, Suntec REIT’s managers reported a distribution per unit (DPU) of 4.074 cents for the 2HFY2022 ended December, 9.7% lower than the DPU of 4.512 cents reported the year prior. According to the REIT manager, the y-o-y decline was attributable to a sharp increase in financing costs.
During 2HFY2022, distributable income fell by 9.0% y-o-y to $117.4 million.
In a Jan 25 note, DBS Group Research analysts Rachel Tan and Derek Tan have the highest target price among research houses mentioned here, maintaining a “buy” call and $1.60 target. This represents a 15% upside against its last traded price of $1.39 on Jan 20.
The DBS analysts point to a strong recovery seen from Singapore assets, especially Suntec City Mall and Suntec Convention Centre. “[Suntec REIT’s] portfolio valuation [is] stable, held up by Singapore assets. Portfolio occupancy inched up marginally by 1 percentage point (ppt) q-o-q to 98%, mainly from Singapore assets. Suntec City Office occupancy inched up further to 99.9% and Suntec City Mall occupancy improved +1.6 percentage points to 98.3%.”
See also: Suntec REIT reports 9.7% drop in 2HFY2022 DPU of 4.074 cents
DBS expects positive rental reversions in 2023 for Singapore retail to be 5% to 10% while the Singapore office is expected to moderate to 4% to 5%. “Despite tech demand for office space having moderated, management believes demand from family offices (albeit smaller bite size) and recovery of some industries (such as shipping or logistics) will remain.”
Despite “challenging macroeconomic conditions”, the DBS analysts believe Suntec REIT’s strong Singapore portfolio will continue to support the performance with growth riding on the return of Chinese tourists to Singapore.
“Suntec has maintained its capital management ratio despite rising interest rates, and we believe management will actively ensure capital management will be sustainable until interest rates stabilise, which appears to be soon,” write the DBS analysts. “Currently, Suntec is trading at 0.6x price-to-book (P/B), below -1 standard deviation (s.d.) of its historical range. At these levels, we believe most of the headwinds are priced in.”
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The analysts have, however, cut their DPU assumptions for FY2023 due to higher interest costs. “We believe our estimates are conservative and below consensus,” they note, adding that “the manager is looking at opportunities to recycle capital through the divestment of non-core properties, which will address its gearing concerns over time.”
Vulnerabilities in low hedge, tech exposure
Meanwhile, RHB Group Research analyst Vijay Natarajan is staying “neutral” on Suntec REIT maintaining his target price of $1.47 even though the REIT’s operational numbers surprised on the upside. Natarajan’s target price includes a 2% environmental, social and governance (ESG) premium based on RHB’s proprietary methodology.
Market concerns over asset value declines and potential gearing breaches proved unfounded, says Natarajan in a Jan 25 note, as the REIT’s Singaporean asset values rose, more than offsetting overseas weaknesses. “But the outlook is moderated by a mix of slowing demand, cost pressures, and steep interest cost rises. While valuation remains inexpensive, Suntec REIT’s relatively low hedge position and exposure to the tech sector makes it vulnerable.”
Looking ahead, Suntec REIT’s overall financing costs in FY2023 are expected to climb to 3.6%, up from 2.94% p.a. In 2022, says Natarajan. “Management guided that every 100 basis points (bps) increase will result in 21% DPU impact. Suntec REIT remains on the lookout for divestments in Singapore and Australia, but only at the right price, which we believe is above book value.”
The analyst has lowered his DPU estimates for FY2023 to FY2024 slightly to 1%, from 2% previously.
A sigh of relief
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Citi Research analyst Brandon Lee has a target price of $1.40 on Suntec REIT while staying “neutral”.
“We have made the following assumptions in our dividend discount model (DDM) valuation: A risk-free rate of 3.5%; overall cost of equity of 9.8%; and terminal growth of 0%. We have not factored in any potential earnings accretion or dilution from any unannounced acquisitions. For revised net asset value (RNAV), we value Suntec REIT’s Singapore properties at a weighted average cap rate of 3.7%, with its Australia assets valued at cap rates of 5.1% and UK office at 4.3%.”
To Citi’s Lee, key risks include a sharp decline in economic activity, which could weaken retail and office space demand, cutting occupancy and rental rates and thus DPU and valuations; a sharp rise in interest rates, which could increase the cost of debt, lowering its DPU while increasing cost of capital and lowering its DDM valuation; and that a large proportion of its properties are located in the same development making it susceptible to a downturn in the micro-property market.
Other REITs have more diversified property portfolios, Lee adds.
Conversely, upside risks include stronger-than-expected take-up for retail or office space which would drive higher occupancies and rental reversion; earnings accretion from acquisitions; or lower-than-expected financing costs, says Lee. “Any of these risk factors could cause the shares to deviate from our target price.”
'Fair' distribution yield with attractive P/NAV
UOB Kay Hian analyst Jonathan Koh has also kept his "hold" call on Suntec REIT with a higher target price of $1.40, from $1.37 previously.
While the REIT's results stood below Koh's expectations, he noted that the REIT's operational performance for its Singapore portfolio was "strong". Its UK portfolio also saw "resilient contributions".
In 2HFY2022, the REIT's Suntec City Mall and Suntec Convention saw "strong recovery" with the former logging its third straight quarter of positive reversion. Suntec Convention is also seeing its recovery gaining momentum with its revenue increasing by three folds y-o-y, notes Koh.
In his report dated Jan 25, Koh has trimmed his DPU forecast for FY2023 by 2.4%.
"Management had previously guided capital distribution at $23 million for two years in FY2022 and FY2023, but has decided not to proceed with capital distribution in FY2023. This was offset by a stronger turnaround at Suntec Convention and improved cost efficiency at Suntec City Office and Suntec City Office," he writes.
Solid operating metrics but higher interest costs a drag
The team at OCBC Investment Research has given Suntec REIT a "sell" call even though it expects the REIT to benefit from the reopening efforts by the Singapore government. The reopening efforts should provide a boost to its retail, convention and office segments, notes the team. Meanwhile, the REIT's convention business would need to see larger-scale international events before a firmer recovery can happen, it adds.
That said, there may be uncertainties over the longer-term impact from the work-from-home (WFH) trends, even though more employers appear to be encouraging their employees to return to office, continues the team.
In Australia and the UK, the REIT's office portfolio is also expected to remain resilient.
However, the team writes that the REIT's asset valuations could be affected should interest rates remain elevated. Other downside risks include currency fluctuations, the REIT's relatively high aggregate leverage ratio and low interest rate hedges compared to peers, coupled with slower-than-expected divestment of its assets, the team adds.
"We cut our FY2023 DPU forecasts by 10.2% but raise that of FY2024 by 6.7% as we push back our assumptions for capital distributions of $23 million to FY2024," says the team. "Rolling forward our valuations, our fair value estimate declines slightly from $1.24 to $1.22."
As at 3.27pm, units in Suntec REIT are trading flat at $1.39.
