Buy: MBFC Acquired at 4% Yield, Growth Likely in 2014

MBFC acquisition to be financed via approximately 70:30 debt:equity
— Suntec REIT plans to finance the S$1,495,8m (total cost amounts to S$1,548.2m) acquisition of the one-third stake in MBFC with 1) proceeds from a private placement of new units and ii) a debt facility of S$1,105m. This would increase Suntec REIT’s debt/asset ratio to 41.5% from the current 33%. EGM is scheduled for 26 Nov 2010 and target date for completion of the acquisition is 31 December 2010.

 Initial yields from MBFC acquisition estimated at 4.0% — In the circular released, Suntec REIT disclosed that the net property income from MBFC is approximately S$60.6m for FY11. This includes dividend income, interest income and rental income support (net of all applicable taxes). Income support for FY11 is expected to be S$37.2m. As rental reviews and expiries will only begin in 2013, yields will be flat for the first three years. 10.1% of its lease will be subject to rental review in 2013 and 31.2% in 2014.

 Acquisition expected to be increase DPU by 1% — Based on Suntec REIT’s own projection, the acquisition will raise its FY11 DPU by approximately 1% from 8.611 cents to 8.699 cents. As our DPU estimates are higher for FY11, the acquisition will be DPU neutral in the initial years and accretive from 2014 onwards.

 TP maintained at S$1.69, Buy maintained — We have reduced our FY11 DPU estimates slightly by approximately 1% due to the slightly lower than expected NPI yield for the acquisitions of MBFC. Our TP remains unchanged the marginal decline in the initial years is offset by slightly higher NPI in 2014 and beyond.
BUY maintained

Valuation
Our target price of S$1.69 is derived from DDM. Inclusive of its 12-month forward DPU of 9.9cents, the stock should be worth at least S$1.79 per share.
We chose DDM as our valuation method as it is the most commonly used metric for valuing real estate investment trusts. We made the following assumptions in deriving our target price: 1) a risk-free rate of 3.4%; 2) an equity risk premium of 5%; 3) beta of 0.5; 4) a terminal growth rate of 0%.

Risks
We rate Suntec REIT shares Low Risk in accordance with our quantitative riskrating system, which tracks 260-day historical share-price volatility. We believe the following are key risks that could cause the shares to deviate from our target price. Downside risks: 1) A sharp decline in economic activity could weaken retail space demand, cutting occupancy and rental rates and thus DPU and valuations; and 2) A sharp rise in interest rates could increase the cost of debt, lowering its DPU while increasing cost of capital and lowering its DDM valuation; 3) A conflict of interest could arise as Suntec REIT is managed by ARA Trust Management, which also manages Fortune REIT, a Hong Kongfocused retail-property REIT listed on the Singapore Exchange; and 4) 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.