Date: 23 September 2024
Broker: OCBC Investment Research
Recent Share Price Outperformance
Suntec REIT’s share price has rallied significantly since 31 July 2024, with a 16.1% increase as of 19 September 2024, outperforming the FTSE ST All-Share REIT Index, which rose by 9.8% during the same period. This rise is largely attributed to investor sentiment driven by the anticipation of a Federal Reserve rate cut cycle. Suntec REIT, which holds a higher proportion of floating rate debt, is expected to benefit from the reduction in borrowing costs as rates decline. However, the report cautions that a rebound in the 10-year U.S. Treasury yields, depending on the outcome of the U.S. presidential elections, could pose a risk to this sentiment.
Operational Challenges
Despite the recent share price surge, Suntec REIT’s operational performance will need to improve to sustain the stock’s upward momentum. The report highlights the softening of Singapore office market rents, which could negatively impact Suntec City Office’s rental income. Expiring rents in FY25 are expected to be SGD 10.05 per square foot per month (psfpm), which is higher than the FY24 expiring rents of SGD 9.47 psfpm as of 30 June 2024. While the REIT’s Singapore retail operations are anticipated to remain resilient, uncertainties loom over its overseas properties.
Modest Benefits from Rate Cuts
Though Suntec REIT’s share price has been lifted by the expectation of further Federal Reserve rate cuts, the financial benefits may not materialize as significantly as expected in the short term. The REIT’s all-in financing costs stood at 4.02% as of 30 June 2024, and these costs are unlikely to see a significant reduction in the near future due to a large number of interest rate hedges expiring in FY25. These hedges were previously entered at lower rates, and as they expire, Suntec REIT may not be able to lower its borrowing costs as quickly as the market anticipates.
Downgrade to “Sell” Rating
Given the divergence between Suntec REIT’s share price performance and its fundamental operational outlook, OCBC Investment Research has downgraded the REIT’s rating to “Sell.” Despite the downgrade, the fair value estimate has been raised slightly from SGD 1.15 to SGD 1.19, reflecting a lowered risk-free rate assumption by 50 basis points to 2.50%. The report also identifies key risks to this negative view, such as faster-than-expected divestments of non-core assets and a sharper-than-anticipated decline in borrowing costs in the event of a soft landing for the economy.
ESG Considerations
Suntec REIT’s ESG rating was downgraded in November 2023, primarily due to weaknesses in its staff management practices. The REIT lacks some of the best practices observed among its peers, such as conducting annual employee satisfaction surveys and offering apprenticeship programs to address recruitment and retention challenges. Additionally, while the REIT’s board has an independent majority, there is no fully independent pay committee, and there is limited disclosure on executive compensation.
On the environmental front, Suntec REIT performed well, with 100% of its portfolio certified to green building standards as of FY22. This is significantly higher than the industry average of 29% as of May 2023, demonstrating the REIT’s commitment to sustainability. Moreover, the REIT’s business ethics framework, including board-level oversight and whistleblower protection provisions, is ahead of most of its global peers. However, challenges remain in areas such as employee management and transparency.
Conclusion
While the market has reacted positively to the prospect of rate cuts, Suntec REIT’s operational fundamentals suggest that the stock may have run ahead of itself. OCBC Investment Research maintains a cautious outlook, citing the need for operational improvements and the potential risks associated with expiring interest rate hedges. The downgrade to “Sell” reflects these concerns, despite a slight increase in the fair value estimate.
