SunCity: Hwang DBS upgrades to ‘buy’

Much awaited catalyst

• RM3.5 billion REIT targeted for mid-10, if market conducive. But rising interest rates could push 6-7% yield target higher

• ~RM560 million net proceeds for landbank expansion and REIT pipeline. Potential 11% earnings dilution post-REITs.

• Excluding REIT’s market cap and net proceeds, SunCity’s property development arm trading at only 5x 2011 PE

• Upgrade to “buy”, raising TP to RM4.70 (from RM3.10)

REIT dream finally coming true? SunCity has announced a list of eight assets (retail, hotels and offices) to be injected into its proposed REIT which has been shelved earlier due to the financial crisis. While details have yet to be finalised, we expect the disposal to be satisfied by cash and shares (SunCity will likely maintain a 33% stake, while GIC which owns 48% of Sunway Pyramid and Sunway Resort Hotel could also be a major shareholder). The REIT assets are estimated to be worth RM3.5 billion or average 7% yield. We understand management is targeting for 6-7% yield vs sector’s 8.5% – a premium for being the largest Malaysian REIT with visible acquisition pipeline (possibly another RM2 billion). But rising interest rates (2010F: 100bps) could force yields higher - every 100bps change, REIT valuation falls by RM419m or 12%.

REIT to help unlock value & improve ROA. We estimate net proceeds at ~RM560 million (after paying off ~RM750 million of REIT asset-related debts), which could be redeployed for landbank acquisitions and development of new investment properties.

We do not discount the possibility of special dividends (cash/REIT shares) to reward shareholders. Post-REITs, there may be a possible 11% earnings dilution as property investment currently contribute 57% of earnings. We expect minimal gains on disposal given the recent revaluation exercise.

Potential re-rating. If we assume 30% gearing, the REIT’s market cap works out to c. RM2.4 billion. Excluding its 33% stake in the REIT and RM560 million net proceeds, SunCity’s property development arm is trading at only 5x 2011 PE vs sector’s 10x.

Other potential catalyst will be stronger property sales in 2010 (RM1 billion target vs 2009’s RM410 million). We upgrade SunCity to “buy” (from “hold”) and raise TP to RM4.70 (from RM3.10) – assuming no discount for property investment and 30% discount for property development (similar to other mid-cap developers under our coverage).