Analysts' Recommendation

Macquarie: Starhill REIT 'Outperform'; target price RM1.14

Macquarie Research, 20 September 2006

Gapping up?

We reiterate our positive view on Starhill REIT after reviewing their prospects.

Over the next 12 months, we understand that there will be some novation of the subleases from Autodome to the REIT. Autodome (which is wholly owned by YTL Corp) has a master lease, which accounts for about 40+% of the rental income of Starhill Gallery and Lot 10. The subleases are expected to expire from Nov 2007. We believe that the novation would be positive for Starhill REIT as the underlying rentals of the subleases are higher than Autodome’s lease rates.

Starhill REIT is also seeing positive developments with tenants. We gather that US apparel group Gap has chosen Lot 10 to open its first store in Malaysia expected in end-2006/early 2007. Meanwhile, Louis Vuitton has recently opened its expanded store in Starhill Gallery.

We see the possibility of acquisitions for Starhill REIT within the next 12 months. The immediate identifiable assets are the Ritz-Carlton Hotel and Ritz-Carlton Residences would be from its sponsor, YTL group and ultimate major shareholder. With gearing at 14% of assets at end FY06, Starhill REIT has the capacity to fund the acquisition entirely by debt. The gearing limit for Malaysia
REITs is 50%. As a sensitivity analysis, assuming that Starhill REIT acquires RM400m of assets with a yield of 7.5%, we estimate the potential DPU accretion is 12% based on funding entirely by debt at 5.2%.

Earnings revision
No change.

Price catalyst
12-month price target: RM1.14 based on a DCF methodology.
Catalyst: Asset acquisition. Higher-than-expected rentals.
Regulatory changes.

Action and recommendation
We reiterate our Outperform rating on Starhill REIT. The price has improved recently on the back of positive regulatory changes (particularly the reduction in withholding tax from 28% to 20% on distribution by REIT to foreign investors) and we see scope for better performance. Over the next 12 months, we see the potential for income to surprise on the upside from the novation of subleases and acquisition potential. We believe that the potential has not been priced in.

Valuation wise, we believe that Starhill REIT is attractive. The DPU yield spread over the risk-free rate is about 290 bps (or 150 bp assuming a 20% withholding tax). Starhill REIT is also trading at a 7% discount to its NAV.