Compelling investment case; initiate with BUY rating

High quality assets. Starhill Global REIT (Starhill) owns 13 properties across five countries with retail and office components. Starhill derives some 60% of its gross revenue from Singapore, where it holds stakes in Wisma Atria and Ngee Ann City, landmark assets on Orchard Road, Singapore’s premier shopping street. Other assets including the newly acquired Malaysia assets are also in high traffic, central locations, with mid-high end or luxury positioning.

Strong sponsor. Sponsor YTL Corporation Berhad (YTL), one of the largest listed companies on the Bursa Malaysia, holds a 28.8% stake in Starhill. YTL has clearly outlined its vision for Starhill as its main platform for ownership of prime retail and commercial properties in the Asia-Pacific region. The benefit is not just in terms of indirect and/or direct financial support – YTL has strong relationships with major global retailers such as Moet Hennessy Louis Vuitton (LVMH) and the Swatch Group.

Stable income profile with growth potential. Starhill enjoys a number of long-tenure leases and master leases that provide long-term income stability to the REIT along with potential for rental upside. Approximately 42% of Starhill’s revenue is derived from such leases (including the Malaysia assets). While we still see weakness in the local office market (estimated 13% of gross revenue), we believe retail sales will be on an uptrend in most of Starhill’s operating markets as those countries emerge from recession and begin to experience economic growth. We also see scope to grow income through asset enhancement initiatives and acquisitions.

Compelling investment case.Starhill is trading at a 34% discount to its book value (as of 31 Mar 2010). This compares favorably to Singapore-only retail and diversified retail/office REITs and overseas-only retail REITs which are trading at an average 1.0x and 0.8x price-to-book respectively. We believe the significant discount is unjustified when considering Starhill’s high-quality assets, healthy balance sheet and its strong sponsor. We value Starhill using our DDM-based valuation model, assuming a discount rate of 6.7% and a conservative terminal growth rate of 0.5%. This yields a fair value estimate of S$0.65, which is fairly reasonable, in our view, at only 0.79x price-to-book. This also translates to an estimated upside of 19% to the current price and an estimated total return of 26%. We initiate coverage of Starhill with a BUY rating. Key risks to our view include macro-economic headwinds, increasing competition in the retail space, foreign exchange risk and changing regulatory and taxation regimes.