Investment Highlights

• We maintain our BUY recommendation for Pavilion REIT (PREIT) with a reduced fair value of RM1.50 (from RM1.59 previously) based on an FY23F target distribution yield of 5%. We make no ESG related adjustment to our FV based on our 3-star rating (Exhibit 4).

• We cut our distributable income forecasts by 20% to RM216.4mil for FY21F, 16% to RM179.6mil for FY22F and 6% to RM227.3mil for FY23F. Likewise, our FY21F-23F distribution projections have been reduced by 5%-21% to 4.1 sen, 5.9 sen and 7.5 sen respectively, translating to yields of 3%, 4.2% and 5.3% respectively.

• Our lower forecasts largely reflect more conservative assumptions for rental recovery at the malls, taking cue from the recent spike in Covid-19 cases locally and globally, which could lengthen the timeline for our country to open our borders to international tourists, thus dampening the footfall recovery at PREIT's malls. Historically, international tourist footfall makes up 30% at Pavilion Mall, which contributes to over 90% of PREIT’s net property income (NPI).

• PREIT's 1HFY21 distributable income of RM56mil (+14% YoY) missed expectations, accounting for only 35% of our full-year FY21F projection and 33% of full-year consensus estimates. We believe the key variance came largely from higher-than-expected rental rebates and lower than expected occupancy rates at Pavilion KL Mall.

• Nevertheless, PREIT’s proposed distribution income increased by 13.7% YoY to 1.8 sen per unit for 1HFY21 (compared with 1.6 sen per unit in 1HFY20) due to the improved results.

• PREIT's 1HFY21 revenue of RM251mil eased by 3.7% YoY, mainly due to lower occupancy rates of its shopping malls with the non-renewal of some expired tenancies, as well as lower income from marketing events and advertising.

• However, 1HFY21 NPI improved by a slight 2% YoY to RM107mil mainly due to lower operating expenses incurred, which dropped by 8% YoY in the absence of contributions made in 1HFY20 to the Malaysian Government to fight the Covid-19 pandemic and lower provision for doubtful debts. There were also savings from marketing and promotional expenses, in line with the drop in marketing events and advertising.

• All in, 1HFY21 distributable income improved by 14% YoY to RM56mil, mainly because of the higher NPI and lower borrowing costs for the quarter in tandem with lower interest rate.

• On a QoQ comparison, PREIT's gross rental revenue eased slightly by 1% to RM125mil. To a larger extent, the company's NPI tumbled by 19% QoQ to RM48mil in 2QFY21 as property operating costs rose 15%, which include the additional rental rebates given to tenants categorised in non-essential services amidst the tighter MCOs implemented during the quarter. Likewise, distributable income shrank by 33% QoQ to RM22.5mil.

• They key takeaways from its analyst briefing yesterday are:

• Under the recent lockdown, the Pavilion KL Mall only recorded 10% of pre-pandemic footfalls during 2QFY21. Meanwhile, the suburban malls (ie. Intermark Mall and Da Men Mall) recorded better performances with 25%-30% of pre-pandemic footfalls, thanks to higher percentage of essential services in the tenant mix at the malls. The company is confident that footfalls will rebound strongly once SOPs are relaxed as vaccination rates continue to increase, mainly supported by the local tourist traffic and pent-up domestic demand, similar to what have been observed in the past.

• The occupancy rate for Pavilion KL Mall declined slightly to 93.9% during the quarter (from 96.4% in 2QFY20), mainly due to non-renewal of some expired tenancies. Despite of the lower occupancy rate, the company guided that demand for retail space may still be supported mainly by new international brands that plan to expand and set footprints in the country.

• PREIT’s debt-to-asset ratio stayed at 30% as compared to 1HFY20, well below the regulatory threshold of 60% (temporarily raised from 50% until 31 December 2022 by the Securities Commission as a Covid-19 relief measure). At current levels, we believe PREIT still has ample headroom to gear up for new acquisitions. The company guided that it does not rule out potential acquisitions if yield accretive assets emerge, which will further drive the REIT’s medium to-long term growth beyond the recovery from Covid-19.

• We believe PREIT’s long-term outlook remains positive given the group’s prominent and strategic assets which are located in the heart of the financial capital in Malaysia, underpinning competitive advantages as compared to its peers. These provide a good platform for new international brands to establish footprints for expansion into the Malaysian market, thus supporting demand for retail space at the malls. We like PREIT as a post-pandemic earnings recovery and distribution yield play which offers more than 4% for FY22F and beyond amidst a low interest rate environment that is likely to be prolonged.

Source: AmInvest Research - 6 Aug 2021