Investment Highlights

• We downgrade our recommendation on Pavilion REIT to HOLD from BUY with a lower our fair value (FV) of RM1.43 (from RM1.50 previously). Our valuation of Pavilion REIT is based on a target distribution yield of 5% over a lower FY23F distribution income. No adjustment to our ESG scoring of 3 stars (Exhibit 8).

• We cut our distribution income forecast for FY23F by 4.4% to RM217.3mil (from RM227.3mil) while raising our expenses assumption. We maintain our distribution income forecast for FY22F and FY24F.

• Pavilion REIT’s FY21 distribution income of RM135mil was slightly above our and consensus expectations. It accounted for 106.5% of our earlier full-year forecast of RM126mil and 105.0% of consensus full-year estimate. The key variance to our projection was mainly due to higher-than-expected gross rental income.

• QoQ, gross revenue climbed 9% to RM121.4mil in 4QFY21 vs. RM111.7mil in 3QFY21. This was contributed by a recovery in shopping malls’ footfall. Distribution income surged 156% QoQ to RM56.6mil in 4FY21 vs. RM22.1mil in 3QFY21. This was mainly due to lower rental rebates given to tenants, which have been reflected by the decline in property operating expenses.

• In FY21, Pavilion REIT’s gross revenue and distribution income rose 9.1% and 7.0% YoY to RM479.3mil and RM134.7mil respectively (vs. RM439.4mil and RM125.8mil in FY20). The improvement was due to the lower rental assistance required by tenants, a reversal in impairment trade receivables as well as lower borrowing cost amid the low interest rate environment in FY21 (Exhibit 1).

• In 4QFY21, the occupancy rate of Pavilion Kuala Lumpur Mall declined to 90.2% vs. 92.3% in the previous quarter but stayed above 90%. Meanwhile, the occupancy rates of Intermark Mall and Elite Pavilion Mall were 83.6% and 86.4% respectively. For Da Men Mall, the occupancy rate improved slightly to 62.3% in 4QFY21 vs. 57.6% in 3QFY21 (Exhibit 1).

• Pavilion REIT’s distribution per unit (DPU) rose 7% YoY to 4.4 sen in FY21 vs. 4.1 sen in FY20. Conversely, the DPU yield dropped to 3.3% in FY21 vs. 4.6% in FY20 due to higher number of units in circulation as management fees were paid in units.

• The net gearing ratio increased slightly to 48.2% in FY21 vs. 44.8% in FY20 with 42.5% of its borrowings in a floating rate.

• The tenancy expiries on NLA in FY2022 are substantially high, amounting to 61%, 62%, and 56% for Pavilion Kuala Lumpur Mall, Intermark Mall, and Elite Pavilion Mall respectively (Exhibit 2).

• Management has provided an update during the analyst briefing yesterday. Here are the highlights:
  1. Major tenancies are due to expire in FY2022. This will result in a higher projected tenancy expiries on NLA. However, management is confident of renewing the tenancy agreements with its anchor tenants.
  2. The progress on the potential acquisition of Pavilion Bukit Jalil is still at the due diligence stage. It is expected to take 9 months to 1 year to complete.
  3. Management also highlighted the robust sales across all its branded stores in 4Q last year led by the recovery of footfall in the malls after the reopening of the economy.

• We have turned cautious on Pavilion REIT’s outlook in FY22–23F due to: (i) the rental reversion rate that is unlikely to recover to the pre-pandemic level in FY22; (ii) higher borrowing cost incurred in FY22–23 due to potential hikes in the interest rate by 25bps 2HCY22; and (iii) negative yield spread between Pavilion REIT and the 10-year Malaysian Government Securities (MGS).

Source: AmInvest Research - 28 Jan 2022