Investment Highlights

• We maintain our HOLD recommendation on Pavilion REIT (PREIT) with an unchanged fair value of RM1.43/share after changing our valuation methodology to the dividend discount model (DDM) from FY23F target distribution yield of 5%. No changes to our neutral 3-star ESG rating (Exhibit 9).

• We raise our distributable income estimate by 23% for FY22F and 5% for FY23F, after taking into account a higher occupancy rate for Pavilion Kuala Lumpur at 96% (from 92.5%) and lower other operating expenses. We do not expect rental waivers to be offered to tenants going forward as all businesses are now allowed to operate after the reopening of the economy and international borders.

• PREIT reported a distributable income of RM67.6mil in 1QFY22 (Exhibit 2). Excluding the write-back of an impairment loss of trade receivables, its distributable income of RM64.3mil came in above our expectations. It accounted for 36% of ours and 33% of consensus’ FY22F distributable income.

• The variance to our forecast was mainly due to the better-than-expected rental revenue and income from advertising coupled with lower rental rebates offered to tenants. A strong pick-up in retail footfall and tenant sales for the CNY festive season also contributed to an increase in rental revenue as rentals collected were based on either the higher of base rental rate or a portion of the tenant’s sales.

• In 1QFY22, PREIT’s gross revenue rose 10% YoY to RM139mil (Exhibit 2). The improvement was attributed to higher rental revenue and income from advertising. Net property income (NPI) climbed 60% YoY to RM94mil. This was supported by lower operating expenses (-75% YoY) as lower rental assistance offered to tenants. Elsewhere, utility costs surged 28% YoY after the expiry of the government subsidy for a 10% discount on electricity bill along with a higher electricity tariff surcharge. The reported distributable income jumped 101% YoY to RM68mil.

• The debt-to-asset ratio stayed at 35%, well below the 60% statutory threshold required by the Securities Commission (SC).

• PREIT is more sensitive to interest rate hikes as 64% of its borrowings is in floating rates. With our in-house economist expectation of 25bps rate hike in 2H2022, we have imputed a higher financial cost of 4.7% into FY22F earnings.

• Pavilion REIT proposed a first interim gross DPU of 2.2 sen in 1QFY22, which was double the 1.1 sen declared in 1QFY21 (Exhibit 2).

• Elite Pavilion Mall’s gross revenue rose 41% YoY to RM15.1mil while net property income soared 169% YoY to RM9.6mil in 1QFY22, mainly driven by a higher occupancy rate and lower rental waivers (Exhibit 4 & 5).

• The occupancy rate in Pavilion Kuala Lumpur improved slightly to 91% during the quarter, yet still below the pre-pandemic level of 98% while that of Da Men Mall remained low at 62% (Exhibit 5). The office occupancy rate in Pavillion Tower fell to 74%, below the peak of 86%–87% in 2019.

• We foresee the occupancy rate for Da Men Mall and Pavilion Tower to continue facing downward pressure due to the oversupply of retail and office spaces in Malaysia (Exhibit 5). This could likely lead to slightly negative rental rates offered to existing and new tenants to increase the occupancy rate moving forward.

• Looking forward, we foresee a gradual pick-up in retail footfall and tenant sales with the reopening of international borders and further relaxation of SOPs.

• Nonetheless, we remain cautiously optimistic about Pavilion REIT’s long-term prospect mainly due to: (i) rental reversions likely remaining flattish in FY22; (ii) higher borrowing costs from the potential rate hike in 2H2022 as 64% of its total borrowings is in variable rates; (iii) a bumpy outlook for retail sales amid the acceleration of inflation which could inevitably erode the purchasing power of consumers; (iv) narrowing yield spread against the 10-year Malaysian Government Securities (MGS) with an uptrend in the interest rate (Exhibit 6). Also, we do not rule out the possibility of stagflation, which could distort the firm’s rental revenue and income due to lower occupancy rates and negative rental reversion.

• Pavilion REIT’s distribution yield of 5.5% for FY22F is currently above our in-house economist forecast for 10- year MGS yield of 4.4%–4.5% in 2022.

Source: AmInvest Research - 29 Apr 2022