Investment Highlights

• We maintain BUY on Pavilion REIT (PREIT) with a higher fair value (FV) of RM1.59/unit (from RM1.56/unit previously) based on dividend discount model (DDM).

• The increase in our FV is mainly attributed to the strongerthan-expected rental income from Elite Pavilion Mall, partially offset by higher risk-free rate due to a surge in 10-year Malaysian Government Securities (MGS) to 4.3% from 3.9%. No changes to our neutral 3-star ESG rating (Exhibits 5, 6).

• PREIT’s distributable income of RM188mil in 9MFY22 (Exhibit 1) came in above our and consensus' expectations. It accounted for 80% of our and 82% of consensus’ FY22F earnings.

• The variance to our forecast was mainly due to the betterthan-expected rental revenue from Elite Pavilion Mall.

• We raise our distributable income estimates by 7%/7%/6% for FY22F/FY23F/FY24F. This is after increasing our assumption on the monthly average rental per net lettable area (NLA) of Elite Pavilion Mall to RM23/sq ft from RM20/sq ft following our observation of a stronger rental income in 9MFY22.

• In 3QFY22, PREIT’s gross revenue rose 27% YoY due to higher rental revenue and income from advertising. Net property income (NPI) surged 90% YoY to RM90mil. This was supported by lower operating expenses (-19% YoY) given the lower rental assistance offered to tenants. As a result, distributable income jumped 2.9x YoY to RM64mil.

• On a QoQ comparison, PREIT’s 3QFY22 gross revenue expanded 2% while NPI improved 9%. The decrease in property operating expenses in 3QFY22 was mainly attributed to lower provisions for doubtful debts as compared to 2QFY22.

• PREIT’s debt-to-asset ratio stayed at 35%, well below the REITs’ statutory limit of 50% (statutory limit after 31 December 2022).

• PREIT proposed a gross distribution per unit (DPU) of 2.1 sen in 3QFY22, which represented a distribution payout ratio of 100%. It was 2.8x of the 0.73 sen declared in 3QFY21 and 2% higher than the pre-pandemic level (3QFY19) of 2.04 sen. Its distribution in 3QFY22 will be paid together with the distribution in 4QFY22 due to its semi-annual distribution policy.

• QoQ, average occupancy rate increased marginally to 80% from 79%. The improvement was mainly attributed to the improvement in occupancy rates of all its retail malls. Meanwhile, the occupancy rate for its office in Pavilion Tower remained stable at 74% (Exhibit 3).

• We understand from management that the rental reversion in 3QFY22 is largely flattish as some of the tenants will still require some time to recover to their pre-pandemic sales level.

• The occupancy rate in Da Men Mall expanded to 61% in 3QFY22 from 59% in 2QFY22. We expect the occupancy rate in Da Men Mall to rise to over 70% by the end of FY22 as PREIT has secured new tenants including A&W, Subway and Big Pharmacy.

• The recent aggressive policy rate hikes in the United States (US) have caused high volatility in 10-year MGS yield, which closely followed the rising trend of 10-year US Treasury (UST). However, we anticipate that the uptrend in 10-year UST yield to be tapering off with the expectation that the Federal Reserve may ease off aggressive rate hikes after the end of 2022 as a result of weaker economic data.

• Meanwhile, we anticipate the yield spread to be widening from FY22F onwards with the gradual recovery of retail footfalls and tenant sales, which translates into a higher distribution yield of 7% in FY22F-24F vs. 4% in FY21. We expect PREIT to be appealing to yield-seeking investors with its higher yield spread against 10-year MGS (Exhibit 4).

• PREIT currently trades at a compelling FY23F PE of 15x vs. its 2-year average (pre-pandemic FY18-19) of 19x. We also like the stock due to its key assets which are strategically located in the capital of Malaysia, providing a good platform for new international brands to establish footholds for expansion into the Malaysian market while supporting demand for retail space at the malls. Looking forward, we foresee a gradual pick-up in retail footfalls and tenant sales with the reopening of international borders.

Source: AmInvest Research - 28 Oct 2022