Investment Highlights

• We maintain BUY on Pavilion REIT (PREIT) with an unchanged fair value (FV) of RM1.51/unit based on our dividend discount model (DDM), which incorporates a neutral 3-star ESG rating (Exhibits 6, 7). The FV implies a FY24F distribution yield of 5%, at parity to its 5-year median.

• We make no changes to our earnings forecast as PREIT’s FY22 distributable income of RM256mil (Exhibit 1) came in within our estimates, albeit above consensus'. It was 1% above our forecast and 9% above street estimates.

• We also take the opportunity to introduce our FY25F earnings with a growth of 6% on expectation of a normalisation of rental reversion of 5%-6% and stronger tenant sales.

• In FY22, PREIT’s gross revenue rose 17% YoY due to higher rental revenue and income from advertising. Net property income (NPI) surged 54% YoY, supported by lower operating expenses (-18% YoY) given the lower rental assistance offered to tenants.

• On a QoQ comparison, PREIT’s 4QFY22 gross revenue expanded 2% while NPI improved 7%. The decrease in property operating expenses in 4QFY22 was mainly attributed to lower mall maintenance costs.

• PREIT proposed a gross distribution per unit (DPU) of 4.3 sen in 4QFY22. The FY22 DPU of 8.4 sen represents a distribution yield of 6%.

• QoQ, the overall average occupancy rate for all segments rose to 82% from 80%. The improvement was mainly attributed to an increase in occupancy rate of all its retail malls, partially offset by a slight decline in the occupancy rate of Pavilion Tower to 73% from 74% (Exhibit 3).

• The FY22 rental reversion for Pavilion Kuala Lumpur (PKL) was 4%-5%. We foresee a stronger rental reversion of 5%-6% for PKL in FY23F/FY24F with the expectation of improving tenant sales brought on by the return of foreign tourists, particularly cash-rich Chinese travellers. Foreign tourists made up 30% of the shopper demographic in PKL prior to the pandemic.

• Meanwhile, the FY22 rental reversion for the remaining malls and Pavilion Tower were largely flattish as some of the tenants will still require some time to recover to their prepandemic sales levels.

• We understand from management that the occupancy rate in DM has breached 70% in January 2023 following the entrance of 2 new tenants. To achieve breakeven, management aims to secure at least 85% of occupancy rate through the intake of new tenants (particularly those in the food and beverage and educational industries) with competitive rates.

• We are also optimistic on the acquisition of Pavilion Bukit Jalil (PBJ), which is scheduled to be completed on 1HFY23. The lower monthly rental rate of RM9.50 psf vs. other prime malls in Klang Valley of RM12 psf provides ample upside for PBJ in terms of rental increment. Meanwhile, its occupancy rate is expected to hold steady at >80% postacquisition.

• We anticipate the Fed rate to peak in 1HFY23 as a result of weaker economic data and softening inflation. Our in-house economist projects another 0.50% hike in the Fed rate in 1HCY23 from the current level of 4.25%-4.5%. Meanwhile, the 10-year MGS yield is forecasted to be lower by the end of 2023 at 3.8%-4%. However, we do not rule out the possibility of a further decline in 10-year MGS yield if there are any signals pointing towards a shift in the Fed’s hawkish tone, which may potentially expedite the end of the rate hike cycle.

• We also foresee the yield spread from FY23F onwards to widen to 2% vs. 5-year median of 1%. Hence, we expect PREIT to be appealing to yield-seeking investors with its higher dividend spread against 10-year MGS (Exhibit 5).

• PREIT currently trades at a compelling FY24F PE of 17x vs. its 2-year average (pre-pandemic FY18-19) of 19x. Meanwhile, distribution yield for FY24F of 6% is attractive vs. current 10-year MGS yield of 3.8%.

• 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 occupancy rates and normalisation of rental reversion with the recovery of Malaysia’s economy and the return of China tourists in postpandemic era.

Source: AmInvest Research - 2 Feb 2023