Investment Highlights

• We maintain BUY on Pavilion REIT (PREIT) with a higher fair value (FV) of RM1.62/unit (from RM1.51/unit) based on our revised dividend discount model (DDM), which incorporates a neutral 3-star ESG rating (Exhibits 6, 7). The FV implies a FY24F distribution yield of 6%, 1 standard deviation above its 5-year median.

• PREIT’s 1QFY23 distributable income of RM72mil (Exhibit 1) came in within our and consensus’ estimates. It accounted for 26% of our FY23F earnings and 27% of consensus.

• Nevertheless, we raise our FY24F/FY25F distributable income by 7%/8% to reflect higher rental rate assumptions for Pavilion Bukit Jalil (PBJ) (Exhibit 4). As at 28 Feb 2023, PBJ has secured committed tenancy of 81% with an average monthly rental rate (MRR) of RM9.43 psf, which is higher than our earlier FY24F/FY25F average MRR assumption of RM7.70 psf/ RM8.10 psf.

• In addition, we increase our FY23F/FY24F distribution per unit by 1%/20% after adjusting PREIT’s weighted average number of unit in issue to 3.6bil from 4bil to account for the issuance of tranche 2 of the private placement, which is 2QFY25 instead of our previous assumption of 2QFY23.

• In 1QFY23, PREIT’s gross revenue rose 16% YoY due to higher rental revenue and advertising income. However, operating expenses grew 34% YoY, mainly due to increase of electricity tariff surcharge by the government from 3.7 sen to 20 sen per kilowatt hour (kWh) from 1 January 2023 onwards. Meanwhile, PREIT also incurred higher marketing cost for Chinese New Year and celebration of Pavilion Kuala Lumpur Mall (PKL) 15th anniversary.

• On a QoQ comparison, PREIT’s 1QFY23 gross revenue expanded 7% while NPI improved 5%. Property operating expenses rose 11% QoQ in 1QFY23 mainly from the increased electricity tariff surcharge.

• QoQ, the overall average occupancy rate for all segments rose to 84% from 82%. 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 72% from 73% (Exhibit 3).

• We are projecting 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. Foreign tourists made up 30% of the shopper demographic in PKL prior to the pandem• Meanwhile, the FY23F rental reversion for the remaining malls is expected to be lower than PKL at 2%-3% as some of the tenants still require some time to recover to their pre-pandemic sales levels.

• The rental reversion for Pavilion Tower is anticipated to be flattish in FY23F given the persistent oversupply of office spaces in Kuala Lumpur city centre.

• We anticipate the Fed rate to peak in 1HFY23 as a result of weaker economic data and softening inflation. Our inhouse economist projects another 0.5% hike in the Fed rate in 1HCY23 from the current level of 4.75%-5%. Meanwhile, the 10-year MGS yield is forecasted to be 3.8%-4% by the end of 2023. However, we do not rule out the possibility of a further decline in 10-year MGS yield if there are 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 FY24F onwards to widen to 3% vs. 5-year median of 1%. Hence, we expect PREIT to be appealing to yield-seeking investors with its higher distribution spread against 10-year MGS (Exhibit 5).

• PREIT currently trades at a compelling FY24F PE of 14x vs. its 2-year average (pre-pandemic FY18-19) of 19x. Meanwhile, distribution yield for FY24F of 7% is attractive vs. current 10-year MGS yield of 3.9%.

• 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 the postpandemic era.

Source: AmInvest Research - 25 Apr 2023