Investment Highlights

• We maintain BUY on Pavilion REIT (PREIT) with an unchanged fair value (FV) of RM1.62/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 5.7%, 1 standard deviation above its 5-year median.

• We make no changes to our earnings forecasts as PREIT’s 9MFY23 distributable income of RM218mil (Exhibit 1) came in within our and consensus’ estimates. It accounted for 77% of our FY23F earnings and 76% of consensus’s estimate.

• In 9MFY23, PREIT’s gross revenue rose 22% YoY while net property income (NPI) improved 21% YoY. This growth was primarily attributed to the recognition of a 4-month contribution from the newly acquired Pavilion Bukit Jalil (PBJ), after its injection on 1 June 2023.

• Excluding the contribution from PBJ, PREIT’s gross revenue grew 9% YoY while NPI expanded 10% YoY in 9MFY23. The improvement was mainly driven by higher occupancy rates (Exhibit 3) and favourable rental reversion in FY22, particularly in Pavilion Kuala Lumpur (PKL) and Elite Pavilion Mall.

• On a QoQ comparison, PREIT’s 3QFY23 gross revenue expanded 25% while NPI grew 20%. The stronger QoQ results were primarily due to the full quarter’s recognition of contribution from PBJ in 3QFY23 vs. 1-month contribution in 2QFY23.

• QoQ, the overall average occupancy rate for all segments inched up to 84% in 3QFY23 from 83% in 2QFY23. The improvement was mainly attributed to an increase in the occupancies of PKL, Intermark Mall and Da Men Mall (Exhibit 3).

• We are projecting a stronger rental reversion of 5%-6% for PREIT’s major contributor, PKL (accounting for 78% of FY23F NPI) 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 pandemic.

• In Budget 2024, the government recently announced its commitment to improve Visa-On-Arrival facilities, social visit passes and Multiple Entry Visas to encourage the entry of tourists and investors especially from India and China. These initiatives are expected to further enhance footfall in PKL.

• Meanwhile, FY23F rental reversions for Elite Pavilion Mall and Intermark Mall are expected to be lower than PKL at 2%-3% as some of tenants still require time to recover to their pre-pandemic sales levels.

• We noticed a sustained increase in the occupancy rate at Da Men Mall, which has now reached its highest level (75%) since FY18. However, to further enhance occupancy rates at Da Men mall, it will be crucial to offer attractive rents to potential tenants. Consequently, FY23F rental reversion for Da Men mall is anticipated to remain flattish.

• In 3QFY23, the average monthly rental rate (MRR) of PBJ was RM9.50 psf while occupancy rate stood at 85% (vs. 84% in 2QFY23). In view of improving occupancy rates and tenant sales attributed to higher traffic footfalls in PBJ, we anticipate that there will be opportunities for PREIT to negotiate for higher rentals in the new mall over the upcoming expiry of tenancies in FY24F. As such, we project the average MRR of PBJ to rise to RM10.21 psf in FY24F (assuming a rental reversion of 5%) and RM10.40 psf in FY25F (Exhibit 4). Moving forward, PBJ is expected to contribute 11% of PREIT’s FY23F NPI. This will gradually improve to 32%/35% in FY24F/FY25F.

• To date, PREIT has completed the renewal of a majority of its leases expiring in FY23F, supported by an improvement in retail sales.

• There was no income distribution declared in 3QFY23 due to its semi-annual distribution policy.

• Our in-house economist anticipates the Fed fund rate to peak between 5.5%-5.75% by 4QCY23 from current levels of 5.25%-5.5%. We expect the uptrend in 10-year US Treasury yield to taper off after a pause in the Federal Reserve’s rate hikes in 4QCY23. Nevertheless, the yield will remain elevated in the near term due to expectations that the high US interest rates will be maintained for longer.

• Our economist forecasts the 10-year MGS yield to be at 3.95% (from current level of 4.15%) in 4QCY23 with a gradual decline to 3.8% by 4Q2024. However, we do not rule out the possibility that the 10-year MGS yield could be lower than our projection of 3.95% in 2023 should there be an earlier than expected Fed pivot on US interest rates.

• We foresee that the yield spread from FY24F onwards to widen to 3.8% vs. 5-year median of 1% with the expectation of the decline in 10-year MGS yield. Hence, PREIT will 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 13x vs. its 2-year average (pre-pandemic FY18-19) of 19x. Meanwhile, distribution yield for FY24F of 7.7% is attractive vs. current 10-year MGS yield of 4.15%.

• 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 foreign tourists in the post-pandemic era.

Source: AmInvest Research - 27 Oct 2023