Investment Highlights

• We maintain BUY on Pavilion REIT (PREIT) with a higher fair value (FV) of RM1.64/unit (from RM1.62/unit previously) based on our revised dividend discount model (DDM), which incorporates a neutral 3-star ESG rating (Exhibits 6 & 7). The FV implies a FY25F distribution yield of 6%, 1 standard deviation above its 5-year median.

• The higher FV stems from raising FY24F/FY25F distributable income by 8%/10% to reflect higher net property income from Pavilion Bukit Jalil (PBJ).

• PREIT’s FY23 distributable income of RM307mil was above expectation, 8% above our forecast and street’s.

• The variance was mainly due to higher-than-expected FY23 occupancy rate in PBJ at 88% vs. our assumption of 85%.

• In FY23, PREIT’s gross revenue rose 31% YoY while net property income (NPI) improved 26% YoY. This growth was primarily attributed to recognition of a 7-month contribution from the newly acquired PBJ, after its injection on 1 June 2023. Meanwhile, PREIT experienced a higher average occupancy rate of 84% in FY23 vs. 80% in FY22.

• Excluding the contribution from PBJ, PREIT’s gross revenue and NPI both expanded 12% YoY in FY23. The improvement was mainly driven by higher occupancy rates (Exhibit 3) and favourable rental reversion in FY23, particularly in Pavilion Kuala Lumpur (PKL) and Elite Pavilion Mall.

• On a QoQ comparison, PREIT’s 4QFY23 gross revenue expanded 5% while NPI grew 11%. The stronger QoQ results were primarily due to higher rental and advertising income and income generated from PBJ exhibition centre.

• QoQ, the overall average occupancy rate for all segments rose to 86% in 4QFY23 from 84% in 3QFY23. The improvement was mainly attributed to an increase in the occupancies of PBJ, Elite Pavilion Mall and Pavilion Tower (Exhibit 3).

• We are projecting a stable FY24F rental reversion of 5%- 6% for PREIT’s prime malls in Bukit Bintang, namely PKL and Elite Pavilion Mall 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.

• Management guided that the current occupancy rate for Da Men Mall has rose to 80% from 73% in 4QFY23. However, to further enhance occupancy rates at Da Men mall, it will be crucial to offer attractive rents to potential tenants. Consequently, FY24F rental reversion for Da Men mall is anticipated to remain flattish.

• In 4QFY23, the average monthly rental rate (MRR) of PBJ was RM9.50 psf while occupancy rate stood at 88% (vs. 85% in 3QFY23). 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 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 9%) and RM10.40 psf in FY25F (Exhibit 4). Moving forward, PBJ is expected to contribute 24%/26% of PREIT’s FY24F/FY25F NPI. To date, PREIT has completed the renewal of a majority of its leases expiring in FY23F, supported by an improvement in retail sales.

• PREIT declared its gross distribution per unit (DPU) of 4.6 sen in 4QFY23. The FY23 DPU of 9 sen represents a distribution yield of 7.3%.

• Our in-house economist anticipates US Federal Reserve funds rate to peak at current levels of 5.25%-5.5%. Our economics team also expects the Federal Reserve to start cutting interest rates in mid-2024 by 75 bps to 100bps. This will eventually bring the Fed funds rate to 4.5%-4.75% by end-2024.

• As such, the 10-year MGS yield has been projected by our economic team to be lower at 3.63% in 4QCY24 from the current level of 3.8%. From FY24F onwards, we anticipate PREIT’s distribution yield spread against 10-year MGS to widen to 4% vs. a pre-pandemic (2017-2019) 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 FY25F PE of 13x vs. its 2-year average (pre-pandemic FY18-19) of 19x. Meanwhile, distribution yield for FY25F of 8% is attractive vs. current 10-year MGS yield of 3.8%.

• We also like the stock due to its resilient earnings, mainly underpinned by its prime asset portfolio as anchored by PKL and Elite Pavilion Mall, which are tourist hotspots that will benefit from the return of international tourists. Further increase in earnings is expected from PBJ in 2024F. We believe PBJ is positioned for a positive rental reversion in 2024F, supported by improving traffic footfalls and occupancy rates.

Source: AmInvest Research - 26 Jan 2024