- We reaffirm our HOLD recommendation on Pavilion REIT (PREIT) with a lower fair value of RM1.40/unit (vs. RM1.55/unit previously), based on our DCF valuation.

- Our lower fair value resulted from the rolling forward of our base year to FY14 and adjustment to our WACC assumption to account for the volatile bond market.

- FY13’s realised net profit was in line.

- DPU of 1.9sen was declared during the quarter, bringing FY13 full-year DPU to 7.4sen.

- The underlying earnings strength was supported by:- (1) higher rentals achieved from Fashion Avenue; (2) 16% rental reversion from the lease renewals (majority had expired in September) for Pavilion Mall; and (2) higher advertising income.

- Underpinned by major rental renewals in FY13, Pavilion Mall’s average rental stood at RM20.90psf (vs. FY12’s RM18.80psf), which is edging close to Suria KLCC’s c.RM23psf. Pavilion Tower’s average rental is RM5.85psf.

- Level 7 (Beauty Hall) and Level 2 (ex Jaguar/Maybank) will undergo asset enhancement initiatives to increase net lettable area and are earmarked to house new retailers in June.

- PREIT’s near-term rental reversion is expected to be flat despite 55% of leases due for renewal at Pavilion Tower this year given:- (1) major rental reversion experienced in FY13; (2) electricity hike, which will be borne directly by tenants; (3) potential assessment fee hikes by DBKL, which PREIT may either partly or fully pass on to tenants; and (4) potential slowdown in retail sales due to rising cost of living (i.e. GST and subsidy cuts), which in turn affects turnover rent.

- Currently, turnover rent is 3% of gross revenue while service charge is at RM4psf.

- In view of the key challenges and post-result adjustment, we estimate an organic growth for PREIT at 5%-6% for FY14F-FY16F. Earnings are projected at RM226mil in FY14F before rising to RM253mil in FY16F. Having said that, Visit Malaysia Year 2014 could potentially boost retail sales ad negate the impact of some of the key challenges.

- PREIT now offers an FY14F distribution yield of 5.7%, based on a 100% payout ratio.

Source: AmeSecurities