- We reaffirm our HOLD recommendation on Pavilion REIT (PREIT) with an unchanged fair value of RM1.40/unit based on a DCF valuation, following a company visit.

- This year, PREIT is focusing on asset enhancement initiatives (AEIs), following the significant lease renewals and tenant remixing in FY13. AEIs at Pavilion Mall are progressing well. The relocation of Seventh Heaven to the Centre Court of Level 7 was just completed.

- Additional net lettable area (NLA) will be created on Level 2 (fronting Jalan Raja Chulan). This is expected to be completed by end-month, with an exciting pipeline of luxury brands. The driveway at the carpark on Level 1 will also make way for more NLA for service shops. Conversion of the previous Seventh Heaven into an F&B area is expected to be completed by year-end.

- Things will likely remain quiet on the acquisition front. Management alluded that it would acquire Pavilion Extension and the underground tunnel (connecting Fahrenheit88 and Pavilion Extension) upon completion. Construction of the extension is envisaged to complete by mid-2016. Rental yields at Fahrenheit88 do not appear to have stabilised as it is still undergoing tenant remixing.

- Effective May 1, the service charge has been raised to RM5.00psf, in tandem with rising operating costs, i.e. electricity rates and assessment fee. Average rental rates stand at RM20.80psf for Pavilion Mall and RM5.80psf for Pavilion Tower.

- Going forward, we have estimated rental reversions to moderate to 6%-7% growth. This year, 16% of NLA are up for renewal. Pavilion Mall saw a strong rental reversion of 15% in FY13 for 70% of total NLA. These locked in rentals would help to negate the impact of a possible slowdown in consumption trend.

- The average cost of debt currently stands at 4.2%, with majority of its debt (i.e. 99.5%) under a fixed rate. As such, we expect PREIT to be well protected from any potential hikes in interest rates. Gearing level is comfortable at 16%, as at end-1QFY14.

- Notwithstanding the quality of the underlying mall and positive rental reversion, its near-term acquisition pipeline remains quiet. The key re-rating catalyst is the materialisation of a meaningful acquisition – the most promising acquisition appears to be of Pavilion Extension, which we think could happen earliest in FY16. 

Source: AmeSecurities