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

- PREIT reported 2QFY14 realised net profit of RM56mil, bringing 1HFY14 realised net profit to RM112mil. This is in line with expectations, forming 50% and 49% of our and consensus estimates respectively.

- PREIT declared 1HFY14 interim income distribution DPU of3.84sen, in line with our full-year FY14 estimate of 7.5 sen. 2QFY14 DPU was 6% YoY higher at 1.90 sen.

- Net property income grew by 5% YoY, on the back of an 8% growth in revenue. The underlying strong revenue growth was boosted by strong rental reversion from leases renewed in 3QFY13. Compared to the preceding quarter, revenue had dipped due to lower percentage rent income as a result of cautious domestic spending and softer tourism activities affected by the MH370. Note that the 2Q is a seasonal weak quarter.

- Portfolio occupancy remained healthy – Pavilion Mall at 95% and Pavilion Tower at 73%.

- Management managed to pass on the utility and assessment fee hike via higher service charge (RM4.60 psf currently) from 1 May onwards.

- Management’s proactive asset enhancement initiatives (AEIs) are progressing well. Relocation of the new Beauty Hall at Level 7 (+9 new shops) and Level 2 reconfiguration (+5 new luxury retailers) was completed in May and June, respectively.

- The driveway at the Level 1 carpark is making way for service shops (+7,000sf NLA). Conversion of the previous Seventh Heaven into an F&B area (+4,000 NLA) is underway and is expected to open in November. All in all, PREIT should benefit from some uplift in rentals given these AEIs.

- This year, 15% of NLA are up for renewal. Therefore, we have estimated rental reversions to moderate to 6%-7% growth vs. FY13’s rental reversion was 15% for 70% of total NLA.

- Gearing remains healthy at 16%. We expect PREIT to be well shielded from any potential hikes in interest rates as 99% of debt is under a fixed rate. Average cost of debt stands at 4.2%.

- While PREIT has a visible acquisition pipeline, we think that the earliest acquisition (of Pavilion Extension) could happen in mid-2016. Rental yields at Fahrenheit88 have yet to stabilised as it is still undergoing tenant remixing.

- The stock is trading with a distribution yield of 5.5 and a yield spread of 150bps over the 10-year MGS.

Source: AmeSecurities