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

- PREIT reported realised net profit of RM57mil for 4QFY14, which brought FY14 headline realised net profit to RM232mil (+8.5%), which is within expectations. DPU delivery remains solid –1.96sen was declared in 4Q, bringing FY14 DPU to 8.0sen (+8.2%).

- Revenue was up7% YoY, driven by a higher average rental reversion of 9% for FY14. Net property income rose 8% despite the electricity and assessment hikes of 18% and 25% respectively. The increase in property operating expenses was manageable as it was passed on to tenants effective 1 May, 2014 through higher service charges (+17%).

- Average rental stands at RM21+psf for Pavilion Mall and RM6+psf for Pavilion Tower.

- Overall portfolio occupancy is stable at 98% for Pavilion Mall and 80% for Pavilion Tower. Management is confident of filling up the two vacant floors of its office tower this year. There is minimal lease renewal for FY15 – 15% and 22% of leases for the Mall and Tower, respectively. 50% of the leases for the Pavilion Mall have been renewed.

- Last year, a total of RM22mil were incurred for capex for AEIs to create additional NLA. The positive impact of AEIs should improve operational efficiencies and support rental reversion in FY15. That said, a flat retail sales are envisaged due to the expectation of softening consumer spending post the implementation of GST. Nevertheless, we think it would have minimal impact on PREIT’s earnings as turnover rent (rental based on tenant sales) only accounts for 3%-4% of gross revenue.

- This year, capex (RM34mil) will mainly be centred on upgrading equipments to reduce energy usage as utilities command the lion share of property operating expenses at 37%.

- PREIT’s earnings is projected to continue charting organic growth underpinned by healthy rental reversion – FY15F (RM251mil), FY16F (RM263mil) and FY17F (RM275mil).

- There is minimal impact from the interest rate hike as 99.5% of debts are at fixed rates. Gearing stands at 15%. On the acquisition front, management noted that it will assess Da:men mall at USJ once construction completes in 3QFY15. Pavilion Extension is earmarked to complete in mid-2016.

- We continue to like PREIT’s superior asset quality and management capabilities. Nonetheless, we believe that the stock is currently fairly valued. The stock currently trades at a distribution yield of 5.7%, a 174bps yield spread over the 10-year Malaysia Government Securities.

Source: AmeSecurities