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

- Our company visit gave us reassurance about PREIT’s earnings growth trajectory. While earnings growth is expected to be organic underpinned by lease renewals, its acquisition pipeline remains bright given the right of first refusal for three assets –da:men mall, Pavilion Extension and Fahrenheit 88.

- Rental reversions is expected to remain flat for FY15 given the softer domestic consumption and minimal lease renewal – 15% and 22% of lease renewals for Pavilion Mall and Tower, respectively. Occupancy rate is expected to remain healthy for both Mall and Tower.

- We opine that 2016 would be an exciting year for PREIT. Earliest injection appears to be da:men mall in 2016 (from its sponsor, being Global Oriental Bhd), we think, as the mall is due for completion in 4QCY15. We understand that average cap rates for retail mall currently is about 6.3%.

- Thereafter, Pavilion Extension is envisaged to be the next acquisition as completion is earmarked by mid-2016. PREIT has the right to use (but not to acquire) the underground tunnel which connects to Pavilion Extension.

- Despite being lowly geared, the overall funding cost has increased. Pricing would be the concern for acquisitions to take off.

- There are no planned asset enhancement initiatives (AEIs) for this year. We are not concerned about this as the company underwent various AEIs in FY14 (RM22mil spent) to create additional NLA and is expected to benefit from higher rentals due to the AEIs. This year, its focus is on improving power efficiency, i.e. upgrading of equipment, as utilities account for 37% of property operating expenses.

- We make no changes to our earnings estimates and HOLD recommendation. The expectation of flat retail sales is seen to have a minimal impact on earnings given that turnover rent (rental based on tenant sales) only accounts for about 4% of gross revenue.

- We like PREIT for:- (1) strong sponsor that offer a pipeline of assets for potential injection which provide better earnings growth potential vs. its peers; (2) sound management capabilities; and (3) its quality assets.

- The stock is fairly valued at the current level – trading at distribution yield of 5.6%, which is at a yield spread of 169 bps against the 10-year Malaysia Government Bond.

Source: AmeSecurities