Pavilion REIT’s 3Q19 core net profit of RM59.4m (+0.4% QoQ, -4.5% YoY) brought the 9M19 sum to RM187.9m (-0.3% YoY). The results were both below ours and consensus expectations, mainly due to higher-than-expected total operating expenses, given higher utilities and maintenance costs. We cut FY19 earnings by 4% as we adjusted for higher operational cost incurred. We maintain our HOLD call with unchanged TP of RM1.81 based on targeted yield of 5.3%.

Below expectations. 3Q19 core net profit of RM59.4m (+0.4% QoQ, -4.5% YoY) brought the 9M19 sum to RM187.9m (-0.3% YoY). The results were below both ours and consensus expectations, accounting for 71% and 70%, respectively. This was mainly due to higher-than-expected total operating expenses.

Dividend. None as dividend is usually payable semi-annually.

QoQ. Revenue was slightly up by 0.2% to RM144.4m, leading to core profit of RM59.4m (+0.4%); this was mainly due to higher rental income (+2.3%). Nonetheless, net property income (NPI) decreased by 0.3%, due to higher maintenance expenses (+9.2%) incurred during the quarter.

YoY. Gross revenue grew by 2.1% against the corresponding 3Q18, mainly backed by higher revenue rent and electricity income from Pavilion KL Mall for supplying electricity to Pavilion Hotel and Pavilion Suites. However, this was partially offset by lower rental income from Da Men Mall due to lower occupancy and rental rate. Property operating expenses rose to RM53.3m (+12.9%) which was caused by higher electricity cost incurred for providing the electricity supply to both Pavilion Hotel and Pavilion Suites. Additionally, the increase in expenses was due to the cost incurred for repairing air-conditioning system and higher marketing and promotional expenses. Therefore, NPI fell by 3.3% bringing down core net profit to RM59.4m (-4.5%) on the back of higher operating expenses incurred during the period.

YTD. 9M19 revenue showed improvement of 7.7% that was significantly driven by the (i) income from Elite Pavilion Mall (acquired back in April 2018), (ii) higher revenue rent, and (iii) electricity income from Pavilion KL Mall. Nevertheless the improvement was brought down by lower rental income received from Da Men Mall. Total property operating expenses incurred was higher by 15.9% due to the same reason as above. Although NPI was up by 3.7%, bottom-line decreased to RM187.9m (-0.3%) due to higher borrowing cost (+14.1%), management fee (+4.8%) and other trust expenses (+16.7%).

Outlook. We believe Pavilion KL will continue to enjoy strong footfalls due to prime positioning with strong branding and well managed tenant mix. We expect seasonally stronger 4Q19 contribution due to year end festive holidays and promotions. However, we remain cautious on the increasing property expenses that have been rising in the last few quarters.

Forecast. We cut FY19 earnings by 4% as we adjusted for higher operational cost incurred by management during the period. However, we maintain our FY20-21 forecast as we expect positive impact from Visit Malaysia 2020.

Maintain HOLD, TP: RM1.81. Maintain our HOLD call with unchanged TP of RM1.81 based on targeted yield of 5.3% which is derived from 2 years historical average yield spread of Pavilion REIT and 10 year MGS.

Source: Hong Leong Investment Bank Research - 25 Oct 2019