We downgrade Pavilion REIT to HOLD with a lower DDM-derived price target of RM1.70, after incorporating our revised earnings forecasts and a higher cost of equity, in view of higher risks for its earnings and prices of retail assets. Higher operating costs and possible slippage in Da Men’s occupancy should weigh on 2017-18E EPU. We lower our 17-19E EPU by 4%-12%. At 4.9% 2018E yield, PREIT’s valuation is within its past-6-year trading range, looking fair.

Pavilion KL Should See Revenue Growth But Cost Is An Issue

Pavilion KL Mall should continue to see revenue growth in 2017-19E, we believe, driven by higher occupancy rates (following the completion of a repositioning exercise in 2017) and positive rental revision (albeit on a lower growth rate). Nonetheless, the anemic revenue growth may be fully offset by increases in operation and maintenance costs, resulting in flat net profit income (NPI) in 2017-18E.

Mixed Performance From New Assets, Positive on Pavilion Elite

Quarterly NPI from Da Men Mall fell from c.RM5m in 2016 to RM1.6-1.7m in 2Q-3Q17. In view of the challenging market conditions and high number of tenancies expiring in 2018 (52% of occupied NLA), we expect Da Men to report weaker results in 2018-19E. In contrast, Intermark Mall has seen a sustainable uplift in its occupancy rate (now at c.90%) and higher revenue. Lastly, we are positive on the proposed acquisition of Pavilion Elite, a seamless extention to Pavilion KL with a high occupancy of c.92%.

Cutting 2017-19E EPU by 4%-12% on Delay, Costs, Slower Growth

We cut our 2017-19 EPU forecasts by 4%-12%, imputing: (i) a delay in the completion of the acquisition of Pavilion Elite from to 1Q18 (from 2H17); (ii) higher operating costs in 2017-18E, normalizing in 2019E; (iii) lower rental growth of 2%-3% (from 4%); and (iv) lower profit from Da Men Mall.

Downgrade to HOLD (from BUY)

We lower our DDM-derived TP to RM1.70 from RM1.95 after incorporating our revised earnings forecasts and a higher cost of equity of 8.5% (from 8.2%). While we continue to like PREIT’s core assets (Pavilion KL and Pavilion Elite), the soft retail mall market conditions, weak performance of Da Men Mall and possible rate hike(s) should weigh on investor sentiment. Downgrade to HOLD. For exposure to MREITs, we like Sunway REIT (SREIT MK, BUY, RM1.74, TP: RM1.90) for its diversified assets.

Source: Affin Hwang Research - 9 Jan 2018