Period  2Q14/1H14

Actual vs. Expectations 1H14 realised net income (RNI) of RM112.3m came in within expectations, making up 50% of the street and our estimates.

Dividends  1st interim dividend of 3.84 sen was declared, which includes a 0.09 sen non-taxable portion. This is on track to meet our FY14E GDPU of 7.7sen (5.7% yield).

Key Results Highlights YoY, topline grew by 8% to RM98.7m from renewal of tenancies with strong rental reversion in Pavilion Shopping Mall (PSM). 1H14 is seeing the full impact of FY13, which was a major rental reversion year. However, operating cost increased by 14% from: (i) higher utilities charges from electricity tariff, renewable energy surcharge, (ii) incurrence of repairs, (iii) preventive maintenance work, (iv) cost from marketing events and (v) increased assessment charges. As a result, RNI increased by 7% to RM52.0m.

 QoQ, GRI declined 2% to RM98.7m due to reduced percentage rent income. 2Q is also a slow quarter for PAVREIT post-CNY festivities in 1Q. On the flip side, operating cost decreased by 5% to RM30.8m as higher utilities cost was mitigated by the overprovision of assessment charges in 1Q14. However, this was not sufficient to pull up net profits as RNI declined by 2% to RM55.6m.

Outlook  CAPEX commitment to date is RM11.9m, which is mainly used for the refurbishment of PSM.

 We expect Pavilion Office Tower (POT)’s occupancy to remain below par due to the supply glut of office spaces in the Klang Valley.

Change to Forecasts We make no changes to our FY14E and FY15E RNIs

Rating  Maintain OUTPERFORM

 Our call is sector driven. We maintain OUTPERFORM as we expect the European QE to be a positive re-rating catalyst for MREITs while most of the near-term earnings risks (e.g. assessment rate hikes) has been put to rest.

Valuation  We maintain our TP at RM1.41 based on our target FY15E gross dividend yield of 5.6% (net: 5.0%) or a +1.8ppt spread to CY15E 10-year MGS of 3.80%.

Risks to Our Call (i) Bond yield expansion vs. our target 10-yr MGS yield and (ii) weakening rental income.

Source: Kenanga