Period  4Q14/FY14

Actual vs. Expectations FY14 realised net income (RDI) of RM232.4m came in within expectations, making up 98% of consensus, and 103% of our estimate.

Dividends  4Q14 GDPU of 4.12 sen per unit (which includes a non-taxable portion of 0.10 sen). This implies FY14 GDPU of 7.96 sen (5.9% yield) which made up 103% of our full-year GDPU estimates and is thus within our expectation.

Key Results Highlights QoQ, GRI declined marginally by 1% to RM100.8m due to the slightly lower percentage rent in 4Q, which is seasonally the case for their mall. This was on the back of higher operating cost (+17%) from: (i) higher marketing expense from festive periods, and (ii) maintenance of advertisement sites. The higher expenditure (+16%) from higher managers’ fee due to revaluation gains weighed on Pavilion REIT (PAVREIT)’s bottom line which declined by 9% to RM57.1m.

 YoY-Ytd, GRI grew by a solid 7% to RM402.1m from: (i) full year impact arising from the strong single-digit rental reversions in FY14 (15% of NLA) with all tenancies renewed, and (ii) higher service charges. NPI margin was stable at 70% while they enjoyed higher interest income (+3.2%) which pulled RNI up by 8.5%.

Outlook  CAPEX for FY14 was RM21.9m, which was mainly for the refurbishment of PSM, while management expects to spend RM34m on PSM in FY15 (refer overleaf).

 Pavilion Office Tower (POT)’s occupancy is still relatively low (80% occupancy) due to the supply glut of office spaces in the Klang Valley, but management is confident on securing tenants in FY15.

 Damen is expected to be completed in 3Q15, while the Pavilion Extension should be completed by mid-FY16. While acquisition cap rates remain unattractive, we believe that the sponsor will move towards a more digestible rate required by PAVREIT in light of economic challenges ahead. However, it will take time and we anticipate that acquisition cap rates will become more realistic in the next 6-12 months.

Change to Forecasts We make no changes to our FY15E earnings and introduce FY16E. We are estimating gross yields for FY15- 16E at 5.4%-5.6%.

Rating Maintain UNDERPERFORM Valuation While we like PAVREIT for its prime asset positioning which will provide them with some resiliency when GST kicks in (as it can weather the effects of rising inflation better compared to neighbouring areas, mass or niche malls due to its shoppers’ higher purchasing power), we are recommending UP largely due to valuations. We believe that bond yields will be more volatile this year, no thanks to the weakening MYR and sovereign credit derating risk which may put downward pressure on MREITs’ unit prices. Since PAVREIT has one of the lowest gross yields amongst the sizeable MREITs at 5.4% (peer average: 6.1%), they will be more susceptible to a selldown if the Malaysian bond yields expands.

 We maintain our TP at RM1.31 based on our target FY15E gross dividend yield of 6.0% (net: 5.4%) or a +1.8ppt spread to CY15E 10-year MGS of 4.2%. As such, total returns to our TP are -5.3% at current levels.

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

Source: Kenanga