9M17 realised net income (RNI) of RM166.8m came in within our (70%) but below consensus expectations (66%). No dividends as expected. Maintain FY17-18E earnings of RM237.0-279.8m. FY17-18E will see minimal expiries of c.24- 22% of NLA on modest single digit reversions, while FY18 growth is mostly driven by the Elite Pavilion acquisition. Maintain OUTPERFORM and TP of RM1.84 on a +0.8ppt spread the 10-year MGS target of 4.00%.

9M17 realised net income (RNI) of RM166.8m came in within our (70%) but below consensus (66%) expectations. We believe the reason consensus estimates fell short was due to over-optimistic margin assumptions, particularly higher financing cost, which has increased 20% YoY, as consensus top-line estimates were within expectations. No dividends, as expected.

Results Highlights. YoY-Ytd, GRI was up 5% on the acquisitions of Damen Mall and Intermark Mall (in Mar 2016), the repositioning of tenants at Pavilion KL (PKL) and positive rental growth from other assets on mid-single digit reversions. However, bottom-line declined 8% on: (i) higher operating cost (+21%) on general upgrading works at PKL and Intermark Mall (i.e. upgrading of air-conditioning system, air chillers rewinding, escalators and steps, light fittings), tenancy costs incurred for landlord provisions at Damen Mall, higher provision of doubtful debts, and higher marketing cost incurred from the sponsorship of 2017 Sea Games, and (ii) higher financing cost (+20%) for the acquisition of the new malls. QoQ, 3Q17 RNI was up by 2% on the back of marginal top-line growth (+1%) from positive reversions, while NPI and RNI margins improved marginally by +0.6ppt and +0.4ppt, respectively, on slightly lower operating cost.

Outlook. FY17-18 will see minimal expiries of c.24-22% of NLA on modest single digit reversions. The proposed acquisition of Elite Pavilion is expected to be completed in 4Q17 and will be funded by a combination of borrowings and 7.2% placement. We are positive on this acquisition as it contributes c.8% to FY18E earnings, and 7.6% to DPU (post placement). Fahrenheit88 acquisition is still on the table, pending the sponsor’s intention to sell, while we believe PAVREIT is eyeing cap rates closer to 6.5%. Additionally, as we had previously highlighted, we reckon PAVREIT could potentially acquire 3rd party assets from WCT (which owns Paradigm Mall and AEON Bukit Tinggi). Note that we make no changes to FY17-18E earnings of RM237.0-279.8m.

Maintain OUTPERFORM and TP of RM1.84. We maintain our TP which is based on FY18E GDPS/NDPS to 8.9 sen/8.0 sen and an unchanged spread of +0.8ppt to our 10-year MGS target of 4.00%. We have applied the thinnest yield spread among MREITs under our coverage (between +0.8ppt to +2.1ppt) as we believe PAVREIT should be traded at thinner spreads on strong re-rating catalyst from expectations of asset injections, aided by its healthy balance sheet and low gearing of 0.26x. As such, we believe PAVREIT warrants an OUTPERFORM call on decent gross/net yields of 5.1%/4.6% and inorganic growth potential.

Risks to our call include: (i) bond yield expansion vs. our target 10- year MGS yield, and (ii) weakening rental income.

Source: Kenanga Research - 27 Oct 2017