PAVREIT will not proceed with the 7.2% placement to partly fund the acquisition of Elite Pavilion (to be fully funded via borrowings) due to the weak share price environment. We are mildly negative as it reduces the DPU accretion to 1.9% for FY18E (from 7.6%) initially. Lower FY18-19E CNP by 5% each on higher borrowing cost, but leave DPU unchanged after removing the dilution impact. Maintain OUTPERFORM but lower TP to RM1.55 (from RM1.60).

Acquisition of Elite Pavilion Mall to be fully funded via borrowings. PAVREIT announced that it plans to fully fund the acquisition of Elite Pavilion Mall (RM580m purchase consideration) via borrowings, (vs. initial plans to fund it by a combination of borrowings and 7.2% placement of 218m shares) considering prevailing market conditions, which have been subdued of late. Note that PAVREIT’s unit price is down c.20% currently from the initial acquisition announcement in July 2017 (refer overleaf).

Mildly negative as impact to DPU is weaker than initially expected. We were not overly surprised with the placement falling through as the recent share price was de-rated sharply over Feb-Mar 2018 alongside the sell-down of MREITs. However, given current market conditions, we believe management has made the right move to minimize dilution impact to investors as current price would demand a much higher share placement. Unfortunately, the macro environment is not conducive for this particular deal. All in, we believe the Elite Pavilion acquisition is still mildly accretive to DPU at 1.9%p.a. in FY18, but lower than our initial expectations (of 7.6% accretion to DPU post placement based on a favourable placement price of RM1.70 in July 2017).

Lower FY18-19E CNP by 5% each to RM252-267m, post increasing our borrowing cost for the acquisition of Elite Pavilion. However, our FY18-19E GDPU remains unchanged at 8.6-9.1 sen (NDPU of 7.8-8.2 sen) post removing the dilution from the placement. This implies gross yield/net yield of 6.3-6.6%/5.7-6.0%. All in, we expect gearing to increase to 0.33x in FY18-19E (from 0.28x each) which is still manageable, as the Group can gear up by another RM2b before hitting REIT’s maximum gearing limit of 0.50x. FY18 growth will be driven by single-digit rental reversions from lease expiries and mild accretion from Elite Pavilion, while FY19 will be driven by organic growth.

Maintain OUTPERFORM but lower our TP to RM1.55 (from RM1.60) based on an unchanged FY18E GDPS/NDPS to 8.6 sen/7.8 sen but a higher spread of+1.6ppt (from +1.3ppt) to our 10-year MGS target of 4.00%. We are increasing our spread to +0.5SD above historical averages, in tandem with all MREITs under our coverage in our upcoming strategy to encapsulate investors’ concerns of potential lackluster earnings in light of tough market conditions (i.e oversupply issues) and fears of an OPR hike affecting MREITs valuations. Even assuming a worst-case scenario for all MREITs by applying historical high spreads, most MREITs still warrant a MARKET PERFORM call, while PAVREIT, CMMT and MQREIT warrant an OP call. PAVREIT’s applied spread is one of the thinnest among MREITs under our coverage (between +1.3ppt to +3.4ppt) as we believe; (i) PAVREIT has earnings resiliency with its landmark asset (i.e. Pavilion Shopping Mall and Elite Pavilion) riding on strong occupancy and above market reversions, (ii) re-rating catalyst from expectations of asset injections with the ability to borrow up to RM2b without resorting to a cash call in light of unfavorable macro conditions currently, while (iii) its balance sheet is healthy with a low gearing of 0.33x post the Elite Pavilion acquisition. As such, we believe PAVREIT warrants an OUTPERFORM call on decent gross/net yields of 6.3%/5.7% and inorganic growth potential.

Source: Kenanga Research - 2 Apr 2018