• 1HFY17 earnings below expectations

• Lower income in 1HFY17

• Acquiring Elite Pavilion Mall

• Proposed placement to fund acquisition of Elite Pavilion Mall

• Maintain NEUTRAL with a revised TP of RM1.70

1HFY17 earnings below expectations. Pavilion REIT 1HFY17 core net income of RM111.4m came in below expectations, meeting 42% and 43% of our and consensus full year estimates respectively. The negative deviation is due to higher-than-expected property operating expenses in 2QFY17 which increased 9%qoq. Pavilion REIT announced distribution per unit (DPU) of 3.96sen (-5%yoy) for 1HFY17.

Lower income in 1HFY17. Pavilion REIT registered higher topline of RM239.2m (+6.5%yoy) in 1HFY17, mainly attributed to rental contribution from Intermark Mall and da:mén USJ mall. Recall that Pavilion REIT completed the acquisition of the two malls in March 2016. Meanwhile, core net earnings for 1HFY17 eased 7.9%yoy to RM111.4m due to higher property expenses (+23.5%yoy), higher borrowing cost (+29.9%yoy) and lower contribution from Pavilion KL shopping mall. Recall that Pavilion REIT reconfigured tenant mix in Pavilion KL shopping mall in 1QFY17 following the opening of Elite Pavilion Mall in November 2016. Nevertheless, occupancy rates of Pavilion KL mall recovered to 96.1% in June 2017 from 93.1% in March 2017.

Acquiring Elite Pavilion Mall. Pavilion REIT announced that it has entered into a sale and purchase agreement with Urusharta Cemerlang (KL) Sdn Bhd for the acquisition of Elite Pavilion Mall for RM580m. Elite Pavilion Mall is an extension of Pavilion KL shopping mall with net lettable area of 242k sf. The acquisition is expected to be completed in 4QFY17. We are slightly positive on the acquisition as the acquisition is expected to be yield accretive whereby gross acquisition yield of 6.4% is greater than financing cost of around 5%. Pavilion intends to funds the acquisition via borrowings and proceeds from placement of units.

Proposed placement to fund acquisition of Elite Pavilion Mall. Pavilion REIT proposed to undertake placement of 218m new units in Pavilion REIT (7.2% of total units) to partly fund the acquisition. Assuming Pavilion REIT funds the acquisition from gross proceeds (RM370.6m) from placement while the remaining from borrowings, we estimate the acquisition to increase FY18 earnings by 14%. Nevertheless, FY18 earnings per unit is expected to increase by a lesser quantum of 5% due to dilutive impact from placement exercise.

Maintain Neutral with a revised TP of RM1.70. We revised downwards our earnings forecast for FY17/18 by 13.4% and 11.1% respectively to account for the higher-than-expected property expenses. Meanwhile, we have not factored in the earnings contribution from Elite Pavilion Mall pending completion of the acquisition. Corresponding to the downward revision in earnings and DPU, we revise our TP to RM1.70 from RM1.77. We maintain our Neutral call on Pavilion REIT due to its unexciting earnings

Source: MIDF Research - 28 Jul 2017