Pavilion  REIT’s  2QFY14  results  came  in  line  with  expectations.  Asset enhancements continue to be the key to its  growth,  going forward. We expect earnings to come in stronger in 2HFY14  as  some refurbishment works  will  bear  fruit  and  the  REIT  has  also  been  able  to  pass  on  the tariff hikes to tenants through higher service charges. We nudge up ourDDM-based FV to MYR1.48 and maintain NEUTRAL.

In line.  Pavilion REIT’s (PavREIT) 2QFY14 core net profit of MYR55.6m (+7.1% y-o-y; -1.8% q-o-q) came in line with estimates. 1HFY14 revenue grew  7.6%  y-o-y,  driven  by  the  positive  rental  reversion  from  Pavilion Kuala  Lumpur  mall’s  (PavMall)  major  rental  renewal  and  newlycompleted  renovations.  Its  1HFY14  net  property  income  (NPI)  margin was still stable at 68.4% despite the tariff hike this year. A distribution per unit (DPU) of 1.90 sen was announced, on track to meet our forecast. 

Asset  enhancement  initiatives  (AEI)  to  underpin  growth.  PavMall’s AEI  on its seventh  level,  which  was completed recently and  resulted inthe relocation of its “Beauty Hall” precinct to a more prominent area, has led to an improvement in rental rates   from these  tenants. The  vacated area is now being revamped, and the REIT plans to introduce more F&B outlets  in  the  area  by  November.  Management  is  also  planning  to convert a driveway on the mall’s Level 2  into new retail areas  as well as to  provide  better  accessibility  for  shoppers  coming  from  the  Standard Chartered  building  nearby.  The  capex  for  these  AEIs  is  estimated  at c.MYR10m, and  are  expected to result in an additional  net lettable area (NLA) of 11,000 sq ft. 

Managing  expenses.  Management  shared  that  in  May,  it  wassuccessful  in  passing  on  the  whole  amount  of  the  recent  tariff  hike  to tenants  through  higher  service  charges  (MYR4.80psf  vs  MYR4.00psf previously).  Furthermore,  Kuala  Lumpur  City  Hall  (DBKL)  recently revised  its  assessment  rate  hike  to  only  25%  from  100%.  Given  the lower cost base, we expect earnings to show some improvements  from 3QFY14  onwards.  It  would  also  be  largely  unaffected  by  the  recent interest rate hike, as 99% of its total MYR707m debt are on fixed rates.

Maintain NEUTRAL.  We raise  our FY14F/FY15F  net profit  by 3% after imputing  the lower expenses.  Maintain NEUTRAL,  with our DDM-based FV revised slightly to MYR1.48 (from MYR1.45). 

Source: RHB