• Maintain NEUTRAL, lower MYR1.29 TP from MYR1.32, 8% upside and c.7% yield. Pavilion REIT’s 9M23 results missed expectations due to higher-than-expected expenses. Pavilion KL (PKL) and Elite Pavilion remained strong with high single to double-digit revenue growth YoY, but the outlook for the REIT’s other properties may be more challenging. While the results mark the first full-quarter contribution from Pavilion Bukit Jalil (PBJ), its NPI margin is relatively low at 49% as some of the signed tenants are still undergoing renovations.

• Results missed estimates. 3Q23 core profit of MYR70.6m (+12.2% QoQ, +15.4% YoY) brought 9M23 earnings to MYR203.5m (+12.2% YoY). This was only at 70% of our and Street’s full-year estimates. The revenue growth was mostly driven by the inclusion of PBJ, which was only acquired in June. However, NPI margin dropped to 60.9% (2Q23: 63.1%), dragged down by PBJ’s lower margins. Interest expenses increased by MYR11.3m QoQ (+19.6m YoY) from the drawdown of borrowings for the acquisition. The REIT recorded a 9M23 DPU of 6.56 sen (9M22: 6.16 sen).

• Strong growth in its flagship malls. Off a seasonally slower base in 2Q23, PKL and Elite Pavilion recorded strong 6% and 10% QoQ revenue growth (+7% and 17% YoY). The REIT has completed the reconfiguration of the tenancy lots at PKL’s Fashion Avenue and Elite Pavilion to increase visibility and clear up space for new tenants (capex: MYR5.7m). We think asset enhancement initiatives (AEIs) such as these are key to ensure the malls maintain their competitiveness.

• Narrowing losses for Da Men Mall. The mall’s net property losses narrowed slightly to -MYR1.98m during the quarter (2Q23: -MYR2.24m, 3Q22: -MYR2.69m). The mall has also seen consistently higher occupancy rates – from 59% in Jun 2022 to 72% in Jun 2023 – but we remain cautious on the mall’s prospects. We expect the mall to only break even in FY25F as occupancy rates improve. We are similarly cautious on Pavilion Tower’s outlook, with its occupancy only at 66%. While securing new tenants would be difficult – given the challenging office segment – downside risks are mitigated as major tenants include the REIT’s sponsor.

• Earnings adjustment. We lower our FY23-25F earnings estimates by 4% after adjusting our interest rate and property expense assumptions. 87% of the REIT’s borrowings are on floating rates, and as such, it would benefit from potential interest rate cuts. Our DDM-derived TP (Ke: 8.2%) incorporates a 0% ESG premium/discount.

• Risks: Faster/slower-than-expected tourism industry recovery and higher/lower-than-expected occupancy rates.

Source: RHB Securities Research - 31 Oct 2023