• Upgrade to BUY from Neutral, with new MYR1.63 TP from MYR1.50, 13% upside and c.7% FY25F yield. As we enter into an interest rate cut cycle, which is favourable for REITs, we turn more positive on Pavilion REIT due to its higher-than-average yield of c.7%, and healthy earnings growth prospects as a key beneficiary of the strong tourism recovery.

• Key beneficiary of the tourism recovery. Despite concerns of increasing competition in the city centre, Pavilion Kuala Lumpur’s (PKL) occupancy rate has recovered to 96% in 1H24, the highest since end-2020. Tourism Malaysia revealed that 11.8m tourists arrived in 1H24, a 29% increase YoY – boosted by the 30-day visa exemption for visitors from China and India. We think this has helped PKL to record the +6% rental growth YoY, and this trend should continue, as the country looks forward to Visit Malaysia 2026 when it aims to attract 36m tourists. Notwithstanding its high average rental rate, management is guiding for mid-single digit rental reversions for the mall.

• High yield. We are forecasting a high c.7% FY25 yield from PREIT, or a +300bps spread from the current 10-year Malaysian Government Securities (MGS) yield. We think this is attractive compared to the historical average spread of 133bps. Our TP implies a target yield of 6% (+220bps from the current MGS yield) which we think is fair as we remain conservative on the REIT’s underperforming assets (Da Men Mall), while pricing in uncertainty on Pavilion Bukit Jalil’s (PBJ) final valuation.

• PBJ re-valuation on the cards. We do not expect PBJ to meet the annualised MYR146m NPI target due to higher-than-expected costs. This is attributed to the imbalance cost pass-through (ICPT) tariff hike in 2023, and increase in service tax rate. On the plus side, the mall’s occupancy and rental rates are improving as expected, with the REIT guiding for >90% in committed occupancy by end-2024, and mid-single digit rental reversions. As the mall will likely be revalued in 2H25 to determine the final price payable to the sponsor, we highlight that the strong share price movement should result in a less dilutive equity placement, if needed.

• Earnings forecasts. We increase our FY25F-26F earnings by 2% and 6% after lowering our borrowing cost assumptions. PREIT has a high proportion of floating rate borrowings (88%), and 32% of its borrowings are scheduled for refinancing in 2026. Our TP incorporates a 0% ESG premium/discount. Key risks: Lower-than-expected rental reversions, and lower-than-expected margins.

Source: RHB Research - 4 Oct 2024