Pavilion Real Estate Investment Trust
(March 27, RM1.51)
Maintain hold call with an unchanged target price (TP) of RM1.55. While Pavilion REIT’s long-term growth prospects are anchored by potential injection of assets with right of first refusal (ROFR), investors are unlikely to price these in until there is further clarity of the injection timeline. 

That said, forward yield of 5.4% remains decent. Our TP is based on the dividend discount model and assumes 7.1% cost of equity and 1.5% terminal growth.

Rental reversions at Pavilion REIT crown jewel, Pavilion KL mall, clocked in at only 9% in 2014 compared to 15% the year before. 

It does not look good this year either due to poor retail spending outlook with GST implementation, and incoming supply of new retail space in Kuala Lumpur. 

Both are expected to give tenants better bargaining power, suggesting reversion rates are likely to be mild. 

Nonetheless, we expect Pavilion KL mall’s occupancy to remain high at above 97% given its prime location.

Pavilion REIT’s ROFRs remain the key rerating catalysts. First, construction of the USJ da:men mall (450,000 sq ft net lettable area [NLA]) is expected to be completed at end-2015. 

The Pavilion Extension (250,000 sq ft NLA) is expected to be completed by end-2016, and will naturally benefit from its proximity and connectivity to Pavilion KL via an underground walkway. 

Finally, it also has the ROFR to Fahrenheit88 mall, which also sits along the Bukit Bintang shopping belt, opposite Pavilion KL. Pavilion REIT’s low gearing (15.2%) suggest there is sufficient debt headroom.

We imputed lower reversion rates of 8%/9%/9% for forecasted financial year ending Dec 31, 2015 (FY15)/16/17F (previously 10% per annum) in light of softer retail space outlook. 

We also removed our earlier assumption of circa 2% dip in net property income margins, as Pavilion REIT had managed to pass on higher utility and assessment charges by raising service charges. 

We adjusted the date of injection of Pavilion Extension to FY17, though first-year dividend per unit accretion will be minor (less than 1%) as the asset is immature. 

Overall, we adjusted up FY15/16F DPU by 3%/2%, and introduced FY17 forecasts. — AllianceDBS Research, March 27

This article first appeared in The Edge Financial Daily, on March 30, 2015.