Pavilion REIT
(Jan 16, RM1.48)
Downgrade from buy to hold with target price (TP) of RM1.48: Pavilion Real Estate Investment Trust (Pavilion REIT) announced a 12 months of 2014 (12M14) realised net profit of RM232.4 million (up 8.5% year-on-year [y-o-y]) and the fourth quarter of 2014 (4Q14) distribution per unit (DPU) of 4.12 sen, which were in line with our and consensus estimates.

The key earnings driver for 2014 was mainly the full year impact of rental reversion in 3Q13 (on 70% of the mall’s net lettable area; additional contribution from new flagship store openings in 2014; and increase in service charge by RM0.60 per sq ft [psf]).

Despite an increase of 6.2% y-o-y in operating expenses, net property income grew by 7.6% y-o-y underpinned by 97% revenue generation from the retail mall and 3% from the offices. Though the overall rental income from the offices shrank by 11.4% y-o-y (as occupancy rate declined from 100% to 81% y-o-y), the average rental psf had increased by 6.5% y-o-y to RM6.50 psf.

We downgrade our rating from buy to hold on Pavilion REIT (as upside narrowed) with an unchanged dividend model-based fair value of RM1.48 (based on an 8.14% cost of equity, a 6% equity risk premium and a 3% terminal growth rate).

At this juncture, we do not foresee strong earnings revision to our 2015-16 forecasts as tenancy renewals are not expected to see robust upward rental reversion (management’s indication is 8% to 9% for 2015).

With the upcoming implementation of the goods and services tax, retail spending is also expected to pull back between 2Q15 and 3Q15, hence, it does not allow Pavilion REIT room to negotiate for higher rates in tenancy renewals.

However, Pavilion REIT continues to offer a financial year 2015-2016 (FY15-16) DPU yield of 5.8% to 6% while near term asset injection (not factored-into our TP) is expected to materialise from mid-2016 onwards.

Key risks include slowdown in expansion and upcoming supply of space.

Risks to our call are slowdown in consumer spending; inflationary pressure; decline in tenancy rates; competition from approximately 10 million sq ft incoming supply of retail space (2015-16); higher debt refinancing rates; and correction in asset prices.— Affinhwang Capital, Jan 16

This article first appeared in The Edge Financial Daily, on January 19, 2015.