Pavilion REIT seen with prime asset profile, resilient profits

Pavilion Real Estate Investment Trust
(Jan 28, RM1.74)
Maintain market perform with a lower target price of RM1.80:Pavilion Real Estate Investment Trust (Pavilion REIT) realised net income (RNI) of RM247.6 million for financial year 2019 (FY19) was slightly below our and consensus expectations, at 93% and 94% respectively. Pavilion REIT’s top line was at 95% but the deviation was mainly due to a higher-than-expected financing cost of 108% as our estimates may have been too conservative.

Year-on-year, the top line was up 5% driven by a higher rental income from Pavilion Kuala Lumpur on positive reversions after a repositioning, and the inclusion of Elite Pavilion Mall in April 2018 (2QFY18). Pavilion REIT’s top-line growth was mildly dampened by the Da Men Mall registering a lower rental and occupancy.

However, Pavilion REIT’s RNI was down 3% on an operating expenditure up 17% due to higher electricity and repairs for air conditioners, lifts and maintenance, and financing cost up 10% due to Elite Pavilion and working capital. Quarter-on-quarter, the top line was flattish (up 1%), while a higher operating cost eroded its top-line improvement, resulting in a flat RNI.

For FY20 and FY21, Pavilion REIT will see 22% to 19% of its portfolio net lettable area expiring, on single-digit reversions. We are confident about Pavilion REIT’s two main drivers — Pavilion Kuala Lumpur and Pavilion Elite, cumulatively contributing about 95% of net property income — securing positive reversions on the minimal leases up for renewal, but a challenging outlook for Da Men Mall is expected to remain in the near term pending a cinema addition in October 2020. For FY20 and FY21, it will still be driven by single-digit rental reversions, stemming mainly from renewals at Pavilion Kuala Lumpur and Pavilion Elite.

We like Pavilion REIT for its prime asset profile and resilient earnings and as such have applied thin spreads at the lower-end among retail mortgage REITs under our coverage, between 1.3 percentage points (ppts) to 2.6 ppts. We are comfortable with our call, with a potential return of 9%, as most upsides — positive reversions and a stable portfolio occupancy — have been priced in, while downside risks appear minimal. — Kenanga Research, Jan 24