PAVILION REIT - Rentals to rise on the back of 69.8% of NLA expiring

- We upgrade Pavilion REIT (PREIT) to a BUY, with a higher fair value of RM1.65/unit (vs. RM1.33/unit previously), based on a 5% discount to our DCF, as we roll forward our valuation to FY13F.

- For FY12, PREIT performed well with a share price appreciation of 28%. The main reasons for our downgrade to a HOLD in July 2012 were the significant yield compression and premium valuation.

- Nevertheless, we believe strong earnings momentum will resume in FY13F, largely driven by Pavilion Mall premised on:-
(1) The bulk of Pavilion Mall’s NLA leases, 69.8%, are expiring this year (the majority in September). This implies a good opportunity to reap benefits from raising rentals. More importantly, Pavilion Mall is in the early stages of its life cycle. We have projected a 12% rental reversion – in line with management guidance of 10%-15%.  Note that rentals were raised by 10%-12% during its first rental reversion in 2010. Average rental stands at RM18.74psf with 98.5% occupancy as at 3QFY12.
(2) New precinct, Fashion Avenue (+5% NLA), opened last September. Footfall appears to have improved. This, we believe, is underpinned by:- (i) Designated entrance with additional pick-up points added to the Raja Chulan entrance to Fashion Avenue; (ii) Enlarged number of speciality stores (+35 stores) and 100% tenanted; and (iii) 30% are international brands making their maiden entry into Malaysia.

- Positively, the group has a sizeable pipeline of potential assets that could be injected – Fahrenheit 88, Pavilion Extension and da:men mall in USJ, providing long-term growth potential, in our view. We do not rule out the possibility of an asset injection to materialise as early as FY14F. Come 3Q this year, Fahrenheit 88 would have just passed its infancy stage (3-year cycle). Management will then need to evaluate the mall’s progress.

- The release of the full-year FY12 result is likely to be announced within the first week of February. We expect a decent FY12, underpinned by the enlarged number of speciality stores, thanks to Fashion Avenue. Rentals for Fashion Avenue are envisaged to nearly double that of the previous anchor tenant’s rental rates. But, the full impact will only be reflected in FY13F.

- Taking all in, our FY13F-FY14F earnings have been fine-tuned by a marginal 1%-2% due to housekeeping work on our model. We project earnings to rise by 19% in FY13F driven largely by  69.8% of NLA expiring for Pavilion Mall and higher rentals achieved for Fashion Avenue; thereafter, a 9% increase in earnings for FY14F. Despite a huge 53% of leases expiring for Pavilion Tower in FY14F, the impact is rather minimal. This is underpinned by a small 4% earnings contribution from Pavilion Tower, with the remaining from Pavilion Mall.

- PREIT remains as our top pick under our REITs universe. We continue to like PREIT’s quality assets and bright prospects. Our DPS translates into a 99% distribution ratio. Dividend yields are estimated at 5.1% and 5.5% (vs. CMMT: 4.8% and 5.1%) for FY13F and FY14F, respectively.

Source: AmeSecurities