Pavilion Reit - Limited upside, earnings upside have been priced in HOLD

- We are downgrading Pavilion REIT (PREIT) to a HOLD, with an unchanged fair value of RM1.65/unit, based on our DCF valuation, given PREIT’s limited upside to its share price.

- Following a company visit, we re-iterate our positive stance on PREIT, underpinned by its asset quality and a growing middleclass. This bodes well for PREIT’s growth.

- Nearly 70% of NLA is due for renewal this year. Given that this represents Pavilion Mall’s second rental cycle (first cycle in 2010) and at early stages, we have factored in a 12% rental reversion.

- However, feedback from some retailers has indicated that mall owners are requesting for sky-high rental reversions that are unjustified. This may in turn suggest a possible softening in rentals in the near term.

- Yet, as KLCC’s average rental is at c.RM25psf, we see room for PREIT (average rental: RM18.80psf) to play catch-up. This is underpinned by Pavilion Mall’s relatively young status and a long waiting-list of interested retailers wanting a presence in the mall.

- Footfall inched up 4% in FY12 contributed by Fashion Avenue and a strong F&B and fashion mix, in our view.

- Should Fahrenheit 88 be deemed fit as a yield-accretive acquisition during an evaluation exercise in 4Q13, it will likely be funded via debt and equity. Any injection will only materialise in FY14F. PREIT is not playing any part in the repositioning of Fahrenheit 88’s tenant mix in an upcoming renewal in 3Q.

- Given the rather weak footfall at Fahrenheit 88 due to the tenant mix, we believe in a turnaround under management hands, should the acquisition materialises. This is underpinned by PREIT’s strong management capability and experience in managing Pavilion Mall.

- Based on our channel checks, retail REITs in town, including PREIT, have acknowledged the lack of quality assets that are yield-accretive for acquisitions. This somewhat limits the REITs’ growth, apart from organically.

- As such, management is of the view that the sponsor would eventually have to venture into greenfield shopping malls. PREIT is eyeing day-to-day consumer malls in the Northern and Southern regions of Malaysia but not Iskandar, Johor. This is largely because PREIT is targeting locals and prefers malls located within city centres.

- We continue to like PREIT for its longer term growth potential, underpinned by quality assets and a sizeable pipeline of potential assets for injection. Dividend yields are decent at 4.3% and 4.7% for FY13F and FY14, respectively, based on a 100% payout ratio.

Source: AmeSecurities