Pavilion REIT’s earnings expected to pick up in 2HFY16

Pavilion Real Estate Investment Trust (July 29, RM1.85)

Maintain buy with a higher target price (TP) of RM2.22: Pavilion Real Estate Investment Trust’s (REIT) first half ended June 30, 2016 (1HFY16) realised net profit of RM121 million (+1% year-on-year [y-o-y]) came within our and consensus expectations, accounting for 45% and 46% of forecasts. While 1HFY16 revenue saw an increase of 8% y-o-y to RM224.7 million due to rental income from newly injected properties, which is to say, DaMen USJ and the Intermark Mall, realised net profit was relatively flat as a result of higher borrowing costs due to the drawdown of additional borrowings for the acquisition of investment properties.

Earnings are expected to pick up in 2HFY16 due to the tenancy renewal of 69% of the outstanding net lettable area in Pavilion Kuala Lumpur, which is set to expire in 3QFY16 to 4QFY16, as well as income from the two new malls. As at 1HFY16, a distribution per unit of 4.14 sen was proposed (1HFY15: 4.09 sen). The Pavilion Mall occupancy rate dropped to 97% from 98% last quarter, and will likely experience a drop to 95% towards end-2016 as reconfiguration of tenants and the relocation to the Pavilion Extension are happening in September. Nonetheless, management has said that retail sales have seen a pickup of 10% y-o-y year to date.

We maintain our “buy” rating on Pavilion REIT based on a higher dividend discount model-based 12-month TP of RM2.11 as we update our risk-free assumption from 4% to 3.5% due to the recent overnight policy rate cut by Bank Negara. We continue to expect interest in the stock due to its acquisition pipeline.

Recall that Pavilion REIT has the right of first refusal for the Pavilion Extension (net lettable area of 250,000 sq ft) and Fahrenheit 88 (net lettable area of 300,000 sq ft). Key risks include slowdown in spending, upcoming supply of space. Risks to our call are a sharp slowdown in upper middle class and upper class retail spending; negative effects of price hike adjustments arising from imported inflation due to a stronger US dollar, non-renewal of tenancies, competition from 16 million sq ft incoming retail supply (2016 to 2021). — Affin Hwang Capital, July 29

This article first appeared in The Edge Financial Daily, on Aug 1, 2016. Subscribe to The Edge Financial Daily here.