Pavilion REIT — initial public offering

Pavilion REIT (Offer price 88 sen)
Fair value of RM1:
Pavilion REIT will be the sole premium retail REIT in Malaysia upon listing, with its most valuable asset being Pavilion KL Mall (with 1.3 million sq ft of net lettable area [NLA]), which is valued at RM3.4 billion. The REIT also manages Pavilion Tower — a 20-storey office tower with 167,400 sq ft of NLA valued at RM128 million. Pavilion KL Mall has a diversified tenant base, ranging from supermarkets/department stores (Parkson, Mercato) to high-end fashion outlets (Prada, Gucci, Michael Kors) only available in one or two malls in Malaysia. Overall occupancy rate is 99% with average rental rates of RM16.76 per sq ft (retail) and RM5.92psf (office).

Near-term growth will be organic, driven by positive rental reversions on expiring leases. Some 67.2% of Pavilion KL Mall's leases are due to expire in FY13, which would lift our FY13F revenue forecast by 4% year-on-year (assuming 5% rental rate hike) to RM324.7 million. Y-o-y growth for FY12 is expected to be marginal as only 5.5% of the mall's occupied NLA is set for renewal. We understand the managers are actively searching for yield accretive acquisitions in the Klang Valley, Penang and Johor that fit the REIT's profile. Pavilion REIT also possesses rights of first refusal (ROFR) for Pavilion KL Mall extension and a retail mall in USJ Subang Jaya. Pavilion REIT also has ROFR for fahrenheit88, a 300,000 sq ft NLA mall located nearby, with plans to inject it into the REIT as early as 2014.

Pavilion REIT — which would be using 93% of its gross IPO proceeds of RM695 million to part finance the purchase price of RM3.3 billion — would have a gearing of 20.1% post-listing, below the 50% gearing limit. This suggests it could borrow an additional RM1 billion to fund its future acquisitions.

Our RM1 fair value is based on a discounted cash flow analysis with 7.5% weighted average cost of capital, 3% terminal growth and 0.5 Beta (based on CapitaMalls Malaysia Trust), thus valuing Pavilion REIT at a market capitalisation of RM3 billion. At our target price of RM1, the stock offers a distribution yield of 5.8% (based on FY12F dividend per unit of 5.8 sen). This is broadly comparable with the one-year forward yields for Sunway REIT (5.7%) and CapitaMalls Malaysia Trust (6.1%), its closest peers with dominant retail exposure and market capitalisation. — HwangDBS Vickers Research, Nov 18

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