Pavilion REIT growth to moderate in near to medium term

Pavilion Real Estate Investment Trust (April 2, RM1.41)

Maintain neutral with a lower target price (TP) of RM1.41: The manager of Pavilion Real Estate Investment Trust (REIT) has announced not to proceed with the previous proposal to issue 218 million new units, which represent 7.2% of the REIT’s existing number of units. The decision came about following the decline in Pavilion REIT’s unit price since the proposal of the corporate exercise.

Following the cancellation of the placement, the initial RM371 million that was planned to be raised through placement will be funded through debt. Hence, we expect Pavilion REIT’s gearing level to rise to 33% from 26%.

The proposed acquisition of Pavilion Elite has become unconditional following the issuance of the new title for the asset. Considering that the acquisition will be funded fully through debt, we expect the exercise to be completed by the second half of financial year 2018 (2HFY18). While we expect Pavilion Elite to contribute about 4% of Pavilion REIT’s full-year revenue, we estimate that the higher borrowing cost to partially offset the positive earnings contribution.

We have also factored in lower rental reversion rates in view of the increasingly challenging market. More importantly, we estimate that the higher borrowing cost to affect its FY19 earnings by -10% to RM255 million. The earnings estimate for FY18 was lowered by -2% to RM252 million in anticipation of lower rental reversion albeit the inclusion of Pavilion Elite. 

Our TP is lowered due to lower earnings estimates resulting from higher borrowing costs as well as a higher required rate of return. Our TP is derived from the dividend discount model method with a required rate of return of 7.9% and a terminal growth rate of 1.6%. Although we think the growth for the REIT will moderate in the near to medium term, we believe Pavilion REIT may still present growth opportunities from potential new asset injections in the long term that can potentially drive growth. Meanwhile, its dividend yield is expected at 5.6% for FY18. — MIDF Research, April 2

This article first appeared in The Edge Financial Daily, on April 3, 2018.

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