Simon Property Group: a high-quality REIT
This is the first in a series of articles about real estate investment trusts that have S&P credit ratings of A or A-. Simon Property Group, Inc. (SPG) is one of only two REITs with an A credit rating from S&P. The company owns (in full or in part) premier shopping, dining, entertainment and mixed-use destinations across North America, Europe, and Asia. A fear of brick and mortar retail may keep you from buying shares, but SPG is worth a look to see how an excellent REIT responds to our ever-changing retail environment. Simon is the only REIT in the Standard & Poor’s 100.
Simon’s property portfolio has four operating platforms, and a fifth platform is in development:
- 116 malls in 32 U.S. states and Puerto Rico;
- 78 Premium Outlets® in 29 U.S. states and Puerto Rico and 7 Outlet Marketplaces in six U.S. states;
- 16 super regional malls in 13 U.S. states; The Mills® purchased in 2007 from the Mills Corporation;
- 33 premium outlets in 13 countries outside the U.S.; and
- an e-commerce platform: Shop Premium Outlets®, an e-commerce platform designed to grow Simon retailers’ online and walk-in business.
From local developer to a world leader among REITs
Simon began as an Indiana shopping center developer in 1960 and was granted REIT status in 1993. SPG pioneered the concept of an enclosed mall with a “big box” anchor. Now, Simon is a leader in developing mixed-use properties. The company maintains an industry-leading balance sheet. March 31, 2019 occupancy was 95.1%. Per square foot sales were $660, up 3.1% for the trailing 12 months. Base minimum rent was $54.34 per square foot. The leasing spread for new leases was $14.17 per square foot, up 27.3% for the trailing twelve months.
Of the 36 Retail Property REITs in the FTSE NAREIT All REITs Index, Simon is the largest by far at $53.8 billion in equity market capitalization. Only two others are over $10 billion: Realty Income (O) at $20.7 billion and Regency Centers Corporation (REG) at $11.4 billion.
David Simon, 58, served as SPG’s president from 1993 to 1996 and has been chief executive officer since 1995 and board chair since 2007. Barron’s and Harvard Business Review have named him one of the world’s best CEOs. In January 2019, President and Chief Operating Officer Richard Sokolov was named vice chairman.
Why bother with brick and mortar retail?
The growth of online shopping has created a caveat emptor season for retail REITs, and for good reason. S&P Global recently noted that 17% of retailers covered by S&P are financially vulnerable at distressed levels. Given consumers’ changing buying patterns and troubled retailers, it’s easy to understand why mall REITs have fallen out of favor with investors.
Is there opportunity amid the rubble? Dynamic economies create winners and losers. Lessee bankruptcies are opportunities for REITs to introduce new brands and new concepts. More retailers are using both “bricks and clicks.” In this environment, Simon keeps properties updated and repurposes malls by replacing big box stores and other vacating retailers with new brands, entertainment, lifestyle/fitness and dining lessees, typically achieving higher leases per square foot.
Many urban residents, particularly Millennials, enjoy the convenience of living, working and playing within walking or biking distance and with access to public transportation. Simon is building some new malls and redesigning some existing malls as mixed-use properties that include adjacent hotels or multi-family residences.
Even if you aren’t interested in SPG as an investment, it’s a worthy study because of its window into the retail sector and ever-changing consumer preferences. In 2018, Simon signed nearly 4,000 leases, including 130 new brands, 60 new restaurants and 20 new lifestyle/entertainment concepts.
Simon Property Group describes “Risk Factors” on pages 11-21 of its 2018 Annual Report Form 10-K. REITs enjoy a pass-through exemption from U.S. federal income tax if they distribute 90% of their taxable income to shareholders. This allows REITs to pay substantial dividends, but it also makes them vulnerable to changes in the tax law. Large payouts mean less money to reinvest, so REITs typically rely on debt to fund growth, which makes them vulnerable to rising interest rates. Simon has navigated numerous economic cycles and its conservative finances and seasoned management should enable it to survive and thrive in this changing retail environment.
Still, as Kirk Spano would say, “It’s a REIT.” Caveat emptor.
Simon Property Group’s financial performance
Here’s a snapshot of selected SPG data from Finviz:
- Trailing 12-month earnings per share: $7.65
- Trailing 12-month price/earnings ratio: 20.92
- Projected 2019 earnings per share: $7.33
- Forward price/earnings ratio: 21.82
- Estimated EPS growth for the next five years: 8.60%
- PEG ratio: 2.43
- Beta: 0.54
- Book Value: $10.26
(Graphs from F.A.S.T. Graphs)
I’ve included two F.A.S.T. Graphs for SPG. The top graph shows AFFO (adjusted funds from operations) and the bottom graph shows EPS (operating earnings).
Simon’s price weakness (black line) since mid-2016 is evident on the above graphs. A growing percentage of AFFO and adjusted earnings (dark green area) is being paid in dividends (light green area). As indicated on the bar at the right, Simon Property Group’s S&P credit rating is A.
Debt is indicated as 82% of capitalization. This is based on SPG’s very low book value of $10.26. My spreadsheet measures debt to equity in two ways. One is by book value. One is by equity market value, which I find more useful.
SPG’s debt of $23.186 billion compared with an equity market value $49.128 billion (309.0 million shares at $159.93 per share) shows debt as 31.9% of $72.6 billion total capitalization. SPG’s debt as a percentage of book value is 88%. (By this measure, the equity value is just $3.170 billion (309.0 million shares at a book value of $10.26 per share), added to debt of $23.186 billion makes a total capitalization of $26.356 billion, with debt comprising 88.0% of capitalization.
F.A.S.T. Graphs projects AFFO to be $11.22 in 2019, growing 4% in 2020 to $11.68 and 4% in 2021 to $12.19.
Operating earnings are projected to dip to $7.10 in 2019 and to grow 2% in 2020 to $7.22 and 5% in 2021 to $7.57.
From SPG’s 2018 Annual Report (Form 10-K)
|Selected financial data||2018||2017||2016|
|Funds from Operations (billions)||$4.325||$4.021||$3.793|
|Change from prior year||7.6%||6.0%||6.2%|
|Diluted FFO per share||$12.13||$11.21||$10.49|
|Consolidated net income (billions)||$2.822||$2.245||$2.135|
|Diluted net income per share||$7.87||$6.24||$5.87|
|Dividends paid per share||$7.90||$7.15||$6.50|
|Percentage of FFO paid in dividends||65.1%||63.8%||62.0%|
Justin Law’s compilation of Dividend Champions (25+ consecutive years of dividend increases), Contenders (10+ years) and Challengers (5+ years) includes Simon Property Group as a Dividend Contender at 10 consecutive years of dividend increases, beginning in 2010. The list is maintained by The DRiP Investing Resource Center, which shows SPG’s five-year dividend growth rate as 12.6%. However, the trend of payout increases is down. The most recent increase was 2.5%.
At the $159.93 closing price on Thursday, June 27, 2019, and a current quarterly dividend of $2.05, or $8.20 annually, SPG’s yield was 5.13%. This reflects the market’s fear of brick and mortar retail. The investment issue is simple. Given Simon’s premium quality properties, its long and consistent history and its financial strength, SPG should receive a premium valuation from the market, with a dividend in the 3% range, which would equate to a price of ~$273. However, retail REITs in general, and malls in particular, are out of favor, with many investors questioning the long-term viability of malls. Thus, the investment decision is not so simple.
F.A.S.T. Graphs projects SPG’s dividend to be $8.61 in 2020 and $9.09 in 2021. Simply Safe Dividends gives Simon a dividend safety score of 65 (with 50 being average).
I’ve been long SPG since May 2017. I’ve written two articles about Simon in March 2017 and in October 2017. My cost basis is $161.88. SPG represents 2.91% of the market value of my retirement portfolio.
Simon’s high yield for the past five years has ranged from 3.5% (in 2015) to 5.4% (in 2018). The high yield has increased each year since 2015. The average high yield has been 4.24%.
What is an appropriate valuation for Simon?
SPG’s 52-week price range has been $158.63 to $191.49. The midpoint of this price range is $175.06. The low price occurred this week on June 26, which was $1.14 below the $159.77 low reached during the broad market selloff on December 26, 2018.
I sometimes use a tool called The Stock Selection Guide that was developed in the early 1950s by the (then) National Association of Investment Clubs (now BetterInvesting.org). Its purpose is to establish a possible price range for the next five years, using selected data from the past 10 years, modified by one’s judgment about factors that may enhance or impede growth.
Estimated high price. I chose a potential high EPS of $10.04 by using a 5.0% estimated EPS growth rate (lower than the 8.6% Finviz estimate and the 5.7% analyst estimate provided by Better Investing). I chose a potential high P/E ratio of 25.7, which is the midpoint between the five-year (2014-2018) average P/E of 30.4 and the current P/E of 20.9. $10.04 x 25.7 indicates a possible high price of $258.10.
Estimated low price. I arrived at a possible low price of $134.00 by shaving 10% off the 2018 low price of $145.80.
Price range. A possible five-year price range of $134.00 to $258.10 represents a swing of about $124.00. I divide this range into fourths, so that the lower 25% is a “buy” range, the upper 25% is a “sell” range, and the middle 50% of the possible price swing is a “hold” range.
Buy and sell ranges. The “buy” range is $134.00 to $165.00 (the lower ¼ of the range). The “sell” range is $227.10 to $258.10 (the upper ¼ of the range).
At a June 27 closing price of $159.93, Simon Property Group is in the buy range. A more conservative investor might set a buy target of $154.80, which would represent a 3-to-1 upside/downside ratio, based on the estimated five-year price range indicated by this study. SPG is 2.77% of the portfolio, which I consider a full allocation. So, my personal target price to add more shares is $149.09, which would represent a 5.50% dividend yield at the current annual dividend of $8.20. I’ve set an alert for that price at Custom Stock Alerts.
(Author’s computations, using Better Investing’s Stock Selection Guide)
Some things to watch for
Simon’s new Shop Premium Outlets® initiative expands its VIP Shopper Club, tying together e-commerce with brick and mortar through apps to promote discounts and guide shoppers to Simon retailers. Watch for signs of increased online sales by Simon’s retailers and whether this effort generates increased foot traffic in the malls.
Simon’s international presence is growing, in part through joint ventures and SPG’s 21% stake in Klépierre S.A. (Euronext ticker LI), which has properties in 16 countries. The 2019 Q1 earnings call named several new premium outlet openings: a Querétaro, Mexico, joint venture in 2019; Malaga, Spain, in 2019; a Bangkok, Thailand, JV in 2020; Cannock, England, in 2020; and Normandie, France, in 2021. Watch for whether SPG’s international exposure grows as a percentage of sales and profits. In short, will Simon’s international platform be accretive to earnings?
Simon’s financial and management strength should enable it to adapt to the changing shopping environment. Simon is one of seven REITs in the Regional Mall sub-sector of the FTSE NAREIT All REITs Index. Its $53.8 billion equity market capitalization accounts for 80.9% of the sub-sector’s $66.5 billion.
From 2014 through 2018, Simon grew net income per share from $4.52 to $7.87, funds from operations from $8.90 to $12.13 and dividends from $5.15 to $7.90. Simon projects 2019 FFO to be $12.30 to $12.40 per share. The current quarterly dividend is $2.05, for an annual rate of $8.20. At a closing price of $159.93 on June 27, 2019, the dividend yield was 5.13%.
The challenges faced by brick and mortar retailers and mall operators are well known. Simon has strong management, high-quality properties, industry-leading financial strength and the ability to adapt to the changing retail environment. I’m sticking with quality.
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Disclosure: I am/we are long SPG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes only (not a solicitation to buy or sell stocks). I am not a registered investment adviser. Everyone’s risk tolerance varies. Please do your own research or consult a financial adviser to determine what investments are appropriate for your individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.