Summary

  • Simon Property Group has a broad portfolio of high-quality and prime location commercial real assets in U.S. and in international markets.
  • The company’s robust balance sheet allows it to pursue high-value market opportunities.
  • Challenges include the impact of recession on malls, a secular shift towards online purchases, and challenges with the previously announced Taubman Centers acquisition.

Lately, Simon Property Group (SPG) has been in the news for many reasons, some good and some not so good. Analysts and investors have been keeping a close eye on this largest mall operator in the U.S. as the REIT works to reopen malls which are mostly located in prime locations in the country.

The company’s attempts to pull itself out of the merger with Taubman Centers (TCO) are also being closely watched. In June 2020, SPG slashed its dividends temporarily by 38%. The company has now joined the long list of mall REITs to have cut down dividends due to the pandemic. The latest Wall Street rumor is about a consortium of mall owners led by SPG and Brookfield Property Partners (BPY) working to bid for the now-bankrupt J.C. Penney.

The COVID-19 pandemic and the related closure of non-essential businesses have been a big blow to all mall REITs, and SPG has been no exception. Hence, when the market tanked in March 2020, SPG followed suit. The company fell from $140.07 on January 2 all the way down to $47.19 on March 20. The stock has recovered and closed at $65.13 on August 18. But the stock is nowhere near its highs of early January 2020.

Despite the many challenges, there are also several positives for this 7.98% dividend yield company. Hence, I strongly believe that there is still significant upside left in Simon Property Group.

Simon Property Group has a broad portfolio of high-quality commercial real estate assets

Simon Property Group owns, develops, and operates malls, both in the U.S. as well as in international markets. The majority of its malls are located in premium geographic locations. The company has not only survived, but has also actually grown in the period of the dead mall which followed the 2007-2008 global recession.

Simon Property Group had reopened all of its U.S. properties, which includes around 200 enclosed malls and outlets, by July 10. However, on July 15th, as per the Californian Governor’s order, the company had to close down seven properties in the state. It has also reopened all of its designer and premium outlets in international markets. Here, 100% of the stores are operational and are reporting retail sales at 90% level as compared to the previous year.

The company’s performance fares much better than peer retail REITs such as Macerich Company (MAC) and Taubman Centers. SPG not only has a broader commercial real estate portfolio, but also a better product mix more suited to the current pandemic environment. While consumers may be wary to visit enclosed malls in the short run, SPG stands to benefit from its outlets spread across the U.S.

To bolster its growth, the company has ventured into several end-markets, such as hotels, apartments, and office spaces. Further, a recent Wall Street Journal article reports that SPG is in talks with Amazon (AMZN) to transform some of its anchor properties into Amazon distribution hubs. Entry into the industrial REIT business can imply exposure to one of the most stable and least volatile asset class in the U.S. The explosive growth of e-commerce has led to solid growth in demand for warehousing facilities. Building warehouses is relatively fast and less expensive, hence much of this construction tracks demand. Thus, the chances of underutilized warehouses remain low.

Although second-quarter numbers were disappointing, there are signs of improving operational performance for SPG

Simon Property Group’s second-quarter revenues were down 24% YoY to $1.06 billion, lower than the consensus by $64.70 million. Its non-GAAP EPS of $0.83 also fell short by $0.11.

The company also reported a 30% YoY decline in FFO (fund from operations) per share to $2.12. However, we need to remember that the YoY decline was far lower than that seen for peers such as Macerich and Taubman. Both Macerich and Taubman reported a YoY decline in FFOs well over 50% in the second quarter.

The rent abatements had a negative impact on SPG’s financial performance in the second quarter. However, the company expects to recover almost 85% of the rent collections scheduled for the second quarter and 93% scheduled for July. With rent collections trending from 51% in April and May to 69% in June and 73% in July, we see that the trend is in the right direction. The company is working to get back its rent collection levels to the normal pre-COVID-19 run rate of 97-98%.

A strong balance sheet has resulted in high financial flexibility for SPG

Simon Property Group has managed to maintain its debt at reasonable levels. At the end of the second quarter, the company’s debt was $27.79 billion, which is almost unchanged from that at the end of the first quarter. This is an admirable feat, considering that its U.S. properties were cumulatively closed to public operations for a staggering 10,500 shopping days in the second quarter. At the end of the second quarter, the company’s total liquidity was close to $8.5 billion, which includes $3.6 billion in cash and a $4.9 billion credit facility.

High financial flexibility is allowing SPG to capitalize on attractive market opportunities in this economic downturn

Simon Property Group has been leveraging its balance sheet strength to acquire bankrupt retailers which have the potential to turn EBITDA positive in a short time frame. The company previously acquired Aeropostale and Forever 21.

Sparc Group, which is a joint venture between Simon Property Group and Authentic Brands Group, placed stalking horse bids for Brooks Brothers and Lucky Brand Jeans. In August 2020, Brooks Brothers agreed for SPG’s $325 million offer. Lucky Brand has also agreed for a $140.1 million offer from SPG. The potential of these acquisitions turning out profitable remains high, considering that the purchases are priced at very attractive levels. Further, Sparc can realize synergies through an overhead overhaul.

Simon Property Group and Brookfield Property Partners are also possibly close to acquiring the now-bankrupt J.C. Penney Co. Although Penney is said to have received a higher offer from private equity firm Sycamore Partners, the company may prefer the Simon Property Group-Brookfield Property Partners offer. This is because the two mall operators seem to have offered significant rent concessions to J.C. Penney.

None of the players in this deal have confirmed these rumors. In case Simon Property Group and Brookfield Property Partners are successful in this offer, it will help prevent the exodus of small retailers from their malls. The landlords will also save on the expenses required for redeveloping these properties. While J.C. Penney Co. does not account for any material revenue contribution for both these mall operators, those stores have definitely acted as anchors and account for a significant percentage of footfall. Simon Property Group and Brookfield Property Partners may also be interested in the upside potential of J.C. Penney, which enjoys a strong brand positioning.

All these acquisitions mean the addition of cheap real estate and robust intellectual property to SPG’s portfolio.

SPG’s dividends are pretty safe

Simon Property Group expects to pay an annualized cash dividend of $6.00 in fiscal 2020. The company was among the last of the REITs to slash the dividend amidst the ongoing pandemic. However, this seems to be a wise move considering the need to conserve cash in these difficult times.

The company’s dividend payment is safe, considering that the annualized dividend per share of $6.00 is significantly lower than the estimated fiscal 2020 FFO (funds from operations) per share of $9.98.

These are risks associated with investing in SPG

Like any other retail REIT, the ongoing economic downturn is a challenge for Simon Property Group. The problems have been further exacerbated by the fact that the pandemic has shown no signs of slowing and an effective vaccine may take some time to enter the market.

Unsurprisingly, many non-essential service players in SPG’s malls across the world had to shut shop during the shelter-at-home measures in the second quarter. Retail REITs have been facing a double whammy in the form of reduced consumer spending and consumers preferring e-commerce over physical shopping. These trends are manifesting into retail shops deferring rent from REITs. The company is also expecting additional requests for rent abatement in August and September 2020.

The increasing risk of retail establishments going bankrupt also adds to the SPG’s credit risks. According to the latest report by Coresight Research, there would be around 20k-25k retail store closures in 2020, much more than the 15k previously predicted by the research agency. It is also estimated that 55-60% of these closures will be for stores located in malls.

SPG’s CEO, David E. Simon, expects the current recession to be deeper and more long-drawn than even the Great Financial Crisis. He has also highlighted the probability of a huge number of bankruptcies in the retail sector. David expects the current recession to be more similar to the Great Recession of the early 1990s. Since commercial real estate is a lagging indicator of the economy, we can see SPG’s real estate asset portfolio pick up in value only after a few more years.

In its second-quarter earnings, SPG’s CEO has also pointed out that the company does not expect new business until 2021. It also has to deal with some renewals which were due in 2020. These may also involve some downward rent adjustments. Further, in case some major tenants opt to move out of the mall, it may affect SPG’s occupancy rate in the short run.

The company has reported Mall and Premium outlet occupancy of 92.9% at the end of the second quarter. However, around 4% of this occupancy involves tenants which have declared bankruptcy. While lease payments are usually treated as senior secured debt, the final outcome is dependent on the decision of the bankruptcy court. Hence, although the contractual build rent percentage has improved through April to July, it may be affected in the short term due to the decisions of the bankruptcy court.

The rise and fall of COVID-19 cases in particular geographies determine the level of comfort consumers have found in an outdoor environment. This, in turn, is a key determinant of retail activity and also a source of uncertainty in current times. Since Simon Property Group is categorized as a non-essential business, it may also face business closure in case the number of COVID-19 patients rises dramatically.

There is some litigation risk involved for investors in SPG. After Simon Property backed out of the $3.6 billion Taubman acquisition, both the retail REITs have approached the court for resolution. The verdict can prove challenging for SPG investors in case the court mandates payment of fines or significant breakup fee to Taubman.

While SPG is working to get back its rent collection to the normal run rate, this may take some time. Some retailers have been trying to conserve cash and may continue to defer rents. Then again, the retail landlord has had to take some of its tenants, including Gap (GPS) to court over pending lease payments.

Finally, leasing out anchor properties for Amazon’s fulfillment centers will impact traffic to in-line stores in the coming months. While this business can bring more stability, it can also significantly affect top line and bottom line performance.

Conclusion

There is no doubt that Simon Property Group is a REIT with solid fundamentals. The company’s dividend yield of 7.98% is exceptionally attractive in these low-interest rate times.

While the entire retail segment and retail REIT segment is under extreme pressure due to the pandemic, this situation is bound to improve someday. The advent of an effective vaccine will see the sector gradually gaining strength. Although the market share of e-commerce is going to go up substantially as compared to the pre-COVID-19 era, consumer traffic to high-end malls is not going to dry up completely. These malls will continue to be a point of congregation for social and recreational activities. SPG’s business definitely has a long way to go, but it will have to overcome this crisis. And the company definitely has enough balance sheet strength to do so.

We see this confidence reflected in the significant insider buying that has occurred in 2020. The chairman and CEO of the company have picked up a significant stake in the company, which boosts overall investor confidence.

According to Finviz, the 12-month target price of SPG is $86.14. Analysts seem to have mixed ratings for the company, although there have been few upgrades in the last two months. Please check the analyst ratings and target prices here.

However, there are significant secular headwinds in the retail REIT sector. This implies that we may see more share price volatility for SPG in the coming months. While I strongly believe this to be the right time to go for this REIT, I also recommend it only for retail investors with significantly higher risk appetite. I also believe that investors need to hold on to this stock for at least two years to see a material rise in share prices.

Author: Healthcare on the Move

Source: Seeking Alpha: Simon Property Group: This 7.98% Dividend Yield REIT Is A High-Risk, High-Reward Pick

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