Thursday, December 5, 2019

Simon Property Group (SPG): A High Yield and High Risk REIT

Simon Property Group (SPG) is a global leader in the ownership of premier shopping, dining, entertainment and mixed-use destinations. Its properties across North America, Europe and Asia provide community gathering places for millions of people every day and generate billions in annual sales. I will analyze it using the guidelines for analyzing REITs that I have outlined before.

Simon Property Group has managed to increase dividends for 9 years in a row. The last dividend increase occurred in July 2019, when the Board of Directors increased the quarterly dividend to $2.10/share. This was a 5 cent increase over the prior dividend amount and a 5 percent increase over the distribution paid during the same time the previous year. If the streak of dividend increases continues, Simon may be able to join the elite group of 400 or so dividend contenders and dividend achievers. The REIT cut dividends in 2009 during the financial crisis, after raising them for about 8 years beforehand.

During the past decade, Simon Property Group has managed to increase dividends at an annualized rate of 8.80%. The historical rate of dividend growth seems favorable, even if we account for the dividend cut from 90 cents/share to 60 cents/share in 2009. It would be interesting to see how the dividend holds up, given the headwinds in the retail sector and malls/shopping centers.

Between 2008 and 2018, FFO/share has increased from $6.45/share to $12.13/share. Simon Property Group is expecting to generate FFO/share in 2019 in the $12 - $12.05/share range. The financial crisis resulted in a 20% decrease in FFO/share. I hope that management will not cut dividends during the next 20% decrease in FFO/share, even if the payout ratios are sustainable.

Developing new properties, raising rents and reducing costs are just a few ways in general to grow FFO/share. With the supposedly difficult environment for retail and malls, it is going to be difficult to grow by expanding too much. Another way to grow is by making acquisitions, which may result in synergies.

The company’s tenant base seems adequately diversified. It’s properties are also viewed as high quality, with average sales per square foot exceeding $650, and average rents hovering around 10 -12% of that figure.

Most retail malls have two types of tenants, anchor tenants and inline tenants. Anchor tenants are the key tenants with large stores and big names in the business. Anchor tenants attract other smaller tenants and customers to the mall. Smaller customers benefit from the traffic that anchor tenants draw to the mall. Anchor tenants pay lower rents and enter into long-term lease duration compared to inline tenants.

In Simon’s case, inline tenants pay anywhere between $50 to $65 per square foot. Anchor tenants pay around $4 to $8 per square foot.

Here is a listing of the top 10 inline lessees, which account for 17% of total revenues and 8.70% of square footage.

The largest anchor tenants are listed below:

These anchor stores account for 31% of square footage but less than 2% of total revenues. It is interesting to note that if these retailers fail, and the space can be re-leased to smaller stores, rental income may increase provided that foot traffic doesn’t materially decrease. After all, a major anchor retailer would fail due to lower foot traffic in the first place, that is not providing valuable foot traffic to the inline stores in the first place. Therefore, it may be a positive that the likes of Sears for example have failed. Using that space for other purposes could unlock hidden value potentially.

Decreasing interest rates have been a tailwind for Simon Property Group, as it has allowed the real estate investment trust to refinance to lower rates and to pick up projects at a lower cost of capital. The company has a conservative balance sheet, which is why it has enjoyed an advantage in cost of capital versus peers. It has a good credit rating, and debt maturities are staggered well.

Increasing investments abroad could be another potential tailwind, as is opening new centers or renewing leases or signing up tenants at higher rates. Redevelopments could also refresh properties, and result in an increase in traffic, rents and tenant interest.

The occupancy rates increased since the financial crisis until hitting a peak at 97% in 2014. Since then, occupancy rates have been somewhat steady around 95%. The financial crisis impacted everyone and the whole economy. The challenges ahead for REITs like Simon seem to be structural, due to changes in the way US consumers shop. The US retail market is overdeveloped, which may not bode well for future occupancy rates, at a time when shopping patterns change, and online becomes a bigger competitor from before.

The FFO payout declined from 55% in 2008 to 48% in 2011. This was due to a combination of dividends cuts and FFO declines. I do not believe the FFO Payout ratio was that aggressive in 2009, in order to cut the dividend. But management, perhaps due to high debt levels and in an effort to preserve liquidity decided to cut distributions at this time, even if they didn’t have to. Simon Property Group was one of the REITs that paid a large share of their distributions in the form of extra shares in the dark days of 2009, instead of providing cash to shareholders. They also resorted to selling stock at the time.

The FFO payout ratio has been increasing steadily from the lows in 2011 to around 65% in 2018. Based on forward FFO projections and the latest dividend increase, the forward FFO payout ratio is at 70%. While there is some margin of safety in the distributions, I do not think that high payouts are justified for companies like Simon. This is no Realty Income that operates under long-term triple-net leases. FFO/share is not expected to grow for the near future, which means that there could be a natural ceiling to dividend growth. I have believed that lack of earnings, or in this case FFO growth, could be a risky sign in terms of dividend safety.

The number of shares outstanding increased between 2008 and 2010, from 222 million to 291 million. This is one of the situations where shares were being given away at fire-sale prices when things were tough. Obviously, that is bad capital allocation. The number of shares outstanding ultimately peaked at 313 million in 2016, and have been going downwards very very slowly.

Simon Property Group is cheap today at a little over 12 times forward FFO/share and a juicy dividend yield of 5.60%. This is a good value in an environment where value is hard to find. Of course, the reason for the good valuation is that there is little FFO growth expected, and due to headwinds from the troubles of US retailers. There are some opportunities for growth, but also some opportunities for things to go wrong as well. You have to decide for yourself if the entry price justifies the risk you are taking, and if the potential return is sufficient to compensate for said risk. FFO/share is not expected to grow for the near future, which means that there could be a natural ceiling to dividend growth.

The situation does seem similar to Tanger (SKT), which also yielded 5% in 2017, but the stock was about to fall by 40%, while FFO/share and dividend growth flattened out. Of course, Tanger never cut dividends in its history, but both companies are connected to their founding families, which is usually a plus.

Relevant Articles:

Tanger Factory Outlets (SKT) Dividend Stock Analysis
Dividend Achievers versus Dividend Contenders & Champions
Five Things to Look For in a Real Estate Investment Trust
Twelve Companies Raising Dividends To Their Investors

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