Simon Real Estate Group (New York Stock Exchange: SPG) is well positioned to benefit from the normalization of the U.S. retail economy in consumer spending trends after the pandemic subsides. It’s common sense for the nation’s largest mall and retail space owner (in addition to properties in Europe and Asia). An additional boost that Wall Street is not pricing in is rising inflation in America that will help the company drive up rents, while underlying real estate values climb faster than usual. Owning real estate through low-interest debt has been a tremendous tailwind to REITs for two years in a row, and it’s a leveraged idea that all investors should consider owning today. today. Finally, $11.70 of FFO projected for 2022 easily covers a superb dividend story of over 6%, with a current cash payout of $6.80 per year. Combining the top three positives and looking at a stock quote that is still trading below its pre-pandemic level, income and defensive-minded investors could benefit from buying this REIT just above – above $100 at the end of May.
Several weeks ago, management outlined the bullish outlook in its March first quarter earnings release. According to the CEO david simon,
Rental dynamics, retailer sales and cash flow accelerated. Given our achievements this quarter and our current outlook for the remainder of 2022, we have increased our quarterly dividend today and are increasing our full-year 2022 guidance.
Simon Property’s board of directors raised its quarterly dividend to $1.70 per share from $1.65 previously. Management has indicated that the company may repurchase up to $2 billion of its common stock over time, believing its valuation to be too low. I agree that buying itself (at lower book values) makes more sense financially than acquiring new properties at higher property prices. The company now expects a 2022 FFO per share of $11.60 to $11.75 versus earlier guidance of $11.50 to $11.70. The FFO numbers still haven’t fully recovered from the pandemic, as you can see in the chart below. However, Wall Street believes that beyond 2022, stable growth is on the horizon.
Compelling evaluation story
I haven’t mentioned Simon as a bull idea in my years on Seeking Alpha. In fact, I suggested the company as an idea to hold or sell since $180 per share in a December 2016 post here. However, I’m quickly preparing for SPG as an investment proposition in mid-2022. Rising property prices and improving margins, with a well above average dividend yield of 6%+ over the current rate of the S&P 500 of 1.4%, become difficult to ignore in combination for the catalysts.
The dividend yield is also a top pick compared to peers and competitors in the retail rental industry. Below is a 1 year chart of the rolling return vs. Real estate income (O), Regency centers (REG), Kimco Real Estate (K.I.M.), Domestic commercial properties (NNN), Federal Real Estate (FRT), Brixmor Property (BRX), and Accept real estate (ADC).
A variety of other valuation statistics are starting to argue in favor of the property. On the basis ratios of price to earnings, sales, cash flow and tangible book value, the REIT is currently trading near its 10-year low, if you ignore the pandemic investor dump from the start of 2020 on government mandated retail closures.
The current P/E ratio (not FFO) is actually one of the lowest numbers at 16x in the retail REIT space. The median peer group average is closer to 24x. Actual profits now cover the distribution of dividends, a major asset in terms of financial solidity.
On company valuations, adding debt to equity capitalization, Simon appears even cheaper. Below are graphs of the ratio of EV to EBITDA (earnings before interest, taxes, depreciation and amortization) and sales. Both are trading at a nice 30% discount to 10-year averages. Historically, Simon’s EV to EBITDA valuation has been set at a figure above the S&P 500 index average. However, the current 13x multiple is a slight reduction from the average equivalent of American blue chips around 15x.
Compared to the peer group, Simon’s EV to EBITDA is the lowest. And, EV to Revenues of 12x is a discount to the median peer average of 13.5x.
My biggest concern over the years has been a higher than industry normal leverage setup. The company’s large size and geographic diversification allowed for more debt issuance, pushed by Wall Street firms. The downside was that the stock lagged its performance as debt servicing weighed on steady earnings and consumer traffic patterns in malls. The growing retail sales demographic has shifted to online outfits like Amazon (AMZN) over time, especially during physical pandemic shutdowns.
Below is a chart of Total Financial Debt versus Cash Revenue, represented by EBITDA.
The current leverage situation is not much worse than the peer group, shown below. However, I would prefer this industry leader in acreage and market capitalization to reduce its total debt to improve flexibility during recessions and increase safety/defensive characteristics for long-term shareholders.
Limited selling pressure
In my technical trading research, the lack of aggressive selling stands out in 2022. Of course, the stock price is down 30% with the REIT sector and the market is down a similar percentage over the first five months of the year. Yet there is no evidence of specific and extraordinary selling pressure on SPG.
Looking at an 18 month chart of daily changes, the 14 day Cash flow index has not reached extreme levels, while Negative volume index actually remained in an uptrend. Another positive point, On balance volume did not decline dramatically with price, signaling that volume sellers were not the problem.
Ultimately, I expect Simon Property to lead any uptrend reversal for retail REITs. The question is when such a turnaround will materialize.
Simon could also benefit from the long-term push to produce cleaner, renewable energy. How? One of the most innovative ideas is to use large commercial spaces to install solar panel farms, either on the roofs of buildings or in parking lots. If a decade from now, Simon generates a significant portion of the electricity needed for company-owned malls, while reselling excess power to local utilities, a stronger value proposition for tenants and a new source of income from existing properties could become reality in time.
What are the risks of investing in SPG? Two stand out for me. First, a weaker economy and/or the return of the pandemic would certainly hurt business growth trends. The Federal Reserve tightening cycle in early 2022 is sure to dampen consumer demand. Whether you’re looking at the -1.5% GDP contraction for the first quarter of the year (adjusted for 40-year high inflation) or following the massive affordability issue in the market residential real estate due to soaring prices and the 2%+ rise in mortgage rates last spring, economic growth in 2022 will be weak at best.
Along with the chances of mall traffic/spending slowing by the end of the year, medical experts fear that new strains of COVID-19 may be present for some time. The 1889-94 Russian flu that circulated in Europe for five years, without a vaccine solution, bears a number of similarities to today’s novel coronavirus. I wouldn’t be surprised by intermittent flare-ups, requiring social distancing and masks, until more widespread exposure and immunity develops in the global population.
A second risk is that management aggressively acquires new properties and borrows at a much higher interest cost than current debt. The company still holds debt levels that make me nervous. A deep recession accompanied by much higher interest costs could significantly reduce earnings. Nonetheless, management’s focus on current properties and the decision to use excess cash flow to repurchase stock are solid ideas in the current economic environment. I would recommend that the company pay off its higher rate debt and use its low interest rate leverage for as long as possible. Real estate inflation of more than 5% per year with debt financed at the same or lower rates is a solid wealth-building formula for homeowners.
I’m working on a plan to buy a stake in Simon Property next week. A small position now, with the possibility of adding weakness, is the battle plan. I have a price target of $120-$150 in 12-18 months. Nothing spectacular for capital appreciation, but the 6%+ dividend yield should help define a total return in the range of 15-20% annualized over the next few years. Outside of a stock market crash or deep recession, I have trouble modeling a price below $90. The real risk on another wave of selling in US equities this fall should be limited to $95 or $100.
Thanks for reading.