REG - Simon Property Group: 5.82% Yielding REIT Room For Dividend Growth

Summary

• Simon Property Group has returned $39 billion to shareholders since its IPO in the form of dividends and has a track record of rebuilding and exceeding its previous dividend after a reduction.
• SPG is trading at a low price-to-FFO ratio and high dividend yield compared to its peers.
• I believe SPG is undervalued and that management will continue to grow the dividend as it currently has a 1.67x coverage ratio from FFO.

When investors allocate capital toward real estate investment trusts ((REIT)), normally their primary goal is to generate income with a secondary goal of capital appreciation. Many REITs have endured a difficult few years due to the pandemic, a rising rate environment, and a challenging macro environment. Simon Property Group ( SPG ) is no exception, and in addition to the recent challenges, they have had to withstand the rise of eCommerce as well. At the beginning of the pandemic, SPG was forced to halt its dividend for a quarter, and when it was reinstated, shareholders received a -38.10% cut to the quarterly dividend. Over the previous 12 quarters, SPG has increased the quarterly dividend by $0.50 (38.46%), and it's within $0.30 (14.29%) of its pre-pandemic level of $2.10. SPG finished 2022 strong, and while guidance for 2023 wasn't anything to rave about, SPG still looks undervalued, and there is certainly room for future dividend growth from their funds from operations (FFO).

SPG finished 2022 strong and eCommerce isn't impacting them in the way some may have suspected

One of the most important numbers a REIT reports is its FFO, as it represents the actual cash generated from the REIT's operation. FFO is a widely used ratio for valuation purposes, as it has become the primary earning metric in REITs. FFO = Net Income + Depreciation and Amortization + Loss on Sales of Asset - Gain on Sales of Assets + Interest Income. In Q4 2022, SPG generated $1.27 billion or $3.40 per share in FFO, which is a 188.89% coverage ratio for its quarterly dividend. For the fiscal year of 2022, SPG generated approximately $4.5 billion in FFO or $11.95 per share, which is a dividend coverage ratio of 166%. Investors received a dividend increase in Q2 of 2022 of $0.05 and another $0.05 increase in Q4 of 2022. SPG returned roughly $2.8 billion to shareholders by paying dividends and buying back shares. SPG also invested $1 billion in accretive development projects and expanded its investment management businesses with its Jamestown partnership.

SPG signed 4,100 leases which totaled just over 14 million square feet in 2022, bringing their newly signed leases to 8,000, accounting for 29 million square feet over the previous 2 years. SPG has been expanding internationally as it opened its 10 ^th premium outlet in Japan, while construction is ongoing for its 2 ^nd outlet in France, which is its 35 ^th international outlet. SPG has been hard at work enhancing and expanding its property portfolio as they have completed 14 redevelopments and expect to begin construction on 6 to 8 mixed-use projects in 2023. What's more impressive is that the mixed-use projects will be funded from internally generated cash.

In 2022 SPG finished the year generating $5.26 billion in revenue, $4.48 billion in FFO, and $3.86 billion in EBITDA. SPG is operating at an 85.17% FFO and 73.38% EBITDA margin. The occupancy rates at U.S. malls and premium outlets were 94.9% at the end of Q4 compared to 94.5% at the end of Q3. SPG's base minimum rent per square foot also increased to $55.13 from $54.80 QoQ in Q4.

Physical retail is still strong as eCommerce is projected to generate 17.94% of total U.S retail sales in 2023. In 2025 e-commerce sales will grow to $1.61 trillion, and while this is an increase of 50.89% from 2022, it is still only projected to be 21.88% of the retail sector. While e-commerce penetrates the retail sector and accounts for more of the sales channel mix, sales in physical brick-and-mortar locations are expected to increase by $178 billion (3.2%) between 2023 - 2025. SPG's locations will be needed as they are critical to the retail sector, and their occupancy rates support what Insider Intelligence is projecting.

The only downside to SPG's earnings call, in my opinion, was the 2023 outlook. SPG is projecting that it will generate between $11.70 - $11.95 per share of FFO. Its guidance reflects domestic property net operating income growth of at least 2%, increased interest expense compared to 2022 of approximately $0.30 to $0.35 per share, the continuing impact of the strong U.S. dollar versus the euro and the yen, and no acquisitions on the horizon. SPG's FFO is basically flat, but that doesn't mean SPG isn't undervalued or that it can't continue to increase the dividend paid to its shareholders.

SPG is still undervalued today compared to its peers, regardless of the guidance

SPG is still trading at the bottom range of its peer group, but when I compare it to its peers, they still look inexpensive.

• Realty Income ( O )
• National Retail Properties ( NNN )
• Kimco Realty ( KIM )
• Regency Centers Corporation ( REG )
• Federal Realty Investment Trust ( FRT )

There are 6 metrics I am comparing SPG to its peer group on, which include:

• Price to FFO
• EBITDA to Total Debt Ratio
• EBITDA Margin
• FFO Margin
• Dividend Yield
• FFO Coverage Ratio on the Dividend

The first thing I look at is the price to FFO because I want to pay the lowest price I can for the amount of FFO a company is generating. SPG trades at the lowest P/FFO ratio in the peer group at 10.29x, while the average is 14.73x. O and FRT both trade at a P/FFO that exceeds 16x.

SPG trades slightly above the peer group average on an EBITDA to total debt ratio. The average is 6.06x, while SPG has a 6.6x ratio. This is far from a deal breaker and well within my acceptable tolerance.

Something that I look at that I don't see a lot of is the comparison between EBITDA and FFO margins. I want to be invested in REITs that have strong margins in these areas. The peer group generates an average EBITDA margin of 73.94% on a range from 61.07% to 91.17%. SPG falls just under the peer group average at 73.33%, which is still a healthy margin for producing EBITDA from its revenue. For every dollar of additional revenue produced 73.33% drops down to EBITDA, which I love.

On an FFO level, SPG outshines its peers. SPG has an FFO margin of 85.17% which is well above the 64% peer group average and well above the next peer group, which is NNN, at a 71.91% margin. Since FFO is arguably the most important number for a REIT having such a high FFO margin is a strong metric for any REIT.

SPG still generates the largest dividend yield of its peer group. SPG spits off a 5.82% yield compared to the peer group average of 4.51%. Its large dividend is also supported by a FFO coverage ratio of 1.67x, which is above the peer group average of 1.55x.

SPG's dividend still has room to grow in 2023

On the Q4 conference call, David Simon (SPG CEO) was asked about deploying capital in the current macro environment since they didn't initiate buybacks in Q4. Mr. Simon responded to the question with the following "from a stock buyback, I think our dividend is really where we're focused growing that." Since SPG's IPO they have paid out $39 billion in pure dividends, excluding buybacks. In 2022 SPG was no stranger to returning capital back to shareholders as they allocated $2.6 billion to dividends and buybacks.

During difficult economic environments, SPG's dividend has been reduced, but it has always grown into a larger dividend over time. Back in 2010, the quarterly dividend was reduced from $0.85 to $0.56, then over the next decade, it grew 375% to a quarterly dividend of $2.10. Since reinstating the dividend in the summer of 2020, SPG has provided shareholders with 6 dividend increases over the next 11 quarters, growing the quarterly dividend from $1.30 to $1.80.

Looking at SPG's annual dividend of $7.20 per share and its forward FFO of $12.02, this is a coverage ratio of 1.67x. Even if SPG generates $11.70 of FFO in 2023, which is on the low side of the projection, its coverage ratio would still be 1.63x. SPG has more than enough room to continue increasing its dividend in 2023. Hypothetically, SPG could bring the dividend back to $8.40 per share, which was its pre-pandemic level, and based on $11.70 FFO per share, the dividend coverage ratio would be 1.39x. There is no reason to worry about SPG's dividend safety, and I would suspect that management will raise the dividend again in 2023.

Conclusion

Shares of SPG look as if they have cooled off after earnings as they have fallen -6.17% since 2/2/23 when they traded at $131.79. Regardless of how the street is viewing 2023 guidance, SPG is undervalued compared to its peers and generates the largest yield. Even at the low range of guidance with $11.70 in FFO, that still puts SPG at a P/FFO ratio of 10.57x which is well below the peer group average of 14.73x. Management was clear on the conference call that they will lean toward dividend growth when returning capital to shareholders. I believe that SPG may trade sideways or even take a leg down in the short term, but for long-term shareholders, this is a buying opportunity. SPG has an FFO margin of 85.17% and yields 5.82%, with room to grow the dividend. Any pullback will be a gift for income investors.

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