2023-10-25 08:06:40 ET
Summary
- SPG has had its price beaten up and now presents an interesting opportunity.
- The starting dividend yield is now 7% and the upside potential sits at 23%.
- Malls are shifting from retail to experiential, incorporating activities and attractions that will contribute to SPG's success.
Overview
I live a short 7-minute drive away from one of the malls in Simon Property Group's (SPG) portfolio. I've been lucky enough to remain working remotely so I find myself often slipping away and heading over to the mall during the week. To my surprise, the malls are always packed. On a random Tuesday at 2 pm, "what in the world are all these people doing here?, Doesn't anyone work anymore?", I ask myself ironically. On a serious note though, we've all been hearing about the slow demise of malls since the pandemic and I'm here to build a case against this perspective. Malls are not dead.
The rhetoric that malls are becoming obsolete is becoming commonplace. Granted, I understand why people have this belief. Especially because if you take the time to walk through some of your local malls, I'm positive you will see a lot of empty storefronts. At first glance this may give off the impression that malls are struggling but this is not the case for Simon Property. Despite SPG being forced to slice their dividend by 38% back in 2020, their recovery has shown us that they are capable of getting ahead.
The top reasons I believe SPG has a solid future ahead are the following:
- Steadily Increasing Cash Flow & Dividends
- Malls Shifting From Retail To Experiential
- Increased Consumer Spend
There are several consumer studies that serve as reinforcement that people are still going out of their way to spend money at their favorite stores. The mall and shopping centers all over America serve as a place for families to get out and spend time together. This sentimental connection with malls perfectly matches the shift that a lot of malls are completing. After seeing the vulnerability from Covid and how a lot of retail-based stores didn't survive, a lot of malls are beginning to incorporate more experience based activities in their locations. Activities like arcades, art studios, gyms, more built out food courts, and movie theaters for example.
Lastly, SPG has a solid business that has stood the test of time from a cash flow perspective. Although I will admit that the price has suffered to see any substantial growth, the profitability metrics remain strong. For these reasons, I continue to hold shares of SPG and will be looking to add to my position at these levels while the yield is above 7%.
Portfolio
SPG operates as a REIT (real estate investment trust) specializing in the ownership of retail, entertainment, dining, and mixed-use venues. This goes beyond conventional shopping malls, as their holdings comprise premium retail establishments globally. SPG has exposure across North America, Europe, and Asia. Since Simon Property Group's IPO in 1993, they have grown their portfolio's market value from $3 billion to over $80 billion. During this same period, they managed to return shareholders with a CAGR (compound annual growth rate) of 12%.
Their largest exposure is to US malls and premium outlets in Florida (18.6%), California (14.1%), Texas (10.2%), New York (6.5%), and Nevada (5.8%). It's nice to see their small exposure to international properties has also been growing with a slight 3.3% year-over-year growth. The thing I like about SPG is that a lot of their properties are designed to feel like walkable town centers rather than the traditional malls we think of.
Occupancy rates have rebounded from their lows in 2020, aligning with the recovery of foot traffic. Covid was such an outlier event that knocked out so many REITs but fortunately, SPG has not only survived but is now also growing. Moreover, SPG's operational profitability has also rebounded, mirroring the levels achieved in 2019. This robust recovery underscores the fact that SPG possesses a portfolio of high-quality properties strategically located in prime areas, which plays a pivotal role in the long-term resilience of its business model.
Experiential Shift
Simon Property Group understands that today's malls are not simply places to buy goods; they are evolving into centers for experiential retail. Experiential retail can be simply described as the shift from selling goods to selling experiences and analytics have shown that this shift is being led by Gen Z. Traditional anchor stores are being complemented by an array of experiential tenants. Gen Z is a generation that grew up in the digital age, making the social component even more essential for them compared to previous generations. Malls provide an ideal environment for them to meet this need. They can explore clothing stores, catch a movie, or enjoy a meal, creating a holistic mall experience that can't be replicated on their smartphones.
Malls now feature immersive art installations, interactive showcases, cultural events, gourmet dining experiences, and even fitness centers. Simon Property Group has recognized that consumers are seeking memorable experiences that go beyond mere shopping. The incorporation of experiential tenants not only attracts visitors but also keeps them engaged for longer periods. This shift towards experiential offerings underscores the adaptability and forward-thinking nature of mall management.
Increased Consumer Spend
Traditional malls provide a physical space where consumers can see, touch, and try products before making a purchase and some people prefer that route. Despite the rise of online shopping, consumer spending in malls has continued to grow. US retail sales are expected to reach $700B by the end of 2023. Shoppers still find immense value in the interactive nature of in-person shopping experiences. This tangible interaction with products remains a fundamental aspect of retail that e-commerce cannot fully replicate.
The appeal of malls goes beyond transactional exchanges; it extends to the emotional and social dimensions of shopping. Well, remember how I opened with my shenanigans of heading to the mall during my work day? For me, it's an escape from the daily routine and I imagine this applies to some of you reading. Malls also offer a place of bonding and fun for families and friends.
Return Potential
Historically, the dividend floated at or below the 5% mark. The current dividend yield sits at 7% due to the stock's recent price decline so you can land a solid yield by starting a position today. SPG actually raised their dividend recently by a slight 2.7%. The dividend payout ratio remains relatively low at only 63% which means there is plenty of room for future raises going forward.
Also, as FFO (funds from operation) grows I fully expect these dividend raises to continue into the future. Some reinforcement that future dividend growth is likely is the continued growth in lease income, interest, and mixed-use operations income as all of these avenues have seen substantial growth compared to the year prior.
SPG has implemented a strategic share buyback program which shows management's confidence in the business. These buybacks are financed by the company's strong cash flows. Notably, Simon's Funds From Operations (FFO) are more than ample to fulfill several financial priorities, which include covering dividend payments, supporting the share buyback plan, allocating funds for property maintenance and redevelopment ventures, and facilitating acquisitions. This was pointed out during a recent global real estate conference :
We have a $2 billion stock buyback authorization. It was reauthorized earlier this year, and we do actively expect that we will use the stock buyback program over time if we were successful in generating proceeds from some of these monetizations that could possibly occur or simply with the generation of free cash flow. If you look at the company, after paying its dividend, generates about $1.5 billion of free cash flow that can be used to reinvest certainly in our properties and to our development and redevelopment, but could also be used to buy back stock and deliver. So, one of the nice aspects or the competitive advantages that we have as a company is that we are one of those unique REITs that generate free cash flow above its dividend, has the ability to invest that back into our business. - Brian J. McDade, CFO
Lastly, there is significance in the FFO payout ratio, which currently stands at 63%. This percentage is notably below Simon's pre-pandemic levels, a significant contrast to the 70% FFO payout ratio recorded in 2019 before the Covid crash. SPG's Price/FFO is estimated to end the year at 11.85x and for reference, the historical FFO over the last decade sat around an average valuation of 14.5x. This would represent an upside potential of approximately 23% going forward alongside the current 7% dividend.
Risk
SPG faces a range of potential risks in the coming months due to the high inflationary environment on a worldwide scale and the presence of elevated interest rates, both of which may exert downward pressure on the company's Funds From Operations (FFO) and revenue growth. It's also worth mentioning that increased interest rates affected SPG's floating debt. This risk however is miniscule since only a small portion of their debt is actually refinanced annually.
In addition, e-commerce can still be seen as a threat. There are still large portions of properties under the Simon umbrella that is still overexposed to retail-based properties. However, there is a growing number of digital companies that have started opening physical locations because it actually increases profits to have a physical store.
Takeaway
Simon Property Group serves as a solid example of proof that the notion of malls fading into irrelevance is not necessarily true. With a strategic geographic presence, SPG continues to thrive, supported by a consistent upsurge in cash flow and dividends. The pivot towards experiential retail and the enduring allure of in-person shopping underscore the company's robust performance.
SPG's unwavering commitment to bolstering shareholder value is underscored by its meticulous share buyback program and the promising low Funds From Operations (FFO) payout ratio, indicating promising room for future growth. While global inflation and the persistent influence of e-commerce present challenges, SPG's adaptability and diverse portfolio position it as an attractive and dynamic player in the ever-evolving retail landscape.
For further details see:
Simon Property Group: Malls Are Not Dead