2023-10-31 09:00:00 ET
Summary
- REITs have declined in the rising rate environment, but Simon Property Group delivered strong Q3 earnings and raised guidance.
- SPG's properties are thriving, with increased revenue, net income, and portfolio net operating income.
- SPG's malls are still popular destinations for human engagement, and the company is generating and distributing cash to shareholders.
The rising rate environment hasn't been kind to REITs as the Vanguard Real Estate Index Fund ETF ( VNQ ) has declined -13.15% YTD while some of the largest REITs, including Realty Income ( O ) have fallen more than -20%. It feels like no matter where you look, REITs have declined, and Simon Property Group ( SPG ) is no exception . With the risk-free rate of return exceeding 5%, there is no scarcity in generating yield. SPG has fallen -11.06% in 2023, and despite the ongoing narratives about the death of the mall and the Amazon ( AMZN ) takeover, SPG delivered a double beat and raised its year-end guidance on Monday, 10/30, after the close. I am long on SPG and will be looking to add to my position as shares have sold off, pushing the yield past 7%. I physically visited an SPG mall last night; it was packed, and there wasn't a vacancy in stores. I think that REITs will have a much better 2024 than they did for 2023, and there are some quality REITs I plan on adding to, and SPG is at the top of the list.
Following up on my last SPG article
In my previous article about SPG, which was published on 7/17/23 ( can be read here ), I discussed its operating metrics from 2019 to the trailing twelve months ((TTM)), if E-Commerce was a threat to physical retail, and how SPG was being valued compared to an expanded peer group. A lot has changed since then, as rate cuts in the back half of 2023 haven't occurred, and geopolitical tensions are soaring. In this article, I am going to discuss what I liked from Q3 earnings, why I see SPG doing well in the future, and how it's attractively valued compared to similar REITs.
Simon Property Group delivered a strong Q3 and showed the investment community that its properties are thriving, not dying.
The only thing better than a double beat on earnings day is when a company raises guidance. SPG delivered this to shareholders as they reported $3.20 of funds from operations (FFO) compared to the consensus estimate of $2.97, $1.41 billion of revenue, which came in $140 million higher than estimates and then proceeded to raise guidance. SPG's previous FFO range for 2023 was $11.85 to $11.95, which has just been increased to $12.15 - $12.25. SPG is generating strong profitability as its net income attributable to shareholders was $594.1 million, up from $539 million YoY in Q3. Operationally, SPG is having a strong year as they have already generated $1.53 billion in net income in the first 9 months of operations compared to $1.46 billion of net income during this period in 2022. Its total FFO has also increased to $3.3 billion from $3.21 billion, and its portfolio net operating income (NOI) increased 4%.
For some time, there has been a narrative about E-Commerce changing the physical shopping experience, and malls would eventually be extinct. At the end of Q2, SPG wholly owned or held an interest in 196 income-producing properties across the United States, which included 93 malls, 69 Premium Outlets, 14 Mills, six lifestyle centers, and 14 other retail properties in 37 states and Puerto Rico. SPG also has an 80% non-controlling interest in the Taubman Realty Group, LLC, which has an interest in 24 regional, super-regional, and outlet malls in the U.S. and Asia. SPG closed out Q3 with $8.8 billion in liquidity, $1.3 billion of cash on hand, and $7.4 billion of available capacity under its revolving credit facilities. The metrics for United States based malls continue to improve as occupancy at malls and premium outlets increased from 94.7% to 95.2% QoQ, with the base minimum rent per square foot increasing from $56.27 to $56.41.
SPG owns and operates arguably the best malls in the country, and their financials are proof that their company is thriving, not dying. Ronald Kamdem (Head of Morgan Stanley's REIT and CRE Research was recently on CNBC and stated that SPG was one of the most interesting value opportunities in the entire REIT space. He discussed how SPG can generate roughly $4 billion of FCF, allowing it to cover the dividend and reinvest in the business easily. SPG continues to be a cash-generating machine as the board declared its latest quarterly dividend of $1.90 per share. Since the pandemic, SPG had reduced the quarterly dividend from $2.10 to $1.30 and gradually brought it back to $1.90. Investors are being paid over 7% through the dividend, and I believe that as the business continues to increase in profitability, more cash will be returned, and the dividend will eventually be back to pre-pandemic levels.
E-Commerce sales in the United States are expected to grow to $1.18 trillion for 2023, which will be roughly 16.4% of total retail sales across the Country. It will take an additional 3-years for this number to cross the 20% threshold, and by then total retail sales is expected to come in at $7.34 trillion in 2026. While it's more common than ever to order goods online, E-Commerce still doesn't even have a 20% penetration into the retail sector. Lower-tier malls may be under pressure, but class-A malls are a destination for human engagement and interaction as they offer much more than shopping. SPG's malls are anchored by restaurants, movie theaters, and other destinations, making their properties a critical aspect of social engagements. The proof is in the numbers as SPG is generating and distributing cash back to shareholders hand over fist, and I think it's still one of the best value plays in the REIT sector.
I think SPG is attractive for income investors at these levels
I compared SPG to the following REITs to see how it was being valued:
- Realty Income ( O )
- National Retail Properties ( NNN )
- Federal Realty Investment Trust ( FRT )
- Regency Centers Corp. ( REG )
- Kimco Realty Corp. ( KIM )
- Brixmor Property Group ( BRX )
Based on the low range of SPG's updated guidance of $12.15 - $12.25 of FFO, SPG is trading at 8.67x its forward FFO, which is the lowest in this group of REITs. The peer group average is 11.62x, and only SPG and BRX trade under 10x their forward FFO. I always want to pay the best price possible for a REITs FFO, and SPG is trading at an attractive level for me to add shares.
REITs are income investments for me, and unless I think a REIT is massively undervalued, it needs to pay above the risk-free rate of return to be a shareholder. Depending on which treasury you want to use as the baseline metric, SPG is paying roughly 2.32% more yield than the 10-year and 2.17% more yield than the 2-year treasuries. SPG has the largest yield in the group at 7.22%, and it is well covered by a 1.6x FFO coverage ratio. SPG is paying out 62.55% of their forward FFO, which provides them with room for future increases and reinvesting in the business. SPG should have no trouble paying the current dividend and continuing to bring the dividend back to pre-pandemic levels.
We're headed into a Fed meeting where mortgages are at 10-year highs over 7%, while mortgage applications are at 10-year lows. Core CPI continues to fall, and it has now reached its lowest level since September 2021. The CME Group Fed Watch Tool is now forecasting a 95% chance that the Fed holds rates and a 5% chance that we get a 25 bps cut. I have been watching this for some time, and this is the first time in the recent weeks where a small chance for a cut has been on the table. Looking out to the end of 2024, there is an overwhelming chance that rates start with a 4 in front of them and not a 5. As the Fed pivots, I feel it will be bullish for well-run income investments where the yield is significantly higher than what can be locked in when short-term CDs or treasuries mature. I think we're going to see an influx of capital come into the markets looking for yield in the 2 nd half of 2024 and 2025, and companies like SPG will be prime candidates for where some of this capital lands. SPG is getting back to dividend growth and looks to be an undervalued REIT based on its level of profitability. As the tide turns, I think that SPG will be an income investment that stands out.
Conclusion
SPG reaffirmed my bullishness with their Q3 results. I am excited for their future and plan on adding to my position throughout the holiday season. Physical retail isn't fading away, and SPG continues to increase profitability as they delivered a top and bottom line beat and increased their FFO guidance for 2023. When I look at the equity REIT space, SPG looks like an undervalued asset, trading at 8.67x its FFO and throwing off a 7.22% dividend yield. REITs could continue to face some difficulties based on what the Fed does, but when I take a long-term approach, I see SPG becoming very attractive to income investors when the risk-free rate of return is no longer at 5%. I plan to add and reinvest the dividends while SPG trades at a large discount to their fair value. I think shares can return to their pre-pandemic levels over the next 1-2 years if the Fed pivot in the middle of 2024.
For further details see:
Simon Property Group's 7% Dividend, Double Beat, And Increased Guidance Attractive