Simon Property Group: My Latest Dividend Growth Stock Purchase

Jan. 08, 2020 12:21 PM ETSimon Property Group, Inc. (SPG)76 Comments45 Likes
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Summary

  • Simon Property Group has raised its dividend for nine consecutive years, making it a Dividend Challenger on the precipice of becoming a Dividend Contender with its next dividend raise.
  • In spite of the challenging retail environment, Simon Property Group's operating fundamentals remain stable.
  • Adding to the case for an investment in Simon Property Group is the fact that the company is trading at a 12% discount to fair value.
  • Between its 5.8% yield, 4-5% annual FFO growth, and 1.3% annual valuation multiple expansion, Simon Property Group is likely to deliver annual returns in excess of 10% over the next decade.
  • This prompted me to initiate a position in SPG that I plan to build upon over the next few years.

Source: I Prefer Income Filter

Given that there are hundreds of dividend growth and high yield stocks and I am an investor that focuses on both dividend growth and high yield stocks, it is important for me to be able to quickly filter through these stocks so that I'm able to find stocks that are worthy of research for further investment consideration.

This is where I Prefer Income factors into the equation for me.

Using I Prefer Income's filter illustrated above, I was able to sort through 153 REITs and narrow my selection down to just 4 stocks for further consideration.

Given that my focus is on mid-cap and large-cap dividend stocks, I'll be explaining what led me to initiate a position in Simon Property Group (NYSE:SPG) (hereafter, referred to as SPG).

I will be discussing SPG's dividend safety and dividend growth profile, SPG's operating fundamentals and risks, as well as the valuation aspect of an investment in SPG.

I'll then conclude the article with my annual total return estimate over the next decade for shares of SPG.

A Safe Dividend To Go Along With Mid-Single Digit Growth Potential

When a yield is approaching 6% as is the case with SPG, it is an especially prudent idea to examine the payout ratios of that company to determine whether the dividend is likely to be maintained or grow further in a challenging operating environment.

In order to make this determination, I'll rely on SPG's FFO payout ratio in its prior fiscal year and the projected FFO for the current fiscal year.

In FY 2018, SPG generated FFO/share of $11.21 against dividends per share of $7.90 during that time, for an FFO payout ratio of 70.5%.

For the current fiscal year, SPG is forecasting FFO/share of $12.00-12.05 against dividends per share of $8.30 during the year, for an FFO payout ratio of 69.0% using the $12.025 midpoint FFO figure.

Given that SPG's FFO payout ratios are well below my 80% payout ratio preference for REITs and that the company possesses a rock-solid balance sheet, I rate the company's dividend safe for the foreseeable future.

Given that SPG

Source: Simply Safe Dividends

Simply Safe Dividends and I both agree that SPG's dividend is safe for at least the next few years, which isn't a surprise when one considers the analysis that I've provided above.

Next, I will be examining SPG's dividend growth potential over the long term.

When I take into consideration that SPG

Source: Simply Safe Dividends

When I take into consideration SPG's FFO payout ratios and the impressive state of its balance sheet, I believe SPG's long-term DGR will match whatever FFO growth it delivers.

Given the average annual mid-single digit FFO growth that the company has produced over the last decade in a period that has included the shift to e-commerce, I believe that SPG is capable of delivering 4-5% FFO growth over the next decade, which should position the company for similar dividend growth.

Transitioning to a discussion of SPG's operating fundamentals, I'll be supporting my argument on why it is likely SPG will continue to generate mid-single digit FFO growth.

Stable Operating Fundamentals, A Fortress-Like Balance Sheet, And Best Of Class Management Team

Source: SPG Third Quarter 2019 Supplemental Information Presentation

SPG is the largest mall owner in America, with complete or partial ownership interests in 233 properties that collectively comprise 191 million square feet in North America, Asia, and Europe. SPG also owns a 21.9% interest in Klépierre (OTCPK:KLPEF), which owns shopping centers in 16 European countries.

According to page 35 of SPG's most recent 10-Q, SPG's property mix is as follows, as of September 30, 2019:

  • 106 malls
  • 98 Premium Outlets (of which, 69 are located in the United States)
  • 14 Mills
  • 11 other retail properties
  • 4 lifestyle centers

It's also worth mentioning that 4 international outlet properties were noted to be under development at the time of the 10-Q's release.

Source: SPG Third Quarter 2019 Supplemental Information Presentation

As illustrated above, U.S. malls and premium outlet assets comprised a significant majority (79.1%) of SPG's NOI, with The Mills and International assets comprising the remaining 20.9% of SPG's NOI.

Source: SPG Third Quarter 2019 Supplemental Information Presentation

In the 9 months ended for this fiscal year, SPG reported $9.09 in FFO/diluted share compared to the $8.90/diluted share in the prior-year period, which is another encouraging earnings report for SPG that reiterates the notion that the company's operating fundamentals remain stable.

Adjusting for a non-cash investment gain in the prior year, higher income stemming from higher income on distributions on an international investment, and the impact of expensing internal leasing costs, FFO/diluted share increased by over 5% YTD over the 9 months ended 2018.

Despite tenant bankruptcies that affected the occupancy rate by 60 basis points, SPG's occupancy rate increased by 30 basis points sequentially from last quarter to 94.7%, as indicated by David Simon in SPG's most recent earnings call transcript.

What's more, SPG's reported retailer sales per square foot and leasing spreads per square foot are trending in the right direction, with the former increasing 4.5% YOY and the latter increasing 22.2% YOY.

Source: SPG Third Quarter 2019 Supplemental Information Presentation

In 2020 alone, SPG expects 13 mall redevelopments to open, 1 premium outlet new development to open, 2 designer outlet new developments to open, 3 premium outlet expansions to open, 1 premium outlet redevelopment to open, 1 designer outlet expansion to open, and 1 mill redevelopment to open.

As a result of the future developments that are set to come online in 2020 and the numerous projects that are in development beyond 2020, I believe it is reasonable to expect SPG's solid growth to continue over at least the next couple of years.

Source: SPG Third Quarter 2019 Supplemental Information Presentation

In addition to SPG's stable operating fundamentals, the company boasts investment-grade credit ratings from the major ratings agencies.

With A and A2 credit ratings and stable outlooks from S&P and Moody's, respectively, SPG maintains a strong balance sheet.

Upon examining a few of SPG's senior unsecured debt covenants, it becomes quite clear why S&P and Moody's maintain stable outlooks on SPG.

SPG's total debt to total assets ratio of 39% is well below its requirement of less than or equal to 65%. Furthermore, SPG's fixed charge coverage ratio of 5.4 is well above the 1.5 or greater requirement of its debt covenant.

Across the board, SPG's debt covenants are easily met and barring a major deterioration in the company's fundamentals, SPG's debt covenants will continue to be met.

Adding to the case for an investment in SPG is the fact that SPG's executive management team collectively possesses over 100 years of industry experience and is led by CEO David Simon, who has served as CEO of SPG since 1995.

For a more complete narrative of the qualifications and experience of SPG's management team, I would refer interested readers to page 9 of the company's most recent 10-K.

When I factor in SPG's stable operating fundamentals, firmly investment-grade balance sheet, and the capabilities of SPG's experienced management team, I believe SPG is likely to be a great long-term investment, if acquired at the right price.

Risks To Consider:

Although SPG is the undisputed best in its class, that doesn't mean the company is without its share of risks that potential and current shareholders must be aware of and periodically monitor.

The first risk associated with an investment in SPG is that as a REIT that derives most of its revenue from retail tenants, the company is indirectly exposed to the conditions within the retail environment (page 11 of SPG's most recent 10-K).

Any adverse developments in consumer spending, consumer confidence, or consumer preferences that SPG's tenants are unable to appropriately anticipate could result in some of SPG's tenants being unable to pay their rent, which could have a material impact on SPG's financial results going forward.

Another risk to SPG is that some of its properties are dependent upon anchor tenants to attract shoppers to SPG's properties and spend at other tenants' place of business, which helps the smaller tenants pay their contractual rent obligations.

The dynamic retail environment poses a threat to larger anchor tenants of SPG if such tenants aren't able to adapt to a changing retail environment.

A failure to adapt to a competitive retail landscape could result in these anchor tenants going out of business, which would have a domino effect on the smaller tenants should SPG be unable to find another tenant to draw consumers to its properties.

If this concern eventually plays out on a more widespread basis and SPG isn't able to continue to address such events, it could challenge SPG's growth prospects going forward, resulting in dampened future dividend growth.

The third risk to SPG is that as a company with interests in consolidated properties around the globe and an equity stake in Klépierre, SPG derived around 10% of its net operating income from international activities (page 13 of SPG's most recent 10-K).

Aside from the relatively minor concern of unfavorable currency fluctuations impacting financial results (such fluctuations tend to even out over time), SPG also is exposed to the operating risks that accompany an international presence.

The modification of existing regulations or introduction of new regulations in any of the international markets where SPG has interests could result in additional compliance costs for SPG, which could harm financial results at any given time.

Furthermore, any international trade disputes could result in a disruption to the supply chain of its tenants or act as a headwind to consumer spending levels.

While the vast majority of SPG's debt load is financed under fixed rates, another risk is that $844 million of SPG's outstanding consolidated indebtedness was tied to variable rates (page 15 of SPG's most recent 10-K). The company may also incur more variable rate indebtedness in the future, which is an important consideration for investors.

Although interest rates appear to have stabilized for now, any unexpected rate hike could lead to higher variable rates for SPG, leading to increased interest expense.

One final risk to consider and monitor is the fact that SPG's net operating income is concentrated in states, such as Florida, California, Texas, and New York, with those 4 states comprising nearly half (47.3%) of NOI.

Given this information, any natural disasters in these states or unfavorable political or economic developments in these particular states could materially impact SPG's future financial results.

While I have discussed a few of the key risks associated with an investment in SPG, I haven't discussed all of the risks for the sake of conciseness. For a more complete discussion of the risks facing an investment in SPG, I would refer interested readers to pages 11-21 of SPG's most recent 10-K and page 49 of SPG's most recent 10-Q.

A Wonderful Company Trading At A Discount

In order to arrive at a fair value estimate for shares of SPG, I'll be using a couple of valuation metrics, as well as a valuation model.

Source: I Prefer Income

The first valuation metric that I will use to assign a fair value to shares of SPG is the historical price to FFO ratio or price to non-GAAP earnings ratio, courtesy of I Prefer Income.

As illustrated above, SPG's current price to FFO of 11.70 is well below its historical price to FFO ratio of 16.05.

While SPG's fundamentals are arguably as strong as they were a few years ago, I will assume for the sake of conservatism that they are not.

Factoring that in with a reversion to a fairly middling price to FFO ratio of 13.50 and a fair value of $167.71 a share, SPG is trading at a 13.3% discount to fair value and offers 15.4% upside from the current price of $145.35 a share (as of January 5, 2020).

The next valuation metric that I'll utilize to determine the fair value of shares of SPG is the 5-year average dividend yield.

According to Simply Safe Dividends, SPG's current yield of 5.78% is elevated well beyond its 5-year average yield of 4.34%.

Again, splitting this difference roughly down the middle and assuming a 5.00% yield and fair value of $168.00 a share, this indicates that SPG is priced at a 13.5% discount to fair value and offers 15.6% capital appreciation from the current price.

Source: Investopedia

The final valuation method that I will use to estimate a fair value for shares of SPG is the dividend discount model or DDM.

The first input into the DDM is the expected dividend per share, which is another term for the annualized dividend per share. In the case of SPG, that amount is currently $8.40 (likely to increase in February).

The second input into the DDM is the cost of capital equity, which is the rate of return that an investor requires on their investment. I require a 10% rate of return because I believe that is ample reward for the time and effort that I spend researching and occasionally monitoring investments.

The final input into the DDM is the long-term dividend growth rate or DGR.

Unlike the first two inputs into the DDM, the long-term DGR takes a more deliberate and focused effort to accurately forecast. Investors must take into consideration a company's payout ratios (and whether they are likely to remain the same, expand, or contract over the long-term), annual FFO growth, the strength of a company's balance sheet, and industry fundamentals.

When I factor in that SPG's payout ratio is likely to remain the same over the long-term, I believe it is reasonable to conclude that dividend growth is likely to match the 4-5% FFO growth that I'm expecting for the long-term.

Assuming a 4.75% long-term DGR and a fair value of $160.00 a share, SPG is trading at a 9.2% discount to fair value and offers 10.1% upside from the current price.

Upon averaging the above fair values, I arrive at a fair value of $165.24 a share.

This implies that shares of SPG are priced at a 12.0% discount to fair value and offer 13.7% capital appreciation from the current price.

Summary: Simon Is A SWAN With An Attractive Yield And Total Return Potential

SPG has managed to grow its dividend at a nice clip over the last 9 years and with the dividend likely to be increased in February, SPG will extend its streak to 10 years, becoming a Dividend Contender in the process.

Despite the challenging retail environment over the last few years, SPG's operating fundamentals have held steady. The company's strong balance sheet and proven management team will play a large part in ensuring that SPG continues to deliver strong results going forward.

Bolstering the case for an investment in SPG is the fact that the company is conservatively trading at a 12% discount to fair value using I Prefer Income's historical price to non-GAAP earnings ratio, Simply Safe Dividends' 5-year average dividend yield, and the DDM as rationale for my average fair value of $165.24 a share.

With SPG's 5.8% yield and 4-5% annual FFO growth alone, the company is likely to meet my 10% total return requirement without even factoring in the 1.3% annual valuation multiple expansion that I'm predicting over the next decade.

It's the aforementioned reasons that led me to initiate a position in SPG that I will add to in the years ahead.

This article was written by

Kody's Dividends profile picture
6.09K Followers
Hi, my name is Kody. I run Kody's Dividends. As you might guess, this is a blog primarily documenting my journey towards financial independence using dividend growth investing as the means to transform the dream of financial independence into a reality.I am forever indebted to this community because it helped me transition from simply being an investor to being an analyst for The Motley Fool back in June 2021 under my real name of Kody Kester. As a display of my gratitude, I will still be writing one article a month for SA starting in July 2022.
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Disclosure: I am/we are long SPG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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