Believe In Simon Property Group? Use These 2 Strategies To Boost Yield
- SPG is perhaps the most widely known retail REIT. It has the highest market cap and the only "A" rated balance sheet among the other sector peers.
- SPG has four distinctive value engines - superb location, fortress balance sheet, resilient cash flows and world class management team - that warrant long-term, sustainable growth.
- The Q1 2020 report revealed massive liquidity reserves comprising 45% of SPG's market cap. All these elements together with the YTD peer outperformance confirm the underlying value in SPG.
- If you hold SPG and believe in its fundamentals and the ability to ride out of the crisis successfully, you should consider selling covered calls and covered puts.
- You would get a 3.4% and 2.4% yield enhancement in just 46 days, respectively, and be exposed to maximum gain of 20% and the potential cost basis of $43.87, respectively.
Whenever someone thinks of retail REITs, Simon Property Group (NYSE:SPG) is the first name which pops up. Rightly so - SPG is the largest retail REIT among the 36 other publicly traded peers. Its market cap of $18.2 billion exceeds that of popular names such as Realty Income (O), Regency Centers (REG) and Kimco Realty Corp. (KIM).
In addition, SPG holds the only "A" (not "A-) investment grade balance sheet in the whole sector, and has a globally recognized management team, winning many awards including the “best-performing global CEOs” by Harvard Business Review in 2013, 2014, 2016, 2017 and 2018.
Source (The Galleria in Houston, owned by Simon Property Group)
SPG and its competitive advantages in the context of COVID-19
Relatively recently, I wrote an article "Simon Property Group: Liquidity Is King" examining both financial and operating leverage of SPG amid the deadly outbreak of COVID-19.
The key takeaway was that even though SPG has a rather sticky cost structure (i.e., degree of operating leverage around 1.1), it is completely offset with the ample liquidity reserves and the fortress balance sheet. SPG has considerable flexibility and capacity to withstand the crisis helping the management to make sustainable, long-term decisions despite a complete demand shock in the industry.
The comment by David E. Simon in the Q1 2020 earning call confirms the robustness of SPG's balance sheet and/or significant liquidity reserves:
"Now, let me turn to the balance sheet. We have always maintained a strong balance sheet in order to capitalize on opportunities, but also to withstand economic downturns. On March 16, two days before we shut down our portfolio, we amended and extended our $4 billion credit facility with a $6 billion facility that includes a $2 billion delayed draw term loan. At quarter end, our total liquidity was $8.7 billion consisting of $4.6 billion of available credit facility, borrowing capacity and the $4.1 billion of cash mentioned earlier. As a reminder, the $8.7 billion is net of $1 billion of US and Euro commercial paper that was outstanding at quarter end."
To put that into perspective, the $8.7 billion of pure liquidity corresponds to 45% of the total SPG's market cap. The cash accounts for 22% of the market cap accordingly.
In my very first article on SPG (in collaboration with Jussi Askola), "Here Is Why Simon Will Thrive In This 'Retail Apocalypse'", we highlighted four value-add engines that truly distinguish SPG from its peers:
- Location, location, location – Almost fully occupied class A properties placed in marvelous locations. This should warrant a sustainable growth and help resist the industry headwinds.
- The best balance sheet among sector peers – As elaborated above.
- Resilient cash flows and growing dividends – Strong track record of growing FFO irrespective of the gigantic headwinds. SPG has managed to increase the FFO at 5-10% per year for the past decade - a true testament of the underlying resiliency of SPG's business.
- Seasoned management team with outstanding track record – As elaborated above.
Finally, the chart below shows how SPG has actually outperformed its closest peers (i.e., mall peers) on a YTD basis, which includes the negative effects from the COVID-19. This is yet another sign of how strong the underlying fundamentals are.
Two simple plain vanilla option strategies to enhance your returns while holding SPG
The following two strategies are meant for the SPG bulls as the title of this article suggests. These strategies should be exploited if you believe in SPG's fundamentals (e.g., location, liquidity and balance sheet) and the management team as these characteristics should impose a floor to how far the share price can fall. Obviously, the opposite direction holds true as well - the stronger the fundamentals, the more pronounced and quicker the recovery.
Since SPG is placed in a sector that has totally fallen out of market's favour, the associated implied volatility provides great opportunities to some extra juicy returns while holding the stock (i.e., implied annualized vol ranging from 50% to above 100%).
Moreover, the chart above reflects the overall notion of high option premiums, where the VIX (i.e., proxy for the market's volatility) is trading significantly above the 5-year average. This obviously confirms the fact that the conditions of writing options are favourable for the yield enhancement strategies.
The current option chain for SPG offers the following exposures (both for puts and calls):
- June 19, 2020
- July 17, 2020
- October 16, 2020
- January 15, 2021
- January 21, 2022
The bolded one is the specific term what I consider the most optimal as using June 19, 2020 imply relatively lower premiums and all of the dates beyond July 17, 2020 are exposed to the potential risk of suffering a second wave of the virus. Unfortunately, under such scenario where the virus comes back with a vengeance in autumn, the probability is VERY high that SPG's share price would be in a freefall.
#1 Selling covered call - strike $70.00, July 17, 2020
Now, this might seem a bit counterintuitive to write a call against SPG and in the meantime being bullish on the SPG. In realty, this investment will allow you to pocket 3.41% of extra yield (from the existing premium - as of May 29, 2020) and to capture the potential gains from the capital appreciation of ca. 18%.
What you loose here is the potential upside above $70.00 until July 17, 2020. To be precise, you lose all the upside what is beyond $70.00 and the $2.19 call premium per share (in total $72.19). However, what is guaranteed here is the 3.41% of yield boost in case SPG plummets or remains flat. And all of this, in just 46 days, which implies close to 20% of annualized return.
All in all, this is a perfect strategy for a SPG investor who intends to hold the shares in the long term and thinks that 18% is the maximum capital appreciation SPG could deliver in the next 46 days.
#2 Selling covered puts - strike $45.00, July 17, 2020
By selling covered puts on SPG, you instantly pocket a premium of $1.13 per share or achieve an enhanced yield of 2.42%.
Also, by writing this covered put, you are exposed to the risk of buying SPG at $45.00 per share even if the actual share price could be trading significantly below that price. It would require a ca. 27% decline in SPG's share price for the put to fall at the money and force you to buy additional shares.
Nevertheless, it bears mentioning that the actual costs basis, if the put gets exercised, is $43.87 due to the previously captured put premium.
This strategy, in my opinion, is a prefect fit for a long-term investor who is bullish on the SPG's long-term growth prospects and considers $43.87 a marvelous entry point to add extra SPG shares - and at the same time is looking for a higher current income.
This article was written by
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