Simon Property: The Bulls Will Likely Prevail (NYSE:SPG)

Simon Property Group (NYSE:SPG) recently hiked its quarterly cash dividend payout by 2.9%, increased occupancy across its portfolio by 170 basis points, and is trading at a valuation 28% lower than its sector at 10x its price-to-forward FFO. The retail REIT has seen its stock price get heavily disrupted in a year that was characterized by the market dancing to the gyrations of Fed interest rate hikes.

Simon Property is down 21.88% on a total return basis year-to-date, performing better than its retail REIT peer Macerich (MAC) but poorer than Tanger Factory Outlet (SKT). I’m bullish on retail REITs going into 2023 and I think this performance dichotomy between Simon Property and its peer will correct itself next year. The underlying base for this bullishness is twofold.

Firstly, this year has been what the French describe as on marche sur la tête, we walk on the head. Stocks retreated multiple times on economic data that was better than expected and rallied on the inverse. This is an exceptional situation with the market placing inflation and interest rates hikes as its number one enemy. This is set to change.

Following a 50 basis point hike in December, rates are now only anticipated to rise further by only three-quarters of a percentage point in 2023 to hit a 17-year high of 5% to 5.25% from its current level. Inflation also looks likely to be past its peak according to KKR. This has been aggregated with forecasts by Goldman Sachs that the US economy will avoid a recession next year. Falling inflation and robust economic growth would be the base macroeconomic conditions required for the market to stage a recovery and Simon Property would see its common shares recover more markedly on the back of this.

Occupancy, Rents, FFO, NOI, Dividends, And Outlook Are Up

The second reason for bullishness is Simon Property’s strong financials even against apocalyptic calls by the bears that the post-pandemic economic zeitgeist will be characterized by a hyper-disruptive digitalization of the shopping experience. This has not entirely panned out with the unique conditions that saw the insatiable growth of eCommerce players during the pandemic all but over to push Shopify and Amazon to be down year-to-date by 75% and 50% respectively.

Indianapolis, Indiana-based Simon Property last released earnings for its fiscal 2022 third quarter. This saw the company’s revenue come in at $1.32 billion, an increase of 1.48% from the year-ago quarter. Comparable FFO was $1.11 billion, around $2.97 per share, and was up from $1.098 billion, $2.92 per share, in the prior year period. The incremental FFO growth was driven by domestic property NOI increasing by 2.3% versus the year-ago period as occupancy rates rose 170 basis points to 94.5% from 92.8% in the year-ago quarter. Rent per square foot at $54.80 was also up by 1.7% compared to the year-ago period.

Overall, the company reported healthy financial metrics with continued strength in overall revenue despite the macroeconomic backdrop. As a result, Simon Property raised its full fiscal year 2022 guidance and hiked its quarterly per share cash dividend to $1.80 with a view by bulls that this will return to its pre-pandemic payout of $2.10 in the near term. The company now expects 2022 comparable FFO to come in between $11.83 to $11.88 per share, up from prior guidance of between $11.70 to $11.77 per share. At the lower end of the guidance range, this will be a beat on the $11.67 analyst consensus.

The Preferred In The Post-Pandemic Reality

Consumer shopping habits are undeniably changing but brick-and-mortar retailing will continue to be a critical part of this for the foreseeable future. Simon Property’s A-class shopping malls and outlets are located in attractive urban and suburban locations and stand to continue to benefit from demand for brick-and-mortar shopping even as less ideally located malls struggle. The mix of dining, entertainment, and shopping has been optimized to create truly worthwhile experiences that aren’t replicated by online shopping.

However, some prospective shareholders might understandably be averse to taking the risk on the commons. This opens up the preferred shares as an option to gain exposure to Simon Property.

The Series J Cumulative Preferred Shares (NYSE:SPG.PJ) pay out a $4.19 coupon quarterly for a dividend yield of 6.95% versus the current dividend yield of 6.1% on the commons. It’s important to note that Simon Property continues to hike the dividend paid out to its common shareholders, which is not a feature of the company’s recovery that is available to preferred shareholders. The preferred also trade at $60.27, a $10.27 premium to their $50 redemption price. To be clear, current owners are paying 20% above the core intrinsic value for the security, albeit with a call date in 2027.

The overvaluation of the preferred plus its lack of exposure to what looks set to be consecutive dividend increases make them unattractive. Simon Property commons also look relatively undervalued with a price-to-forward FFO multiple of 10x, 27% lower than its sector median. The current price looks attractive from an entry perspective but I’m neutral on taking a position until peak inflation is in.