Let's start with the obvious. Malls and mall-REITS were under pressure before the COVID-19 Pandemic hit, and the pressure many have faced under COVID-19 restrictions has been existential for many.
But not all malls - and not all mall REITS - were created equal. Some have vastly better prospects than others, while many of the least well positioned fortunate ones have already bitten the dust.
In this article, I look at one of the better ones, for many the best one, Simon Property Group (SPG).
I last wrote about SPG in April 2018.
In that article, I tried to balance the fundamental strengths of SPG against the problems faced by its sub-sector in the REIT universe, after many REITS had come under pressure from rising rates.
I offered Seeking Alpha readers three conclusions:
(1) Don't worry about further severe pressure on SPG arising from market rate expectations.
(2) SPG's outlook is fairly clear and involves decent, mid-to-upper single-digit growth in FFO and dividends. This looks cheap on value screens and DCF models and makes the stock defensive in a pressured mall sector. So for someone with a residual position in CBL, this defensiveness has its attractions.
(3) SPG is not a strong buy. Better mall data and optimism will be good for all SPG peers and there are many REITs with the kind of upside to target price envisaged for SPG by the sell-side consensus right now. So it's a good relative position, but investors should ask whether they need to be there.
Yes, I had a small position in CBL Properties (NYSE:CBL) at the time, having cut in 2017, but not enough.
At the time of that writing, SPG had been performing in a lackluster way for a number of years, while the high quality of its balance sheet and assets was well understood. I argued that whatever the strengths of its relative position, it simply wasn't in a great sub-sector of REITdom. It faced headwinds, real and imagined, and the question I asked was, who wants to be locked into a stock with poor price performance, however solid the dividend?
And this proved to be a good framework for approaching SPG.
Performance since that time has been seriously lackluster, with the stock falling from $157 to $142 immediately before the COVID-19 plunge in March 2020, essentially behaving like a value trap.
Of course, this performance was resilient when we compare SPG to its peers in the mall space. Only Taubman Centers (TCO) had done better over the last five years, and this recently.
The intervention of the COVID-19 pandemic and recession has meant SPG, despite a decent recovery so far from the initial plunge, is still 54% below its pre-COVID-19 price, and the yield, at 7.9% looks tasty.
Not only is the yield higher than has been normal in SPG's history, it is far higher than normal vs. a benchmark such as the 10-year T-Bill.
The 10-year is at 0.65% yield to maturity (YTM), giving SPG 7.45% clearance. When I wrote my last article on SPG, the 10-year yielded around 3% with SPG yielding around 5%, or 2% over the 10-year. So the spread between these two instruments has more than tripled. The market, then, has priced in a lot more risk into SPG.
Of course there's more here than the 'simple' matter of a recession, however deep it is. I have recently written about Realty Income (O) and W. P. Carey (WPC), both of which are well down vs. pre-COVID-19 levels, but whose cash flows have been disrupted far less than those of SPG, as we will see in a moment. (WPC, in fact, has hardly been touched in terms of collections).
But on top of the obvious burden of physical retail outlet closures during lockdowns, there is also the secular trend of growing stay at home behavior which may, to an extent that will only be revealed over time in a post-COVID-19 economy, have been accelerated by the pandemic.
In discussing the contrarian nature of this REIT at the moment, I am not referring to the secular, e-commerce-threatened, long-term picture. Think about this. The market, before the pandemic, was pricing SPG at fairly modest yield spreads over the 10-year, meaning it did not consider it especially risky, meaning, in turn, that it knew all about SPG's conservative balance sheet and liquidity as well as its strong occupancy and rental cash flow. What you are going against if you buy it here is the current market pricing of its future cash flows in terms of the yield vs. risk free rates. Presently, little if any degree of recovery is in the price. This is all about SPG's current exposure to malls, not the longer-term picture.
SPG Collections Are Down, But Coming Back
NOI was down 21% YoY in the second quarter of 2020, reflecting a combination of rent abatements and credit provisioning. The second quarter dividend was cut from $2.05 to $1.3, and first half dividend was down from $4.1 to $3.4 over the prior year.
SPG is coming back from a depleted position, but doing so in large steps. Here's CEO David Simon on the last results call:
We have collected from our US retail portfolio including some level of rent deferrals approximately 51% of our contractual build rent for April and May combined, approximately 69% for June and approximately 73% for July with only de minimis deferrals.
We've been generally encouraged by the shopper response to our reopening...with many tenants reporting sales better than their initial expectations. Just a little color on that and the centers that reopened in early May, tenants who reported sales, reported May was approximately 50% of their previous year volume for the same period. And in June, that increased to more than 80% of prior-year volumes. Tenants continued to reopen, and we currently had 91% of all tenants, or nearly 23,000 tenants across our US portfolio are open and operating.
Note that net debt did not increase over the acute period of the lockdown, and liquidity is abundant, with $8.5 billion available across a $4.9 billion of credit and $3.6 billion of cash. Credit ratings were not affected (S&P rates SPG debt A/negative), cost of debt has of course fallen (3.3% to 3%) and SPG remains confident of a $6 minimum dividend in 2020. To a large extent, this solid financial base means the precise pace of the recovery matters less now it is happening, given the shares of this REIT remain way below their Pre-COVID-19 level.
SPG Keeps Moving
SPG is still investing in developments, with $140bn of cash slated to complete under-construction projects in 2020.
This slide shows a robust level of capex vs. the 2019 levels, given the environment. As long as the economic (and retail traffic) recovery holds, these numbers convey a business as usual picture that should fire the shares in due course.
SPG is investing in troubled retailers. The risk is obvious: a doubling down on businesses that stand in the way of the secular trend of decline in physical outlet retailing.
The most important thing to understand about this strategy, from the perspective of its financial risk, is that it does not involve SPG committing serious levels of capital as a percentage of its $34 billion balance sheet or when considered in a long-term framework opposite a normal level of SPG operating cash flow, or even the depressed $814 million over the first half of 2020. Its move to save Lucky Brand with Authentic Brands involved a commitment of $140 million (Brooks Brothers was $325 million with Authentic, and J.C. Penney with Brookfield Property Partners (NASDAQ:BPY) was $300 million on a 50/50 basis).
CEO Simon talked about the strategy on the last results conference call, mentioning SPG's frequent partner in these rescues, Authentic Brands Group:
... it's not like we want a huge portfolio of this. But listen, ABG, Authentic Brands Group, is a fantastic intellectual property group, does business throughout the world and has a ton of brands. So, normally - and they provide a lot of value on sourcing, marketing, international operations, et cetera. So, normally, when we're doing that, we work with them. They're very, very good about understanding where there is value in the brand because they know how they can monetize that intellectual property.
...the brands got to have value. We got to believe we can - without trying to hit an inside straight, we better believe we can make it EBITDA positive pretty easily. We're not into miracle worker here.
This discussion highlights the targeted and fairly limited scope of the strategy. Look at the partner. Here is Sanford Stein at Forbes:
As a key partner in the resurrection of these four retail brands, Authentic Brands Group is employing its highly refined toolkit to overcome what has been overlooked and should introduce measures of brand sustainability. Their portfolio of over 50 consumer brands reads like a Who's Who of popular culture and fashion. Additionally, they have built a stable of best-in-class manufacturers, wholesalers, and retailers.
ABG has created over 100,000 sale touchpoints across specialty, luxury, mass, mid-level, department store and e-commerce channels, internationally. They generate an eye-popping $12+ billion in sales, annually.
You Can Make A Significant Capital Gain Here
When I last wrote about SPG, I said that if you could short a group of the weaker mall REITs it would be a good long on the other side. That strategy would have worked (if you can be bothered with the iffy math of shorting!). It was a great relative position, even in the COVID-19 chaos of the spring.
This has all changed. SPG is worth buying as a 'naked' long position, which is how most of us invest. The clincher is probably the Fed pledge to let inflation run hot for an extended period (should it be able to get inflation, which is a very big 'if').
In a sustained economic recovery, which in the US will involve decent foot traffic in quality malls of the sort SPG owns, you will see benchmarks like the 10-year moving up from the currently risk-averse levels. Normally rates moving up like this is seen as bad for REITs.
But, if this were to happen, the risk premium currently inlaid in the pricing of SPG, with the spread against the 10-year at over 700 basis points, would collapse, and the stock would recover substantially. Yes, market rates would be moving up, but the "de-risking" of the risk premium in SPG shares would be a bigger factor.
Conclusion
If, like me, you were right to ask whether you really needed to be in SPG back in the spring of 2018 (you didn't), you should reassess the view now. SPG can more than double if it regains its pre-COVID-19 level, and even if it does not, economic normalization should still deliver you a strong capital gain, after collecting a near 8% dividend in a zero rate environment while you wait. I'd tell anyone worried about the big picture for malls 'out there' to worry about it then.
I am bullish on SPG and will open a position shortly.
