Thesis

Some investors believe that Covid has permanently changed the way we live our lives. They invest with the belief that people will work, eat, entertain and shop from their homes.

I strongly disagree with this view and I’m investing accordingly.

The fear surrounding the retail sector has presented investors with a great opportunity in this class A mall operator.

As a result of the negativity around the whole sector, Simon Property Group(SPG) now trades at an extremely attractive valuation, which combined with a high dividend is likely to deliver attractive returns to investors over the coming years.

Source: SPG Investor Relations Page

Fears vs Facts

The bears point to the following:

  • E-commerce threat
  • Overbuilt mall space in the US
  • Struggling tenants
  • Covid to fundamentally change life and business

However, these are the facts:

Pre-Covid

Although lower-quality malls will suffer, class A malls such as the ones SPG owns have much better prospects.

In 2019 the company reported strong growth across all segments:

  • 4.8% increase in retail sales per square foot.
  • 14.4% increase in lease spreads per square foot.
  • 1.7% comparable property NOI growth (constant currency)

After Covid

SPG’s business has been strongly affected by the Covid pandemic and resulting lockdowns.

The business performance will suffer this year as SPG’s customers had a long period when they were legally not allowed to operate.

It’s not fair to blame SPG for this truly unpredictable event.

The business results were still far from disastrous though and are already improving.

$1.2 billion in NOI ( down from $1.5 the previous year) generated in the 2nd quarter of 2020, at the height of this unprecedented pandemic. The company expects to write off or reserve for around 15-20% of Q2 rents.

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As of 11th August 91% of US tenants open with sales at 80% of previous year’s levels in June already (expected to be higher by now).

July rent collections 73% up from 69% in June.

The company expects (after completing deferral/abatement deals) to eventually receive 93% of July rents and return to the normal collection figures of 97-98% after that.

100% of designer and international premium outlets open with sales at approximately 90% of last year’s levels.

Occupancy 92.9% with lease spreads essentially flat for TTM.

Yes, the business is suffering with reported 21% NOI decline in the 2nd quarter and the one-off rent write-offs.

But as locations are re-opening, retail sales have bounced back quickly and rent collections will reflect that going forward.

Balance sheet is strong:

  • $8.5 billion in liquidity.
  • of which $3.6 billion in cash
  • fixed charge coverage 4.8x
  • total debt/total assets of 44%

The balance sheet has the capacity to fund redevelopment projects which will help SPG replace struggling tenants with new occupants.

Business performance is certainly not as bad as the share price decline would suggest, with the current stock price of $64 trading -55% down from pre-Covid levels.

Opportunity

The dislocation of the stock price from the business performance presents investors with a great total return opportunity going forward.

I don’t expect SPG to trade at it’s 20-yr historical average valuation of 14.5x FFO anytime soon.

However, the market eventually will have to price in the recovering business performance.

If the stock will be revalued to roughly 10x FFO over the coming years(well-below historical average), current investors are looking at 100%+ total returns.

Source: FastGraphs.com

Risks

Covid-induced lockdowns hurt SPG’s tenants as they were legally not allowed to operate. This understandably trickled down to lower rent payments and profits for SPG. However, as things are returning to normal, rent collections have picked up.

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Some tenant’s have been on unsteady footing for a while and eventually SPG will have to find new tenants to replace the struggling ones. This requires a lot of funding as redevelopments are not cheap. The company has a lot of cash in hand and the potential to borrow more at attractive rates to fund those redevelopments.

E-commerce is a viable threat to many retailers, but I don’t see it affecting high-quality malls as much – which has been evidenced by SPG’s business performance pre-Covid. There will always be demand for premium retail space and e-commerce and brick&mortar can work hand-in-hand. Although nothing concrete has materialised yet, there has been a lot of chatter about Amazon working together with SPG on that front.

SPG is also becoming more active in investing in certain retailers, where they have previous experience in making good returns. However, every such deal comes with execution risk and is outside their core business operations.

Summary

SPG’s business has suffered through no fault of his own, but the tenant activity is picking up and the impact will not be long-lasting. Rent collections are trending up thanks to the re-opening of locations and positive sales figures. Due to the massive decline in the stock price, current investors have to possibility to pick up shares of SPG at a very depressed level, which can provide excellent total returns going forward.

I rate shares of SPG a “STRONG BUY” with around 100% total return potential from current levels.

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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