Mall real estate investment trusts (REITs) have been hit hard by the efforts to slow the spread of COVID-19 -- and Simon Property Group (SPG -0.68%), the largest and most diversified name in the space, hasn't been spared. With so much still in flux around the coronavirus, only aggressive investors should be looking at this mall landlord. And even then, you'll need a glass-half-full outlook. Here are five things to consider before you make a purchase of Simon stock.
1. Big and diversified
Simon is the largest publicly traded mall-focused real estate investment trust, with a portfolio of more than 200 enclosed malls and outlet centers. In addition to having a large number of malls, it also owns a number of retail assets in Europe and Asia, providing at least some geographic diversification. Moreover, its malls tend to be well located and desirable assets; the company has historically been able to charge high rents because its assets generate material sales per square foot.
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None of that helped when governments around the world asked non-essential businesses to shut down and requested that citizens practice social distancing, of course. But it provides a foundation for recovery that will be important as malls start to reopen and retailers start to welcome guests back to their stores.
2. Benefiting from some pain
There's something of a reverse network effect in the mall sector, which was slowly taking shape because of the so-called "retail apocalypse," the term used to describe the increasing prevalence of online shopping. However, it's a bigger issue than just online shopping: Some retailers either fell behind peers in the effort to adjust to changing buying habits and trends, or they encumbered themselves with so much debt that they had little flexibility to adjust to much of anything. Thus many retailers are struggling, closing stores, and going bankrupt. Some, such as Pier 1, are closing for good. That means fewer tenants to fill malls.
But if you step back, there's another important trend here as well. Lesser malls are struggling more than well-located malls, and they are more likely to be shut permanently. So there are fewer stores -- but also fewer malls. And that suggests that the best malls will be increasingly attractive places to open a store (or to maintain one that is already open).
The retail apocalypse isn't all bad news, though it is truly terrible news for poorly located and low-quality malls. For many years this was a slow-moving process, but COVID-19 has sped things up, which has investors concerned even though some malls will likely end up benefiting from this trend.
3. Solid foundation
The big question at the start of 2020, before the coronavirus started to spread around the world, was if mall REITs had the financial wherewithal and portfolio quality to muddle through the long-term shifts taking shape in the retail space. The same questions exist today, but it's more along the lines of wondering if they can handle the hit from those shifts if they all get compressed into a single year or two. The answer is clearly no for some REITs, with CBL & Associates rumored to be on the brink of filing for Chapter 11 bankruptcy protection.
Simon is at the other end of the spectrum, with one of the strongest balance sheets in the mall niche. For example, its financial debt-to-equity ratio is one of the lowest in the mall REIT peer group. Moreover, at the end of the first quarter, it reported that it had $8.7 billion in liquidity (with cash making up $4.1 billion of that number and the rest coming from a credit facility). Simon is a large company for sure, but that's still a huge amount of cash to lean on during difficult times. It looks like it will be able to muddle through this period.
SPG Financial Debt to Equity (Quarterly) data by YCharts
That said, it won't be pretty. In fact, during Simon's first-quarter 2020 earnings conference call, CEO David Simon telegraphed a 50% dividend cut. However, that's actually not so bad compared to other mall REITs that have completely suspended their dividends, reduced them to mere token payments, or enacted larger reductions. It suggests that Simon remains fairly confident about the future, which is basically the sentiment that the CEO expressed in the conference call.
4. Circling the wagons
There's a lot of activity going on right now that might spook investors, but it's not as bad as it may seem. For example, Simon is suing one of its largest tenants for unpaid rent. It's unclear how the case will unfold, but Simon is basically trying to assert its rights under existing leases. The other option is to let renters do whatever they please, which is a bad business decision. Clearly, it would be better to work things like this out without having to go to court, but sometimes that's just not possible.
Also, Simon has terminated its merger agreement with smaller peer Taubman Centers (TCO). That deal was inked before the full fallout from COVID-19 started, and it looked increasingly like Simon was overpaying given the changed retail landscape. This could become a more complicated situation, as Taubman wants to fight the decisions, but calling off this purchase will give Simon even more financial flexibility since it will reduce its future financial obligations by roughly $3.6 billion.
And while Simon's operating expenses are destined to rise because of COVID-19, the extra cleaning and safety efforts will be vital to assuaging consumer concerns about going to the mall. At this point, the costs are table stakes for any mall owner that wants to remain open long term. While that's not a good thing per se, Simon has the financial strength to put best-in-class practices in place and further set itself apart from lesser peers.
5. Early signs are good
Rounding this out, there are some positive signs taking shape. At the most basic level that includes the fact that economies around the world are opening up for business again. It's been a slow process, often including multiple stages spread across many weeks. However, a number of retailers (Simon's direct customers) are saying consumers are coming back more quickly than they expected. That list includes key anchor tenant Macy's and smaller fashion-oriented names like Abercrombie & Fitch.
That said, results at these companies are nowhere near back to normal. Macy's sales were about 50% of their year-ago levels, with Abercrombie achieving a much better 80%. Still, the numbers show that consumers haven't lost the shopping bug, which means there's hope for the future.
Tread carefully
Simon appears to be one of the best-positioned mall REITs in what is a very difficult time for the retail sector. That's great, but it doesn't mean that investors should run in and buy the stock. There are still a great many risks here, and only time will tell what the long-term impact of COVID-19 will be -- infections appear to be growing again in some states. At this point, Simon is really only appropriate for more aggressive investors. But if you can handle the uncertainty in the mall sector, it is probably the mall REIT you'll want to own.
