Given that the term "retail apocalypse" is a part of the investor vernacular, and 2020 was particularly tough on retailers, how safe is a real estate investment trust (REIT) that operates shopping malls? Simon Property Group (SPG +0.65%) went through a decline in earnings and a dividend cut, but has emerged on the other side of COVID-19 crisis. Let's see if its stock, and more importantly, its dividend is still an income investment.
Last year was awful for retailers
While government-imposed closures negatively affected just about every company in the U.S., social distancing orders took center aim at shopping malls, as they were considered non-essential businesses. These closures were fatal or near-fatal to many of Simon's tenants who were unable to make rent payments. In the second, third, and fourth quarters of 2020, Simon collected 90% of its billable rent.
Simon Property Group entered the COVID-19 crisis with numerous challenges, including having just negotiated a deal to buy competitor Taubman Centers. The timing couldn't have been worse. Simon tried to get out of the deal, and ended up going forward at a reduced price. Simon also purchased some of its distressed tenants, including Forever 21, J.C. Penney, and Brooks Brothers.
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Don't expect to see a rapid bounce-back in results
For the full year 2020, Simon reported funds from operations (FFO) per share of $9.11, which was a decline of 24% compared to 2019. Earnings per share were just about cut in half, however FFO is the preferred method of looking at a REIT's earnings. This is because property depreciation is such a big expense, and it is a non-cash charge. For the full year 2021, Simon is guiding for FFO per share to rise to between $9.50 and $9.75. Given the size of the earnings drop-off in 2020, investors might have expected more than 5.6% growth, but it looks like the recovery will take a few years.
Simon's occupancy rate fell from 95.1% at the end of 2019 to 91.3% at the end of 2020. Finding new tenants to replace bankrupt ones will take time, and that might explain why the company is guiding for such low growth. Department stores are still having a rough time, and they are the anchor tenants for shopping malls. Often retailers are permitted to break their leases if a department store is vacant.
Still, the company is quite safe and the dividend is well covered
How safe is Simon Property? Simon is pretty safe. It is the premier operator of shopping malls in the United States, and it is in a strong financial position. Despite the lousy year in 2020, the company generated $3.2 billion in funds from operations, which more than amply covers its interest expense of $616 million. At the end of 2020, the company had $8.2 billion in liquidity between cash on hand and borrowing capacity.
What about the dividend? Well, Simon was forced to cut its dividend from $2.10 per share to $1.30 per share, which is painful for any income investor. That said, at current levels, the dividend payout ratio (basically the dividend as a percentage of funds from operations) is 54%, which is low for a REIT in general. In 2019, Simon paid 69% of its FFO in dividends, so investors should probably be expecting a dividend hike more than a dividend cut. Applying a 69% payout ratio to the midpoint of Simon's guided FFO per share gives an annual dividend of $6.63, which works out to be a 5.5% dividend yield.
Despite the reflation trade (basically a big recovery bet) being the flavor of the month and investors focus on companies that should rebound fastest, from a real word perspective it'll take time for people to feel comfortable going back to malls and flush enough to start spending on discretionary goods. And that's reflective of Simon's stock that's yet to regain its pre-COVID-19 price along with management's less than ambitious FFO guidance for next year.
That said, Simon seems safe from a future dividend cut, thanks to ample liquidity, and may even have some room for a dividend hike sometime soon. A full recovery, however, will take years, not months, so investors may have to wait a while for the stock to regain its past glory.
