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Morningstar | Mall Fundamentals Are Strong in 4Q, but Results Are Just In Line for Simon

Fundamentals remained very strong and met our expectations for narrow-moat Simon Property Group in the fourth quarter, leading us to maintain our $187 fair value estimate. Retail sales continued to be strong in 2018, with the fourth quarter up 5.3%, the company's best quarter since the first quarter of 2013, pushing sales per square foot up to $661. Occupancy went up sequentially 40 basis points to 95.9%, slightly higher than we expected. Re-leasing spreads also picked up sequentially to 14.3%, above our estimate of 11.7% for the quarter. However, the strong occupancy and high re-leasing spreads did not translate to base rent growth, which only went up 2.0% (the lowest mark for a quarter since 2011) as retailer restructurings negatively affect results. As a result, comparable net operating income was up 2.1% for the fourth quarter, slightly ahead of our 1.9% assumption. Simon reported funds from operations of $3.23, 2% below our estimate of $3.30 due to some nonrecurring other income and expense items. It is very positive to see mall fundamentals so strong, but we would have hoped that it would have translated into results better than just in line with our expectations.

Management's guidance for 2019 seems a little conservative to us, setting a relatively easy goal for Simon to beat this year. NOI growth is expected to be 2%, which is below our 2.3% estimate, though management did point out that several department stores will be closed for renovations this year and that the growth from those stores will be a tailwind next year. Management set an FFO range of $12.30 to $12.40, which after accounting for a $0.13 impact from accounting changes and $0.15 from nonrecurring gains in 2018 results in 4.1% growth in 2019 but is still 1.7% below our estimate. Given that Simon's portfolio picked up strength through 2018, we think a solid year is a real possibility in 2019 and that Simon will be commenting about how it outperformed come this point next year.

Simon increased its quarterly dividend 5.1% to $2.05 per share from a quarterly dividend payout of $1.95 per share in the first quarter of 2018. This increase is greater than the anticipated FFO increase for 2019 but lower than the annual increases since 2011 that have averaged 11% over the past four years. Still, we think Simon is starting to approach a dividend payout ratio that returns an appropriate amount of cash flow to shareholders but still leaves the company significant cushion to prevent a cut to the dividend even if we were to enter a typical recession. We typically like to see a REIT target paying a dividend that is 75% of the company's adjusted FFO, which adjusts FFO for noncash items and capital expenditures. After dropping to approximately a 60% ratio in 2009 when it cut its dividend during the financial crisis, the company has been slow to increase payout ratio. Given the midpoint of management's 2019 FFO guidance, the projected 2019 dividend finally brings this dividend to the target of 75%. Going forward, we would expect to see management matching dividend increases with its expected adjusted FFO growth.