EUR 850.00 For Business Accounts Only

Morningstar | Occupancy, Re-Leasing Spreads, and Dividend Up for Simon Property Group in 3Q

Third-quarter earnings results for narrow-moat Simon Property Group were in line with our expectations, leading us to maintain our $187 fair value estimate. Retail sales in 2018 continue to be strong, as sales per square foot for the total portfolio grew 4.5% year over year to $650 and pushing year-to-date sales growth to 4.4%, which if that continues into the fourth quarter would be the best year for retail sales growth since 2012. Occupancy went up sequentially 0.8% to 95.5%, slightly better than we expected. Re-leasing spreads were very strong at 13.9%, the strongest quarter since the beginning of 2016 and reversing a recent trend of decelerating spreads, leading to average base rent growth of 2.8% in the quarter. However, operating margins declined slightly in the quarter, leading to comparable net operating income growth of only 2.4%, though that was still ahead of our estimate of 0.6% NOI growth. Funds from operations came in at $3.05 for the quarter, in line with our assumptions, and the company raised the low end of its 2018 FFO guidance to bring the midpoint for 2018 FFO up to $12.11. Simon increased its quarterly dividend by 5 cents in the third quarter to $2 per share, representing a 2.6% sequential increase and an 11.1% year-over-year increase. We like the shareholder-friendly move to share profits and believe Simon's continued cash flow growth should be able to sustain future increases to the dividend. The third-quarter results should give investors confidence that high-quality malls can still produce strong fundamentals even in a retail environment that is increasingly pressured by e-commerce.

The recent announcement that Sears will be closing 63 stores across the U.S. will significantly affect Simon, but we think that despite some near-term loss in rent this represents a major positive for the mall owner. Simon started the year with 67 Sears in its portfolio, and that number dropped to 59 by the end of the second quarter, due to prior store closing announcements and leases not being renewed. Re-leasing some of these stores to other tenants at higher rents is part of the reason for the double-digit re-leasing spreads Simon has achieved this year. After the most recent announcement, Simon expects to only have 29 Sears in its portfolio by the start of 2019. While some of the stores are owned by Sears or Seritage and Simon can't control what happens to that real estate, Simon directly owns 17 of the closing stores and shares ownership of another five in a joint venture with Seritage.

We think there is significant upside to these boxes for Simon. The company expects to spend a little more than $1 billion in redeveloping these assets at 7% to 8% yields, which we think is achievable given that it has executed on redevelopment projects at these yields over the past several years. Simon may target single anchor tenants to replace Sears, redevelop the box into smaller junior-anchor boxes, or redevelop the box into a mixed-use wing like the one it just started at the Phipps Plaza mall in Atlanta, where the company is turning an underperforming 150,000-square-foot department store into a hotel, an office building, a gym, a food hall, and an outdoor space that adds approximately 500,000 square feet of incremental rent-paying area. Whatever Simon chooses for each location, the end result is most likely to provide higher rents than the below-market rents Sears paid and should drive more traffic to the mall, which should in turn increase sales growth and turn into higher re-leasing spreads for Simon in the long term.