Thesis

Recent corrections have caused the valuation of Simon Property (New York Stock Exchange: SPG) at an attractive level. In terms of dividend yield, it currently yields 6.7%. Compared to its long-term historical average, this represents a valuation discount of more than 50%. The spread against the risk-free rate is at 4%, the highest level in a decade excluding the 2020 stock market crash.

At the same time, its financial position and cash flow remain strong to support shareholder returns. The recent outsized dividend increase of 21% demonstrates management’s confidence. The dividend is safe and the payout ratios are on par with the long-term average. Interest coverage stands at 4.47x, the highest level in a decade. New properties and ongoing development projects add further upside catalysts. These include the Jeju Premium Outlets (which opened in mid-October in South Korea) and the Fukaya-Hanazono Premium Outlet in Japan which is scheduled to open in late 2022. In addition to these international properties, SPG has also ongoing projects at his home in Georgia, FL, NY, et al.

Yield gap

An effective way (and in my opinion the only reasonable way) to evaluate is to evaluate the valuation against the risk-free interest rates. This work will use the spread of dividend yields over risk-free interest rates as a valuation measure. Details of these concepts and approaches were provided in our previous article. Dividend yields and the yield spread are what we check first before making any investment decisions. Fortunately, we have had very good success with this approach due to:

• PE or current price/cash flow multiples provide partial or even misleading information due to the differences between accounting results and owners’ results.
• Dividends provide a back door to quickly estimate owners’ income. Dividends are the most reliable financial information and the least subject to interpretation.
• The dividend yield spread (“YS”) is based on timeless intuition. No matter how times change, the risk-free rate serves as the gravity of all asset valuations and therefore the spread ALWAYS provides a measure of the risk premium investors pay over risk-free rates.

GSP yield spread over Treasury rates

As can be seen in the following chart, SPG’s current dividend yield is around 6.7%, significantly above the historical average. You can see he started the decade with a dividend as low as 2.24%. And over the past decade, its dividend yield has averaged 4.43%. And so, in terms of yield, it’s currently about 51% off the historical average. If the outliers in 2020, when the dividend yield reached 19%, are excluded from the calculation of the average, the current discount would be even greater. The bottom panel shows the risk-free rates represented by 10-year Treasury bills. As can be seen, risk-free rates are now back to where they were in 2014, at around 2.75%.

This next chart shows the yield spread between the GSP and the 10-year Treasury. As can be seen, the spread started around 0% about a decade ago (i.e. at that time GSP was yielding the same yield as 10 year). And the spread increased gradually. Despite the changes, the YS has been in the 0% to 2% range most of the time (and the 2020 timeframe is an obvious outlier, as mentioned above). Such a YS suggests that when the spread is near or above 2%, the GSP is significantly undervalued relative to 10-year treasuries (i.e. I would sell treasuries and buy of the GSP). And vice versa.

And at the time of this writing, the yield spread is around 4%, with the GSP yielding 6.7% and 10-year rates hovering around 2.7%. It sits near the end of the historical spectrum thickness (again, when the outlier year 2020 is excluded), suggesting very manageable near-term risks.

The following chart provides a more quantitative risk assessment. This chart shows that the GSP’s 1-year total return (including price appreciation and dividend) has fallen over yield spreads. As can be clearly seen, there is first a positive correlation showing an upward trend in total return relative to widening spread increases. The correlation coefficient is 0.57. In particular, as the orange box shows, when the deviation is around 6% or more (the extreme cases occurred in 2020), the total returns for the following year were all positive and out of proportion. Again, the yield gap is currently around 4% as shown, closer to the thicker level.

SPG’s Financial Strength and Dividend Security

Although we don’t suggest you buy stocks that have a thick yield spread. YS is the first thing we check, but certainly not the last. The main risks for a REIT stock in the short term are its debt burden and the safety of dividends. And we’ll take a close look at both below.

The following graph illustrates SPG’s debt position in terms of interest coverage. Interest coverage is calculated here by dividing EBIT by interest expense. As can be seen, its debt coverage is currently at a decade high. Coverage started as low as around 2.4x at the start of the decade, and now sits at 4.47x.

After verifying its debt coverage, the following chart shows the safety of its dividends in terms of FFO payout and earnings payout ratios. As the first chart shows, SPG has managed its dividend payout consistently. The FFO payout ratio started below 40% at the start of the decade. And then it gradually picked up and stabilized around an average of 56.3% since 2016. The current FFO payout rate is 61.2%, a little above the historical average and a very sign reassuring.

In terms of the payout ratio, as you can see from the following chart, the situation is also very similar. Its payout rate has also been very consistent, around an average of 127% over the past decade. And currently, its payout ratio is 126%, which is the historical average.

Looking ahead, the balance sheet and cash flow remain strong to support shareholder returns and ongoing development projects. The company just announced a dividend of $1.70 per share, which is an outsized 21% year-over-year increase. As CEO David Simon commented:

Our balance sheet is strong and continues to be a significant advantage for us while our cash flow generation gives us the flexibility to adapt when conditions warrant and as we have proven time and time again. We will be thoughtful and opportunistic on the buyout and keep in mind that this comes on top of the more than 20% increase in our dividend that we announced today.

Conclusions and final thoughts

The current SPG rating is too compressed to ignore. Measured by dividend yields, it is more than 50% below the historical average. The 4% yield spread signals very manageable risks relative to short-term Treasuries. Strong financials, a current dividend yield of 6.7% and high-end new/pipeline properties add further security and catalysts to the upside.

The main short-term risks include:

Foreign exchange risks. As a global REIT player, SPG owns and manages properties in the United States and overseas, such as South Korea, Japan and France, as mentioned above. As the Fed raises rates and the dollar strengthens, when SPG releases international earnings in dollars, earnings will be negatively impacted. And management mentioned that this impact could be more than that of the rising interest rate environment.

Risks related to variable rate debt. SPG currently has approximately $25 billion in long-term debt, and some of it is at floating rates, which may create higher interest charges for SPG if interest rates continue to rise. increase. As CEO David Simon commented,

And the only offsetting negatives are that we have some exposure to floating rate debt. We’re probably at the very, very low end of other real estate companies, but we have a few.