Simon Property Group

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Simon Property Group is a leading real estate investment trust (REIT) that owns and manages a diverse portfolio of premier shopping, dining, entertainment, and mixed-use destinations across North America and internationally.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Simon Property Group (SPG) operates as a Real Estate Investment Trust(REIT). A REIT is a company that owns, operates, or finances income-producing real estate. This is an important distinction since REITs have to distribute at least 90% of taxable income to shareholders and receive tax advantages in return. Due to that they have high dividend payouts and lower retained earnings, therefore the source of growth is mainly dependent on its ability to raise external capital. A detailed understanding of REITs can be helpful when evaluating SPG.

Business Overview Simon Property Group (SPG) is the largest owner, developer, and manager of retail properties in the United States, and is one of the world’s largest real estate investment trusts (REITs). The company’s portfolio encompasses a wide array of properties, from regional malls and premium outlets to lifestyle centers and mixed-use developments. This diverse portfolio aims to cater to different customer segments and maintain stability amidst varying economic conditions.

  • Revenue Distribution: The company primarily derives its revenue from rents paid by its tenants who operate retail stores and other businesses in its properties. These leases typically have a fixed term with a combination of fixed and variable elements. Revenue is also generated through management and other fees from joint ventures and other activities.
  • Industry Trends:
    • The retail industry has been facing continuous challenges from e-commerce, which has led to a shift in consumer preferences and reduced foot traffic in traditional shopping centers. SPG is responding by diversifying its properties to become mixed-use destinations that offer more than just shopping, including entertainment, restaurants, and residential units.
    • Inflation has caused a rise in rental rates and prices. This is being offset by a drop in consumer demand. This shift can have a volatile impact on retail companies, both those that have high margins and low pricing. As for REITs, rising rental rates can mean better profitability, if those rates can be sustained. The uncertainty created by inflation might be a risk on future stability.
    • The retail industry has been consolidating, with big players acquiring smaller companies. This can reduce competition, but can also lead to higher price premiums as buyers scramble to acquire desirable targets.
  • Competitive Landscape:
    • The retail real estate sector is competitive, with other large REITs, smaller REITs, and privately held companies all vying for strong tenants and assets. The barriers to enter are high, due to the significant capital requirement to acquire prime real estate and develop facilities. However, once in, most of the tenants will be interchangeable, making switching costs low for companies.
    • The company faces significant competition from other mall operators, especially as some retailers have been pushing for lower rents and new lease terms with greater flexibility. The threat from e-commerce is ever-present and forces retail owners to adapt their business and strategies.
    • The retail industry has seen a rise in outlet malls as well, but SPG, having a presence in both outlet malls and traditional malls, is well-positioned to benefit from different sub-segments of the sector.

Simon Property Group differs from its competitors through several features that combine to create their strengths:

  • Scale and Diversification: SPG’s massive and diversified portfolio provides a significant advantage through economies of scale and reduces risks. This provides an advantage against smaller players who would need a lot more capital to compete on an equal footing.
  • High Quality Portfolio: The company emphasizes having “Class A” malls, typically featuring high-end retailers and above-average consumer foot traffic. This provides more stable and reliable income from these tenants. In addition, the company has also diversified in outlet malls and mixed-use facilities to be present at all desirable locations.
  • In-house management and development: SPG is one of the few publicly traded companies that manage and maintain their own properties rather than outsourcing it, creating a cost advantage and higher profitability. This also means they have greater control over the quality of its operations.

Financials

  • Income Statement
  • SPG’s revenue is primarily derived from lease revenues, which are variable and depend on the state of the economy and occupancy rates of its facilities. Lease revenue has been increasing in recent years due to an increase in occupancy rates and higher rents, but might be affected by macro-economic situations.
  • The company’s operating margins have been around 70% in recent years, although might fluctuate depending on macro-economic situations. With its large size and diversification, the company has the power to keep its operating expenses at reasonable levels.
  • Net income has been volatile in recent years because of factors like interest rate changes, sale of assets, gains/losses from investment etc, which are not easily predictable.
  • Balance Sheet
    • The assets are comprised of primarily the properties themselves which account for over 90% of its total assets. They also have small portions in cash, investments, and other assets. The large part of investments in real-estate property means book value and market values could vary wildly and are dependent on a number of factors, such as interest rates.
    • The company’s debt, is fairly high compared to its equity, but the management has done a good job in actively managing its debt and interest obligations through debt restructuring and refinancing. Long-term debt forms a big part of total debt. Short-term debts are limited and can be covered by its revenue stream.
    • The equity of the company is highly tied to the net assets of the company and the real state market, therefore it can be volatile. The retained earnings are limited as most profits are paid out to investors via dividends.
  • Cash Flow Statement
    • The operating cashflow is generally very high due to their leasing activities. However, they have higher capital investments than other similar companies, due to their expansion efforts. In general, they have enough free cash flow to distribute to sharehodlers.

Risks to the Moat and Business Resilience

  • Economic Sensitivity: SPG’s business is heavily reliant on the overall health of the economy and consumer spending. A major recession or economic downturn can greatly reduce consumer spending and cause tenants to default on their leases.
  • Interest Rate Risk: Because REITs are highly sensitive to interest rates, increases in interest rates can lead to higher borrowing costs and lower property valuations, which can lead to decline in profitability and dividends. This also affects its ability to raise new capital at favorable prices. * Competition From Other Retailers: Increasing competition from large retailers and other retail locations can cause reduced foot traffic in its own locations and reduce the potential for rent growth. The rise of online stores also poses a threat to its long term sustainability. * Technological Disruption: Changes in technology and digital shopping habits of customers can reduce the need for physical stores and malls in the future.
  • Management Turnover: While it might be tempting to give great importance to CEO and management, it is actually a non-important factor. Business performance has a high correlation to the structure and economics of its business and industry, and not due to management. As a REIT, SPG is not exposed to a major influence of its CEO.
  • Accounting Gimmicks: The company could potentially mask short-term declines or other financial issues by utilizing several methods in GAAP. This could include, but not limited to, using non-reoccurring items, changes in depreciation, or other accounting techniques, which would provide a false impression of profits.
  • Legal and Regulatory Changes: Tax rules and regulations are constantly changing and that can impose challenges, both on how the company operates and pays its taxes, but also the market’s willingness to invest in the company. Furthermore, any unexpected legal hurdles related to a real-estate business might affect its ability to operate.
  • Operational Risks: The quality of the tenant base can also pose a risk. A larger tenant could suddenly change plans, or go bankrupt, thereby affecting occupancy rates. In addition, the firm may have limited control over external variables that affect the performance of tenants, such as sales volumes.
  • Business Resilience:
  • SPG has consistently generated high levels of cash flow from its operations. These cash flows can be used to buffer the impact of the downturn and to maintain its payout ratio for shareholders. This is in contrast to other businesses with high volatility in their revenue.
  • SPG has a good history of being able to expand during economic downturns by acquiring companies for cheaper valuations, due to their strong balance sheet and market presence. This is something the company’s management is actively pursuing.

Recent Concerns/Controversies

  • Inflation and Macro-economic situation: In the latest reports, management has noted that “the environment remains very difficult to predict with respect to the pace of the recovery in retail sales or the timing of recession, or how consumer discretionary spending may change throughout the year.” In terms of inflation, management has noted that “rent increases will offset some of the higher expenses as we move into next year, but until then higher expenses and reduced consumer spending is expected to impact the company’s profits.”

Management has noted that they are focusing on the core business which has been the most resilient during downturns. The company is working hard on controlling costs and maintaining quality of properties. They have also noted that they are looking for suitable acquisition opportunities to grow their portfolio for the long term.

Understandability: 2 / 5 Simon is a REIT, which adds a bit of complexity to the overall valuation process, since REITs do not operate like normal companies. Understanding these nuances requires more effort to understand. But given its business model, it’s relatively simple to understand the basics, with revenue being driven from tenants and operating costs being dependent on that. So, while there is a moderate amount of complexity, it is possible for most individuals to gain a basic understanding of the company’s operations.

Balance Sheet Health: 4 / 5 Despite being a debt heavy business, the company manages its obligations well, and has access to enough cash and a reasonable cash flow to cover any short term liabilities. While a highly levered business has its own share of risks, SPG appears to be handling it well and is set to continue its profitability for many years to come. Although it’s not completely flawless, I am reasonably optimistic about its balance sheet.