The global coronavirus pandemic has upended normal life, including how we shop. That's been a painful blow for mall owners like Simon Property Group (NYSE: SPG), which has suffered through government-mandated shutdowns, store closures, retailer bankruptcies, and reduced customer traffic. Is it worth buying into this terrible news, or should investors stay away from a faltering business model?
What is a mall?
Perhaps the most important thing to understand about a mall is that it's not simply a property where a group of stores are located. It's more like an ecosystem, where each store plays a role in the overall look, feel, and desirability of the mall for retailers and customers. Mall owners need to curate the list of stores and physical amenities of the property to ensure peak performance. It isn't an easy task in normal times, and it's been almost impossible during the pandemic.
That's because outside forces have impacted the normal flow of business. Worse, the coronavirus arrived while malls owners like Simon were dealing with the so-called retail apocalypse. While a notable piece of that issue is related to increasing use of online shopping among consumers, it's a broader problem. Retailers falling behind consumer taste trends and those with high leverage are increasingly unable to compete. Those three factors together are the real underlying causes of the retail apocalypse. The problem has been exacerbated by the pandemic.
Which helps to explain why mall- and outlet center-focused real estate investment trust (REIT) Simon Property Group saw a year-over-year funds from operations (FFO) decline of 24% on a revenue drop of 17%. That's brutal and helps explain the roughly 40% dividend cut made in 2020. That said, with the stock still off 20% from its pre-pandemic highs and some 40% from where it peaked in 2018, some investors might be thinking there's a turnaround opportunity here.
What's the future look like?
The first thing to consider is that there's no quick fix for what ails Simon Property Group -- or any other mall landlord. Empty stores take time to fill, so any recovery will be a multiyear effort. If you aren't willing to stick around for at least a few years, you shouldn't invest. There's also no guarantee Simon will be successful. So, given the difficult state in the retail sector, conservative investors might want to avoid the REIT as well. That said, more aggressive investors with a long-term focus should find a few things about Simon to like.
For example, the REIT has been in the doldrums before, notably during the 2007 to 2009 recession, when it last cut its dividend. During and following that period, Simon looked to improve its industry position so it could refocus on growth. The effort led to a long period of dividend growth, with the quarterly payment rising from $0.60 per share to $2.10 per share before the most recent cut. Growth in the dividend tracked along with the company's improving business fortunes.
This downturn has been no different, with Simon again looking to improve its industry position. For example, it bought a controlling stake in competitor Taubman Centers, which owns a global collection of well-positioned malls. It has also opened a few new outlet centers, both domestically and abroad. In addition, Simon has been letting weaker malls go, at times handing the keys back to lenders. This isn't exactly a great outcome for anyone, but it prunes the portfolio so Simon can focus on its best assets.
And the REIT, with partners, has been investing in troubled retail brands it believes can be saved. This effort is being modeled on the company's successful turnaround of Aeropostale, which, according to David Simon, CEO of Simon Group, went from -$100 million in EBITDA to positive EBITDA of $80 million in the three years after it was bought by Simon and its partners. That success was disrupted by the pandemic, for sure, but it shows the potential, noting that Simon is buying into iconic retailers like Brooks Brothers and J.C. Penney at very low prices because it's acquiring them out of bankruptcy.
So there's turnaround appeal here, and the foundation for improvement is being set. But, as noted, it won't be a quick recovery. For example, FFO in 2020 was $9.11 per share. Simon is projecting 2021 FFO of $9.50 to $9.75 in 2021, an increase of between 4% and 7%. And that range is still well below the $12.04 of FFO seen in 2019.
But, assuming it can hit those numbers, the worst may actually be past for the mall landlord. Meanwhile, the dividend would only eat up around 55% of FFO at the low end of 2021 guidance, so there's no reason to fear the 4.9% yield (as of this writing) is at risk. It's more likely the dividend will start to be increased again at some point in the near future than there's a risk it will get cut again.
All in, Simon is basically looking to do exactly what it did the last time it faced a huge business downturn, a fact CEO Simon highlighted during Simon Property Group's fourth-quarter 2020 earnings conference call. It won't be an easy task, and it will take time and a great deal of effort to get the job done, but this mall REIT looks positioned to get back on track.
That job, meanwhile, will get even easier once the world learns to deal with the coronavirus. For long-term investors willing to ride out what is likely to be a bumpy recovery, Simon could be a very rewarding option.