Undervalued Dividend Growth Stock of the Week: Simon Property Group (SPG)

A successful investor doesn’t need to be a genius.

They just have to avoid being a fool.

Charlie Munger, never one to mince words, summed it up:

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

I’ll tell you how to avoid being a fool. 

Don’t invest in poor companies.

Boom.

You can pay me later.

I jest, but it really is that simple.

And one of the best ways to accomplish that is by being a dividend growth investor.

Charlie’s partner in crime, the great Warren Buffett, is basically a dividend growth investor.

And so am I.

Dividend growth investing is a very powerful investment strategy.

In fact, I’ve used this strategy to go from below broke at 27 years old to financially free at 33.

I even tell you how you, too, can retire early in my Early Retirement Blueprint.

By avoiding poor choices with my money, and by avoiding poor companies, I’ve built up my FIRE Fund.

That’s my real-money early retirement stock portfolio.

It generates the five-figure passive dividend income I live off of.

I’m now living the early retirement life of my dreams.

It required no genius level of intellect.

But I’m no fool.

Dividend growth investing is almost a fool-proof strategy because you’re, by definition, investing in companies with proven track records of success.

Those track records are exemplified by lengthy streaks of rising cash dividend payments to shareholders.

It’s the “proof in the profit pudding”, if you will.

The Dividend Champions, Contenders, and Challengers list gives you hundreds of these companies to select from.

Of course, only a fool would randomly select a stock off of that list and buy it.

Jason Fieber's Dividend Growth PortfolioFundamental analysis is extremely important.

And valuation is critical.

Price only tells you what a stock costs, but value tells you what it’s worth.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and reduced risk.

That’s relative to what the same stock might otherwise offer if it were fairly valued or overvalued.

All else equal, since price and yield are inversely correlated, a lower price results in a higher yield.

This higher yield leads to greater long-term total return potential.

Total return is, after all, the sum of investment income and capital gain.

Boosting yield gives you more potential investment income.

Capital gain gets a potential boost, too.

That’s via the “upside” between a lower price and higher intrinsic value.

All well and good.

These favorable dynamics also reduce risk.

Undervaluation introduces a margin of safety.

That’s a “buffer” that protects the investors downside against unforeseen issues.

I don’t need to be a genius to see how this all works to my advantage.

Fortunately, taking advantage of all of this doesn’t require extreme intelligence.

Fellow contributor Dave Van Knapp has made that easier than ever.

He put together a fantastic piece on valuation, Lesson 11: Valuation.

It’s part of a fantastic series of quality articles on dividend growth investing.

With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…

Simon Property Group Inc. (SPG) is a self-managed real estate investment trust that owns, develops, and manages a real estate portfolio that’s primarily focused on regional malls.

One of the largest REITs in the United States, their portfolio consists of ownership or interest in 206 different US properties spread out across 37 different states and Puerto Rico.

These properties break down as such: 107 malls, 69 Premium Outlets, 14 mills, four lifestyle centers, and 12 other retail properties.

The company also has ownership interest in outlets in Asia, Mexico, Europe, and Canada.

In addition, Simon Property Group owns a 21.3% equity stake in Klépierre SA, a Paris-based real estate company that owns or has interest in shopping centers in 16 countries in Europe.

In an age where e-commerce is swallowing up B&M retailers whole, operating a mall seems like an old-fashioned approach at best, and a path to bankruptcy at worst.

However, Simon Property Group proves that’s not the case at all.

Their operating metrics show that shoppers are still interested in shopping as an experience.

Retailers who can differentiate themselves and add value through a high-quality retail experience continue to fare well. E-commerce is complementary to that, not destructive. It’s simply another channel in an omnichannel strategy.

Omnichannel retail hasn’t gone anywhere.

Instead, it’s the retailers that never adapted to new customer standards regarding quality, differentiated experiences, and omnichannels that have gone bust.

It’s become more of a winner-take-all retail world.

Poor retailers go out of business, while great retailers are doing better than ever.

The losers are losing terribly. And the winners are winning big.

Simon Property Group clearly caters the latter, as evidenced by the fundamentals.

That bodes well for their ability to continue profiting and sending their shareholders ever-larger dividends.

The company has increased its dividend for 10 consecutive years.

A solid track record.

However, there’s a slight blemish here: Simon Property Group cut its dividend during the Great Recession.

The quarterly dividend was slashed from $0.90 to $0.60 for Q2 2009.

They were far from the only company to cut their dividend back then. The near-unprecedented arrest of the global financial system put a lot of companies in a tight spot.

REITs were particularly vulnerable due to their financial structure.

However, the company put things back on the right track in less than two years.

The 10-year dividend growth rate is sitting at an impressive 8.8% as a result.

Whenever I see 8.8% long-term dividend growth, I’m happy.

But what makes it exceptional in this case is, the stock yields a monstrous 5.18%.

This yield, by the way, is almost 150 basis points higher than its five-year average.

And with a payout ratio of only 66.7% (against TTM FFO/share), the dividend has plenty of room for sizable increases.

Before the cut in 2009, Simon Property Group had an outstanding legacy of dividend growth.

Other than that small bump in the road, this is a stock that increases its big dividend like clockwork.

Now, we can see what’s already transpired.

But the more important piece of information is what is yet to come.

We invest in the future, not the past.

I’m going to build out a future trajectory for dividend growth, which itself will heavily rely on a future trajectory for FFO/share growth.

Keep in mind this is a REIT.

That means the typical EPS profit metric doesn’t apply.

We’re going to be looking at funds from operations on a per-share basis.

This is a more accurate representation of a REIT’s profit because of the structure of the business and the way depreciation can artificially skew results.

The trajectory I’m building will use a combination of the proven past and a forecast for the future.

As such, I’ll first show you top-line and bottom-line growth over the last decade.

Then I’ll compare that to a professional profit growth forecast.

Blending what’s occurred with what appears likely to occur should give us plenty to work with.

Simon Property Group increased its revenue from $3.775 billion to $5.658 billion between FY 2009 and FY 2018.

That’s a compound annual growth rate of 4.60%.

Strong top-line growth. I usually look for a mid-single-digit revenue growth rate. They were right there.

However, a REIT like Simon Property Group routinely accesses the capital markets in order to fund growth.

They issue shares. And they take on debt.

This is partly because a REIT is required by law to pay out at least 90% of their taxable income to shareholders in the form of a dividend.

So it’s a cash flow machine whose cash flows right to shareholders.

In exchange, you’re looking at debt and share issuance. It’s give and take.

The give is that big dividend.

The take is, the outstanding share count has grown by approximately 15% over this period.

It’s always important to look at growth on a per-share basis. But it’s particularly true in this case.

Let’s do that.

The company increased its FFO/share from $5.33 to $12.13 over this 10-year period, which is a CAGR of 9.57%.

Well, there you go.

Even after factoring in the dilution, the bottom-line growth has been impressive. Very impressive, actually.

I noted earlier that Simon Property Group caters to winners.

Look, you don’t grow by almost 10% annually by catering to losers. That’s not how it works in this extremely competitive retail world.

Moreover, we can look right at the company’s occupancy rate.

This gives us two key pieces of information.

It tells us how healthy the tenants are (bankrupt tenants don’t lease retail space).

And it gives us insight into how attractive Simon Property Group’s properties/locations are to tenants.

The occupancy rate was 95.1% for Q1 2019.

A high rate all by itself, it actually increased YOY from the 94.6% occupancy rate the company registered for Q1 2018.

A retail apocalypse, I think not.

Looking forward, CFRA forecasts a 6% CAGR for Simon Property Group’s FFO/share over the next three years.

They acknowledge Simon Property Group’s superior, Class A properties.

But they also believe that tenants will remain challenged with more bankruptcies ahead.

I think this forecast is reasonable.

It’s lower than what’s transpired over the last decade. But it should be.

The 10-year FFO/share growth rate I threw at you earlier was juiced by the fact that the starting number represented the trough of the Great Recession.

That number is basically in a most favorable light.

More recent growth has been relatively tepid, although the company is still growing enough to support high-single-digit dividend growth. Getting that on top of a 5%+ yield is obviously compelling.

Adding further color to this, at least over the very near term, Simon Property Group’s most recent FY 2019 guidance calls for $12.35 in FFO/share at the midpoint. This would represent less than 2% YOY FFO/share growth.

We could even go right up the middle here and assume that Simon Property Group will compound FFO/share at 4% over the next few years.

That would still allow for high-single-digit dividend growth by virtue of the low payout ratio.

No matter how you slice and dice it, the dividend appears safe. And it’s in a position to grow at least in the mid single digits over the near term.

Moving over to the balance sheet, I have good news.

Total assets of $30.7 billion line up well against $26.9 billion in liabilities.

The fixed charge ratio is approximately 5.

And their senior debt has a rating of A/A2 from Standard & Poor’s and Moody’s, respectively.

Well into investment grade territory here.

Profitability is difficult to measure for a REIT. The GAAP numbers don’t really tell the whole story.

But the fundamentals across the board are rather incredible.

A lot of REITs have had their valuations pushed up as of late. With interest rates staying lower for longer, yield-hungry investors have bid up REITs to stratospheric levels.

However, this stock has been left behind.

I think a lot of that is due to fear. Perhaps misplaced. But a lot of investors are fearful of the long-term prospects of a large mall operator.

The thing is, e-commerce has been booming over this last decade. It didn’t start yesterday.

Yet Simon Property Group continues to print great numbers.

Of course, there are risks to consider.

Regulation, competition, and litigation are omnipresent risks for every business model.

While e-commerce hasn’t noticeably harmed the company, larger moves to online shopping could reduce demand for their properties.

The company is heavily exposed to potential tenant bankruptcies.

Being one of the largest REITs out there, the size works against them in terms of growth potential. This is compounded by a US retail market that is saturated.

But these risks appear to be more than priced in, creating a very attractive valuation…

The stock is trading hands for a P/FFO ratio of 12.87.

Equalizing for earnings, that’s well below the broader market’s valuation.

The P/S ratio, at 8.6 is notably lower than its five-year average of 10.4.

If we drill right down to cash flow, the stock’s multiple on cash flow of 13.1 is markedly below its own three-year average of 16.5.

And the yield, as noted earlier, is substantially higher than its recent historical average.

So the stock does look cheap. But how cheap? What would a reasonable estimate of intrinsic value look like?

I valued shares using a dividend discount model analysis.

I factored in an 8% discount rate (due to the high yield) and a long-term dividend growth rate of 3.5%.

I’m being ultra conservative with the DGR because of the nature of the business model.

The long-term track record is much higher than this.

Even the most recent numbers are well in excess of this.

And the forward-looking forecast for FFO/share growth, along with the low payout ratio, implies that Simon Property Group should be able to easily increase the dividend in the mid-single-digit range for years to come.

But with retail being in a state of flux, and with the size of Simon Property Group working against them, I think this is prudent.

The DDM analysis gives me a fair value of $188.60.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

Even with a very cautious valuation model, the stock still looks cheap.

But we’ll now compare that valuation with where two professional stock analysis firms have come out at.

This adds balance, depth, and perspective to our conclusion.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates SPG as a 4-star stock, with a fair value estimate of $195.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates SPG as a 4-star “BUY’, with a 12-month target price of $190.00.

We have a rough consensus here. Averaging out the three numbers gives us a final valuation of $191.20. That would indicate the stock is possibly 21% undervalued.

Bottom line: Simon Property Group Inc. (SPG) is a high-quality REIT. They have fantastic fundamentals across the board. The stock offers a 5%+ yield, double-digit long-term dividend growth, a low payout ratio, and the potential that shares are 21% undervalued. Dividend growth investors should think about going shopping and buying this stock while it’s on sale.

-Jason Fieber

Note from DTA: How safe is SPG’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 65. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, SPG’s dividend appears safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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