Most investors know by now of the controversies surrounding physical “brick and mortar” retail stores.
Some experts think that all physical retail is being killed off by Amazon (AMZN) and online purchasing in general.
Others think that brick and mortar retailing will come out just fine, especially in high-end segments where consumers like and expect to see and feel the goods, and where a highly satisfying personal experience is provided.
Simon Property Group (SPG) is a retail real estate investment trust (REIT) that owns high-end malls.
This is a segment of physical retail that many experts believe will not only survive, but will thrive even against the onslaught of online buying opportunities.
Here is Simon’s Quality Snapshot. I derive this from the following sources, which I have come to trust and respect over the years:
As you can see, Simon stacks up as a good-quality company. It gets green ratings across the board.
Simon’s “A” credit rating is among the best as REITs go. Many REITs get BBB or BBB+ ratings from S&P. Not all REITs are even considered investment-grade.
Morningstar’s narrow-moat rating is based on:
• Simon’s efficiencies of scale that result from the company’s portfolio of high-quality, well-located, and productive properties;
• Morningstar’s belief that there will always be demand for high-quality retail locations;
• Simon’s locations in many of the best markets with dense populations and high disposable incomes;
• Simon’s ability to provide a shopping and activity experience that is hard for other retailers to replicate.
Simply Safe Dividends rates Simon’s dividend safety in its 2nd-highest category: Safe and unlikely to be cut. The company has a reasonable payout ratio, but it does carry pretty high debt, which is not unusual for REITs.
Simon’s dividend yield is 5.8%, and it has raised its dividend for 9 straight years.
Simon cut its dividend during the Great Recession, although it did not take long for its dividend payout levels to rise and surpass its levels prior to the recession.
[Source; Simply Safe Dividends]
Given its yield (5.8%) and 5-year growth rate (10% per year), I would label Simon Property Group as a high-yield, fast-growth dividend stock.
In 2019, Simon has raised its dividend twice for a total increase of 5%.
To value a stock, I use four different methods, then average them out. For more details on my approach, see Dividend Growth Investing Lesson 11: Valuation. Valuations are assessments, not physical traits, so they are never exact. For that reason, we want several points of view. So we use multiple models.
Model 1: FASTGraphs Default Valuation
In the the first step, I check the stock’s current price against FASTGraphs’ basic estimate of its fair value.
For REITs, I use the funds-from-operations (FFO) metric rather than reported or operating earnings. FFO is universally considered to be a more useful measure of profits for REITs.
FASTGraphs compares the stock’s current price-to-FFO (P/FFO) ratio to the historical average P/FFO ratio generally considered to be “fair.” That reference ratio is 15.
The orange line is the reference line, drawn at P/FFO = 15. Simon’s actual price is the black line, and its actual P/FFO is circled.
You can see that Simon’s price is below the reference line, indicating undervaluation.
Here’s how to calculate the degree of undervaluation: Create a valuation ratio from the two P/FFO ratios.
Formula for Measuring Valuation on FASTGraphs
Actual P/FFO divided by Reference P/FFO
12 / 15 = 0.80.
That suggests that SPG is 20% undervalued.
To calculate Simon’s fair price, we divide its actual price by the valuation ratio:
Formula for Calculating Fair Price
Actual Price divided by Valuation Ratio
$146 / 0.80 = $183
Model 2: FASTGraphs Normalized Valuation
Next, we “normalize” the fair-value reference line to reflect Simon’s own long-term valuation rather than the market as a whole.
I use the stock’s 5-year average P/FFO ratio (17.3, circled) for this step. That is used to draw the blue fair-price reference line. The actual P/FFO for imon is the same as in the first model.
This method suggests that Simon is even more undervalued than the first model. That’s because its 5-year P/FFO ratio of 17.3 is higher than the 15.0 that was used in the first step.
The formulas for the valuation ratio and fair price are the same as before. Applying them, we get:
Valuation ratio: 12 / 17.3 = 0.69, or 31% undervalued
Fair price: $146 / 0.69 = $212
Model 3: Discounted Cash Flow
The next step is to consult Morningstar’s valuation of the stock.
Morningstar ignores P/E and other valuation ratios.
Instead, they use a discounted cash flow (DCF) model. Using conservative projections, they discount all of the stock’s estimated future cash flows back to the present to arrive at a fair value estimate. (If you would like to learn more about how DCF works, check out this excellent explanation at moneychimp.)
Here is Morningstar’s conclusion:
Morningstar calculates a 23% undervaluation, with a fair price of $189 per share. Morningstar gives this valuation 4 stars on their 5-star system.
Model 4: Current Yield vs. Historical Yield
The 4th and final valuation method is to compare the stock’s current yield to its historical yield.
If a stock ‘s current yield is higher than its historical average, that suggests that it is a better value than usual. You are “paying less” for the stock’s dividends, because you can buy more shares with your money. Because dividends are paid per share, you will get more dividends for your money.
[Source: Simply Safe Dividends]
Simon’s current yield of 5.8% is 38% higher than its 5-year average yield of 4.2%. That suggests that the stock is significantly undervalued.
To calculate the degree of discount, I again form a valuation ratio, this time by comparing the yields:
Formula for Measuring Valuation by Comparing Yields
5-Year Average Yield divided by Current Yield
4.2% / 5.8% = 0.72
When I use this comparitive-yield model, I cut off the ratio at 0.80, because this is an indirect method of measuring valuation, and I want to avoid extreme results.
Using 0.80 as our valuation ratio, we get a fair price of $146 / 0.80 = $183.
Simon’s Valuation Summary
The average of the four methods suggests a fair price of $192 for Simon’s shares, compared to its actual price of about $146. That’s a 24% discount.
Even if we throw out result #2 as an outlier from the others, we get a fair price of $185, which represents a 21% undervaluation.
With its high yield, good growth rate, good quality rankings, and 24% undervaluation, I think that Simon Property Group is an attractive dividend growth investment. It really comes down to whether you think that high-end malls will continue to be attractive to shoppers as more and more retail activity moves online.
In May, 2017, I selelcted Simon as my Dividend Growth Stock of the Month. While that article is stale now in terms of current statistics, the following summary from that article is still on point.
Here are Simon Property Group’s positives:
• Good dividend resume: 4.2% yield [now 4.8%] is amply covered by cash flows and supported by strong dividend safety. The company has a history of raising the dividend annually, sometimes more than once per year.
• Good quality company with a narrow moat and one of the better credit ratings that you will find among REITs.
• Portfolio of high-end retail malls, outlet malls, and mixed-use developments.
• Solid operating history and capable management.
• Steady increases in funds from operations every year since the Great Recession. Analysts forecast a 10% increase for 2017.
• Stock is undervalued.
And here are the negatives:
• High debt, although that is not uncommon for REITs, which cannot retain significant profits to fund growth (they must distribute them to shareholders).
• Possible secular shift away from physical malls and stores resulting from customer preferences shifting to online shopping and home delivery.
This is not a recommendation to buy Simon Property Group. As always, perform your own due diligence. Check the company’s complete dividend record, business model, financial situation, and prospects for the future, as well as its effect on your portfolio’s diversification.
And when you are investing, always be sure to consider how and whether the asset you are considering fits (or does not fit) your long-term investing goals.
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