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

We’re coming up on the end of another year.

More than that, this is the end of a decade.

As 2020 fast approaches, now is the time to think about setting your investments up correctly.

And not just for the next year, but for the next decade – and beyond.

The stock I’m discussing today could help you do just that.

If you want to set your investments up correctly for the long term, it’s tough to do better than dividend growth investing.

This investment strategy advocates buying shares in some of the best enterprises in the whole world.

And you know how great they are, because they’re sending their shareholders growing cash dividends.

Those growing cash dividends are the “proof in the profit pudding”.

Don’t tell me how profitable you are. Don’t tell me how great the business is.

Show me. Show me the money!

The Dividend Champions, Contenders, and Challengers list catalogs more than 800 US-listed stocks showing their shareholders the money.

I used dividend growth investing to go from below broke at 27 years old to financially free and retired at 33, as I lay out in the Early Retirement Blueprint.

Through this strategy, I built my FIRE Fund.

That’s my real-money dividend growth stock portfolio.

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

Now, dividend growth investing is a phenomenal investing framework.

But you still have to be intelligent and cautious regarding how you approach it and execute.

Jason Fieber's Dividend Growth PortfolioThe exact stocks you buy, as well as when you buy them, will have a lot to say about your success.

It’s important to focus on the highest-quality dividend growth stocks. And it’s important to buy them when they’re undervalued.

While price is what you pay, it’s value that you actually get.

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

This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.

Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.

That higher yield correlates to greater long-term total return potential.

This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.

Prospective investment income is boosted by the higher yield.

But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.

And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.

These dynamics should reduce risk.

Undervaluation introduces a margin of safety.

This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value. It’s protection against the possible downside.

It’s very easy to see how understanding and harnessing undervaluation could greatly increase the amount of wealth and passive income you go on to accumulate throughout your life.

The good news is, undervaluation isn’t all that difficult to find.

Fellow contributor Dave Van Knapp made it easier than ever to understand and harness undervaluation.

He’s done that with Lesson 11: Valuation, which is part of a larger series of “lessons” on DGI.

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)

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.

It might seem odd that I’m selecting a mall operator as a stock choice for 2020 and beyond.

After all, there’s this perception that malls are dead.

And perception is reality.

Well, except for the fact that this perception is actually dead wrong.

This current perception is similar to the one that’s been prevalent over the last decade, especially with e-commerce basically owning this period.

Yet all Simon Property Group did over the last 10 years was make more money.

And pay a growing dividend straight through that period.

Indeed, they’ve increased their dividend for the last 10 consecutive years.

The 10-year dividend growth rate is 8.8%.

If that kind of dividend growth is the “death of malls”, it’s a death I’d sure like to have.

And with a payout ratio of 69.9%, based on the company’s midpoint FFO/share guidance for this fiscal year, the dividend is easily covered and in a position to continue growing.

On top of all of this is the stock’s massive yield of 5.76%.

That yield is almost three times higher than the broader market’s yield; it’s also more than 200 basis points higher than the stock’s five-year average yield.

It’s not often that you get high-single-digit dividend growth on top of a near-6% yield.

These gaudy numbers should pique any dividend growth investor’s interest.

Of course, we ultimately invest in where a company is going, not where it’s been.

Thus, I’ll now build out a forward-looking growth trajectory for Simon Property Group, which will later help us estimate the stock’s intrinsic value.

I’ll first rely on what the company has done over the last decade in terms of top-line and bottom-line growth.

Then I’ll compare that to a near-term professional forecast for profit growth.

Blending the proven past with a future forecast like this should allow us to reasonably extrapolate a growth path for the company.

Revenue has grown from $3.775 billion to $5.658 billion between FY 2009 and FY 2018.

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

This is a pretty strong top-line growth rate, especially considering how challenging the last decade was for this business model.

That said, it’s not uncommon to see great top-line growth from REITs.

The more accurate measure for true growth is to look at the expansion of funds from operations per share (essentially EPS for REITs).

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

In order to fund growth, a REIT typically turns to the capital markets.

That means issuing shares and/or taking on debt.

It’s highly important to consider a REIT’s revenue growth through that prism.

I’ll now put the top-growth into context.

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

This is impressive.

They actually grew FFO/share faster than revenue, which goes to show the quality of the business and the intelligent selection of growth projects/investments by management.

There’s no death occurring here. It’s actually the opposite. It’s a lively business that’s moving profit and the dividend in the right direction.

That’s further evidenced by the fact that the REIT has maintained an occupancy rate above 95% for the last seven years. Reported retailer sales across their portfolio came in at $661/square foot for FY 2018, an increase of more than 5% YOY.

Looking forward, CFRA is forecasting that Simon Property Group will compound its FFO/share at an annual rate of 5% over the next three years.

They cite Class A Properties, quality fundamentals, buybacks, and the ongoing shift away from apparel (and toward Internet-resistant restaurants, fitness, and entertainment options) as key tailwinds for the REIT.

On the other hand, they believe more retail tenant bankruptcies are to come, especially across apparel and department stores.

In my view, the REIT does not have to grow FFO/share at almost 10% in order to be an appealing long-term investment.

Coming in at closer to the 5% range that CFRA is forecasting seems more likely than the ~9.5% that was posted over the last decade, especially when looking at recent numbers from Simon Property Group.

However, that still sets the mall operator up for like dividend growth, when looking at the payout ratio.

And ~5% dividend growth on top of a 5.7%+ yield is awfully nice. I don’t know of many investors who would pass up that kind of combination of yield and growth. Even a dividend growth rate in the low-single-digits is compelling with the yield being so high.

One element of the business that is very interesting, as well as a possible catalyst for future growth, are the equity investments and partnerships that Simon Property Group has been pursuing.

For example, they recently partnered up with Rue Gilt Groupe to focus on digital value shopping.

In addition, their equity portfolio now includes investments in an array of consumer brands that counts the likes of Life Time, Pinstripes, and Allied Esports.

Diversifying the business into successful and proven players in more experiential and “Internet-proof” brands that cater to health, entertainment, and even food mitigate against the erosion of value in their core real estate portfolio.

Moving over to the balance sheet, Simon Property Group maintains a rock-solid financial position.

It’s one of the best REIT balance sheets out there.

Total assets of $30.7 billion line up well against $26.7 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.

This is obviously investment-grade debt.

I usually like to show profitability metrics, but they’re tough to gauge for a REIT. That’s because GAAP numbers often don’t apply or don’t show an accurate picture of results.

Nonetheless, it’s clear that this is fundamentally a high-quality company across the board.

What’s odd is that, even with this quality, Simon Property Group’s stock has been positively left behind in the wake of a lot of other REIT stocks out there.

Low interest rates have boosted the valuations of a lot of REITS, as investors have flocked to yield. Furthermore, the business models are more attractive and durable in an environment with low rates.

But with this stock down approximately 12% in a year in which the S&P 500 is up almost 30%, a sizable disconnect between price and value looks to have occurred.

However, there are risks to consider.

Regulation, competition, and litigation are omnipresent risks in every industry.

While the e-commerce explosion hasn’t yet materially harmed the company, larger moves to online shopping could reduce demand for their spaces.

Related to this, the company is heavily exposed to potential tenant bankruptcies. This is particularly true in the case of apparel.

And as one of the largest REITs in the US, their size works against them in terms of growth potential. It’s the law of large numbers. This is compounded by a US retail market that is saturated.

Finally, any rise in interest rates will make debt servicing more expensive and the stock less attractive.

Even with these risks known, shares look extremely cheap here…

The stock is currently trading hands for a P/FFO ratio of 12.12, based on midpoint guidance of $12.025 for FY 2020 (which is almost over).

The P/FFO ratio is analogous to an ordinary stock’s P/E ratio. And with the S&P 500’s P/E ratio sitting at over 20, there’s clearly a low valuation present.

We can also look at cash flow.

The stock’s P/CF ratio is sitting at 11.7.

That’s materially lower than the stock’s own three-year average P/CF ratio 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 might it be? 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%.

This DGR is admittedly cautious.

While Simon Property Group has undoubtedly performed well over the last decade, questions remain about the long-term viability of malls.

I’d rather err on the side of caution here.

With a 5% FFO/share growth forecast from CFRA, a rock-solid balance sheet, and a modest payout ratio, the company is poised to deliver better dividend growth than this.

But I think it makes sense to be wary here and demand a large margin of safety on the valuation.

The DDM analysis gives me a fair value of $193.20.

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 an abundantly conservative valuation, the stock still looks absurdly 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 $189.00.

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 3-star “HOLD”, with a 12-month target price of $158.00.

I came in right about where Morningstar’s at with the valuation. Averaging the three numbers out gives us a final valuation of $180.07, which would indicate the stock is possibly 24% undervalued.

Bottom line: Simon Property Group Inc. (SPG) is a high-quality real estate investment trust. Excellent fundamentals, new equity investments, and smart partnerships show a prudent and aware management team. With a market-smashing 5.7%+ yield, a decade of big dividend raises, a modest payout ratio, and the potential that shares are 24% undervalued, dividend growth investors should think about scooping this stock up next time they go shopping.

-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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