Some claim the American mall is on its deathbed. From their perspective, any revival is a prelude to a relapse and an eventual but certain demise. Furthermore, the theaters, restaurants and other experiential businesses designed to revive the patient now appear like a bad diagnosis serving to increase morbidity.
There’s no doubt retailers are struggling, and the pandemic accelerates and intensifies woes faced by mall owners. But just as tests for the coronavirus can provide false positives, the market’s review of stocks can result in false narratives.
Here is stunning data: early this year, the retail sector announced 1,200 store closures. For believers in the retail apocalypse, that’s not shocking info. But here is a fact that will surprise most. As of January, there were 500 more planned stores opening than shutterings.
To evaluate Simon Property Group (NYSE:SPG), one must understand the impact of anchors on mall properties (the effect of anchors is more complicated than it seems at first glance).
I acknowledge investors are aware of broader trends in the retail space, but many are missing the genesis of other developments.
In this article, I grapple with these subjects and examine Simon’s recent acquisitions of bankrupted retailers.
There’s no doubt much hinges on the health of anchor stores. Department stores account for 30% square footage in US malls, and Green Street Property Management estimates half of all mall-based department stores by close of 2021.
The department store is just a format that does not work anymore. People don’t want to wade through a four-story megastore to find a couple of items. So instead of these anchors being a traffic generator, they became an anchor in a literal sense, dragging down these malls. – Chris Kuiper, CFRA analyst
Let that sink in for a moment. Over half of the anchors in our malls could close in the next 16 months. This can trigger co-tenancy clauses and result in rent relief and/or lease cancellations.
Green Street also projects 50% of malls will close by the end of 2021. Jan Kniffen, a retail consultant and former exec at The May Department Stores, predicts a third of malls will close in that time span.
I don’t want to unrealistically minimize the effects anchor closures can and will have on malls. For many, it must result in the eventual closure of the property. However, data associated with anchor stores should be considered by investors, and Simon’s latest 8-K provides some clarity..
Although department stores drive traffic, the average anchor provides a relatively paltry share of a company’s revenue. Macy’s (NYSE:M) leases 103 stores within Simon’s malls; however, it represents just 0.3% of Simon’s total base rent. Simon’s 313 anchors’ combined contribution is approximately 1.2% of the company’s base rent.
Consequently, Simon’s revenues won’t spiral into the ground due to the loss of base rents from department stores.
Considering the specter of ailing anchors, one has to wonder how the department stores in Simon’s portfolio are managing. Macy’s and J.C. Penney (OTCPK:JCPNQ) combined represent over half of Simon’s anchors.
J.C. Penney announced the closure of over 150 stores (18% of that company’s portfolio). I compared that roster to Simon locations. (Penney later announced 242 closings, but I could not find a list of those stores). The result? None of the 150 stores is in a Simon property.
I conducted a review of 31 stores Macy’s plans to shutter. I found one in a Simon mall.
So, of 181 planned closures of J.C. Penney and Macy’s anchor stores, only one is operated in a Simon mall. This is testimony to the resilience of Simon’s properties.
There is a second aspect of anchor closures to consider. Oftentimes the mall owner redevelops vacant anchor spaces into more valuable spaces. Seritage Growth Properties (SRG) operated this way for years with a reasonable degree of success. The company reconfigures department stores to accommodate differing retailers. The company has been leasing redeveloped properties for roughly 3X prior rents.
I understand Seritage stock has suffered lately. However, I contend the company relies too heavily on a redevelopment strategy. There is significant capex and a time lag required to turn properties around, and this is where Seritage has problems. However, when used appropriately, and by a company with the requisite financial resources, the strategy can be quite effective.
Look no further than Simon’s Phipps Plaza for a differing example. When Belk vacated Phipps, Simon opted to replace the anchor with a 150 room Nobu Hotel and Restaurant, 300,000 square feet of prime office space, a Life Time fitness center and a 30,000 square foot food complex.
Redevelopments on this scale take time and significant financial resources. Simon has the financial firepower to drive these initiatives, and that is a prime reason why the company will survive when others falter.
There is another aspect of the anchor store conundrum to consider. Simon operates 69 premium outlets. That means many of the company’s properties have no anchor stores in the traditional sense.
I’ll add that it is difficult to find a weakness in Simon’s international operations. The company has 31 properties overseas, and it currently boasts a 99.3% occupancy rate. During the last earnings call, management stated 100% of international properties are open and their combined retail sales are at 90% of last year’s levels.
Acquiring Bankrupt Retailers. An Act Of Desperation Or Business Acumen?
Aeropostale, Forever 21. Lucky Brand, Brooks Brothers and J.C. Penney. All iconic names rescued by Simon with the aid of Authentic Brands from bankruptcy (at times with additional partners).
When surveying SA commentary, it is common to find investors questioning the wisdom of these deals. Oftentimes, there is the belief that they are acts of desperation.
I confess I had reservations too, particularly when the company scooped up the bankrupt J.C. Penney. As I dug deeper into the data, I found a method to the madness. To better understand the pros and cons, one must view these acquisitions from a variety of angles.
Take Aeropostale as an example. In 2016, the firm was acquired by Simon, Authentic Brands and three additional partners. The firms collectively spent $243 million to rescue the retailer from bankruptcy. When the deal was completed, the plan was to keep 229 stores open.
Today Aeropostale has 350 stores and is expanding into Canada.
Since that time, Simon teamed with Authentic Brands (once again, other firms are sometimes partners) to rescue Forever 21, Lucky Brand, Brooks Brothers and J.C. Penney from bankruptcy.
The deal for Forever 21 cost Simon, Authentic Brands and Brookfield Property Partners (NASDAQ:BPY) $81 million. (For additional information regarding that deal see my article, Simon Property Group And The Rescue Of Forever 21).
Last August, Simon and Authentic Group pulled Lucky Brand out of the fire for roughly $140 million.
Now the two are closing a deal on Brooks Brothers for $325 million while Simon and Brookfield Properties partner to free J.C. Penney from bankruptcy for a cost of $150 million apiece.
It was my intent to examine the J.C. Penney deal in this piece; however, an excellent article by Brad Thomas beat me to the punch and provides greater detail than the length of this article would allow.
Suffice it to say (provided you aren’t inclined to read the linked article) that J.C. Penney is far from a moribund business.
These deals acquired assets at bargain basement prices. Furthermore, Authentic Brands Group is an excellent firm to partner with for these transactions. That company now has $13 billion in annual sales, and the source of those revenues are primarily distressed companies acquired over the years.
It is important to consider the sums paid for these transactions. The combined costs total less than $1.1 billion, much of which was shouldered by Simon’s partners. Now consider that in 2018, Simon budgeted $1 billion to redevelop 33 Sears stores.
All considered, acquiring an interest in five prominent retailers appears to be a pretty savvy business move.
A Review Of The Top 10 Tenants
The Gap (GAP) is Simon’s largest tenant with 403 stores. It accounts for 3.5% of Simon’s base rent. Simon sued Gap claiming the company failed to pay $65.9 million in rent.
L Brands (NYSE:LB) leases 287 stores and provides 2.2% of base rent. L Brands has plans to close approximately 250 Victoria’s Secret stores. The company, in the midst of restructuring, is laying off 850 corporate employees.
PVH Corporation (NYSE:PVH) has 234 stores and accounts for 1.7% of base rent. The company is dumping 162 outlet stores dedicated to Heritage Brands and cutting 450 employees.
In the middle of last year, Ascena Retail Group (OTCPK:ASNAQ) shuttered 650 Dressbarn locations. Last July, the company filed for Chapter 11 bankruptcy with plans to close 1,600 stores. Ascena operates 350 Simon stores and provides 1.5% of the REIT’s base rent.
Signet Jewelers (NYSE:SIG) with 337 stores, Capri Holdings (NYSE:CPRI) with 139 stores and American Eagle Outfitters (NYSE:AEO) with 199 stores collectively represent 3.8% of Simon’s base rent. These stores are not in immediate peril but bear watching.
The final three companies comprising the top 10 tenants are Tapestry (NYSE:TPR), Foot Locker (NYSE:FL) and Luxottica Group (OTCPK:LUXTY). Collectively these retailers operate 829 Simon stores. Tapestry provides 1.5% of Simon’s base rent while Foot Locker and Luxottica each contribute 1.2% of base rent. These retailers have strong business models and present no concerns.
Little Known Data
The facts most commonly related to investors regarding retail trends support an apocalyptic scenario. Lesser known data tells a different tale. In the opening of this article, I noted there were 500 more planned store openings than closures reported for 2020. While I doubt those numbers will prevail through this pandemic year, the last three years witnessed significantly more store openings than closures.
Source: Data Statista/ Chart by Author
There is another point to be made regarding retail trends. A brick and mortar presence drives increased online sales and vice versa. A study by ICSC determined that after online retailers establish brick and mortar stores, 60% of subsequent sales occur in physical locations.
An omnichannel strategy creates a powerful symbiotic relationship. When a visit to a store is followed by an online experience, shoppers increase their spending by 167%. A customer who first spends online and then visits a brick and mortar location increases spending by 131%.
Though many are inclined to pit e-commerce against physical retail, those retailers that offer their customers both options – a choice of shopping online and in stores – tend to boost sales in both arenas. – ICSC report
Don’t Underestimate The Headwinds
The gist of this article was to provide evidence of the strength of Simon’s business model. Nonetheless, there are real difficulties facing the company. The charts below provide a synopsis of legitimate concerns.
Source: For both charts: Ozy
The perils assailing the mall industry are real; however, for class A malls, I believe they are exaggerated. I will posit that in locales with multiple malls, the demise of one will lead to increased business for survivors.
I admit I looked askance at Simon’s repeated acquisitions of ailing retail chains. However, after delving into the details, I now believe they are beneficial to the company’s operations. Furthermore, the sums devoted to these deals are quite moderate in relationship to Simon’s resources.
Thousands of stores close in any given year while thousands more open. This is not a sign of a retail apocalypse, but rather an evolution in retail.
In 2019, Simon Property Group reported a 4.8% increase in sales per square foot. During the same period, the leasing spread improved by 14.4%, and the comparable FFO per share grew by 4.4%.
Those are not the metrics of a business headed to oblivion. It is obvious the pandemic wreaked havoc in the retail sector; however, the stronger players will likely benefit in the long term as weaker competition withers away.
An important competitive edge Simon holds over rivals is the company’s financial strength. S&P rates the debt A/negative. At the end of 2Q, the firms had a debt to equity ratio of about 1.4 times. This compares well with Macerich (NYSE:MAC) at 1.8 times and Taubman’s (NYSE:TCO) 3.9 times ratio. Furthermore, Simon covered its interest costs 3.6 times versus Macerich’s 2 times coverage and Taubman’s 0.3 times.
The REIT’s FFO reportedly fell 30%, but that still is in positive territory at $2.12 a share.
I would pose this question: if a shock as great as the pandemic cannot push Simon’s FFO into negative territory, why should I consider the REIT a poor investment?
With the above in mind, I rate SPG a Strong Buy.
I caution an investment in Simon is not for the weak hearted or the impatient. The headwinds facing the company are formidable and the market can remain irrational for extended periods.
One Last Word
I hope to continue providing articles to SA readers. If you found this piece of value, I would greatly appreciate your following me (above near the title) and/or pressing “Like this article” just below. This will aid me greatly in continuing to write for SA. Best of luck in your investing endeavors.
Disclosure: I am/we are long SPG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have no formal training in investing. All articles are my personal perspective on a given prospective investment and should not be considered as investment advice. Due diligence should be exercised, and readers should engage in additional research and analysis before making their own investment decision. All relevant risks are not covered in this article. Readers should consider their own unique investment profile and consider seeking advice from an investment professional before making an investment decision.