Simon Property Group Inc (SPG) — Q1 2016 Earnings Call Transcript

Thank you, Andrew. Good morning, everyone. Presenting on today’s call is David Simon, Chairman and Chief Executive Officer. Also on the call are Rick Sokolov, President and Chief Operating Officer; Andy Juster, Chief Financial Officer; and Steve Broadwater, Chief Accounting Officer. Before we begin, a quick reminder that statements made during this call may be deemed forward-looking statements within the meaning of the Safe Harbor of the Private Securities Litigation Reform Act of 1995, and actual results may differ materially due to a variety of risks, uncertainties, and other factors. We refer you to today’s press release and our SEC filings for a detailed discussion of forward-looking statements. Please note that this call includes information that may be accurate only as of today’s date. Reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures are included within the press release and the supplemental information in today’s Form 8-K filing. Both the press release and the supplemental information are available on our IR website at investors.simon.com. For our prepared remarks, I’m pleased to introduce David Simon.

Okay. We had a strong start to 2016. We completed several significant redevelopment projects, started constructions on others, and announced more that will further enhance the value of our real estate. We completed the acquisition of The Shops at Crystal, extending our presence in the Las Vegas marketplace and we continue to achieve strong operating financial results which were highlighted by FFO of $2.63 per share, which is an increase of 15.4% compared to the prior year. Our key operating metrics include Mall and Premium outlet occupancy at 95.6%. Leasing activity remains healthy, with the Mall and Outlet business having re-leasing spreads of $10.24 per square foot, an increase of 17.5%. Our base minimum rent was $49.70, up more than 4% compared to last year. Total sales per square foot for our Mall and Outlet business was $6.13 compared to $6.21 in the prior year period. We measure our success through growth of operating income and cash flow. We have a unique ability to drive growth through not only increases in comparable property NOI, but also through disciplined capital allocation for new development, redevelopment acquisitions, and investments. In our press release and supplement this quarter, we have provided additional new metrics summarizing the composition of our total portfolio NOI. These new metrics provide further detail in the profitability generated by our portfolio and we have broken them out into four categories: comparable property NOI, NOI from new development, redevelopment, expansions and acquisitions not included in comp NOI, NOI from our international properties which is our premium outlets and designer outlets, and our share of NOI from investments which includes Klépierre and HBS Global Properties. Below the property NOI line, you have the corporate sources of NOI. Importantly, for the first quarter of 2016, our total portfolio NOI increased 7.8%, of which comp NOI increased 5.1%. As stated in the supplement, at the end of the first quarter, redevelopment expansion projects were ongoing in 33 properties across all three of our platforms, with our share being approximately $2 billion. We finished the two-year transformation of Roosevelt Field, including comprehensive enhancements throughout the mall and the addition of a two-level fashion specialty store expansion anchored by Long Island’s first Neiman Marcus store. We also are nearing completion with Stanford Center, which includes the new Bloomingdale's as well as reclaiming that space for specialty stores. Transformations like these add to our overall profitability. We started construction on several new projects, including the significant expansion at the Outlets at Orange, and construction continues on other major redevelopment and expansion projects at some of our most productive properties and best properties in the country. The Fashion Centre at Pentagon City and King of Prussia are among those. Most of these projects will be completed in the next 12 months. Construction continues on two new domestic outlets in Columbus and Clarksburg, both scheduled to open later this year, as well as our designer outlet in Provence, France, scheduled to open in the spring of 2017. We also started construction during the quarter with our partner, Ivanhoe Cambridge, on our fourth outlet in Canada in Edmonton, Alberta, which is scheduled to open in the fall of 2017. Construction continues on two new developments, one in Miami at Brickell City Centre and the other in Fort Worth at The Shops of Clearfork, both scheduled to open in 2017. Brickell will open in the fall of this year. We completed the acquisition of The Shops at Crystal, with a purchase price of $1.1 billion. We plan to place a $550 million mortgage on the property in the next two months, and we are a 50/50 partner with Invesco. We look forward to building upon this high-quality asset with its successful foundation. We acquired a majority interest in a leading outlet center in Ochtrup, Germany, with our partner, McArthurGlen. During the first quarter, we sold interest in two residential properties and one non-core retail property. Gains and losses on our non-retail assets, including investments, are included in our FFO per share, which we believe is consistent. This resulted in a quarter-over-quarter benefit of approximately $0.06. In capital markets, we completed a notes offering of $1.35 billion, with a weighted average interest rate of 2.97% and 8.2 years of duration. Our liquidity stands at $6 billion. We announced our dividend at $1.60, a year-over-year increase of 6.7%. We increased our guidance to $10.72 to $10.82, reflecting very good performance. We are very pleased with our overall results, given the overall lackluster U.S. economy, and we welcome your questions.

Hey, David, it's Michael Bilerman for Christy. I just wanted to go first and then Christy will have one. I was wondering, how do the markets you think about Simon strategically going forward? It’s about two years to the day when you spun off WPG, all the assets under $10 million of NOI and arguably lower sales productivity. Now you are left with this immensely high-quality model portfolio, a global outlet portfolio, and the mills portfolio, while also taking some other sort of ventures around. Should we think about potential spins of any of those businesses going forward, or do you think you are still going to own assets across the price spectrum of retail real estate?

Yes. We have no intention of spinning off any other assets. We think they are absolutely synergistic with our retailer relationships. We have the lowest overhead and the lowest cost of capital, given the portfolio. We have historically the best comp NOI growth. As long as we can continue to do what we are doing, I don’t see any reason why we would want to spin anything off. They all fit nicely together. They are all in major metro markets, and all the assets are producing great cash flow. Our results speak for themselves. The WPG spin-off was really a focus on smaller properties, and we thought that was in the best interest of the shareholders, but we don’t see any other reason to take any further corporate restructuring beyond that.

Hi, good morning, it’s Christy here. I’m just wondering if the tax fund stopped paying rent at any time during the first quarter, and if reserving for that might have impacted your bad debt at all in Q1? Could you also give us an update on your overall outlook for retailer bankruptcies and store closings for the rest of the year, and whether or not you are more or less cautious than a quarter ago?

Well, I think a quarter ago we were cautious, and we continue to be cautious. I don’t want to mention specific retailers whether they paid rent or not. The only one that has filed bankruptcy thus far is Paxton. I’m sure there were some pre-petition amounts that we wrote off in the quarter, but it’s not overly material and that’s part of what we have dealt with for 60 years of retail bankruptcies. So we remain cautious, and our biggest reason for caution is that the U.S. economy continues to flatten out; there’s not a lot of growth. I suggest you look at a lot of industries beyond real estate to see what’s going on in the U.S. economy—it is what it is.

Thank you.

We have been cautious on those couple of retailers, but we will deal with it.

Thank you. I notice other income and consolidated properties were up significantly; was that related to one specific area?

Well, I would suggest you look to page 21 in our supplemental. Our corporate, after our property portfolio NOI, corporate and other sources were up roughly $20 million, which was a function of the residential interest we had that flowed through our corporate NOI number.

Okay, and you have been doing a great job touching on some really big redevelopments. I just wonder if as you start to touch more of your top properties, will the shadow of the pipeline start to consider including maybe a second tranche of redevelopments to continue that path of growth?

If you look at our 8-K, you can see all the stuff that we are working on. I just spent an hour and a half with the guy who does residential, and they just made $20 million, which isn’t bad. We sold those at a lower cap rate than what we bought at crystals, which I thought was a pretty interesting dynamic in our industry. He’s got plenty of things going on across the portfolio. If you look at our 8-K, all the stuff they are doing is touching a lot. We just opened Dick’s Sporting Goods at Independence Mall, just to give you one small example of a solid middle market mall that produces cash flow year after year, but we think we’re going to get better. So, we are indeed touching everything.

And just bringing up crystals, is there an expansion opportunity with the Harmon powers at that property?

Yes.

Great, thank you. I just wanted to ask about the retail landscape. I feel like over the years Craig and I have covered the sector; in this past year we have seen some real dramatic changes. How have things changed in your view from a year ago? What are your latest thoughts regarding lease contracts or your approach with retailers?

Honestly, I think maybe you are getting caught up in the media discussions. Our business is as solid as it has ever been. We’ve had top NOI increases at 5.1%. Our earnings grew 15.4% per year. We are projecting to have $10.72 to $10.82. Our simplistic view is it’s not as bad as people want to write about. The biggest issue out there is that the U.S. economy is flatline, and yet we are holding our own and gaining market share with a lot of our properties. We’ve got great tourist-oriented centers that have had a tough year; we will probably anniversary the stronger dollar here coming up, but we’ve seen the tourism sales decrease unnecessarily. However, the traffic is holding. The media about the death of retail—we don’t see it. We will keep plugging along.

Okay, great. Thank you.

Yes, hi good morning, David. First, thanks for page 21; the NOI breakout is helpful. A quick question: maybe you commented on the residential upfront, but can you give a little more color on which projects they were? As we go through the rest of the pipeline, you know obviously you have the tower that you announced down in Houston, but how much embedded potential is there in the portfolio? Should we expect over the next several years more of these $20 million quarterly benefits?

Yes, I think we tend to look at these things as investments rather than operating properties. Just like in Q1 2015, we had a gain from a development side; we decided to flip in Europe as opposed to staying involved. The good news is we are able to create additional income in this company through all of our activity. We have had a few mistakes—we are not perfect—but we have been able to generate additional income. When we report Q2, please remember that we had a sizeable gain in the sale of marketable securities. I think we will continue to create value with our Simon Venture group. Anything that is profitable will flow through FFO. Anything that is a loss will wash out, and we have actually written off a couple of investments because we don’t see the value anymore. But, I’m hopeful we will continue to create value, including building and selling residential.

You guys have been quite vocal on that point. On crystals, can you talk about your decision to joint venture that especially if there’s development upside, especially in that market given how it books cases, the strip? How do you determine when to take something wholly versus bringing in a partner?

The answer is relatively simple. We approached a partner and we believed it would be beneficial to do a joint venture. The assets have a great foundation; it’s been well leased and does high sales productivity. We hope to add value to it over time with a great partner. Each deal is a little bit different; we may or may not partner depending on circumstances, but in this case, they approached us. We think it will be a good deal for us in the not too distant future.

Okay, thank you.

Are you guys able to hear me okay? We’re getting comments you can’t hear me, but it sounds like you can hear me fine.

Yes, you are coming through clearly.

All right, appreciate it.

Hi, good morning. I was just wondering again on those non-retail gains included in the first quarter results. Was that $0.06 gain that you referenced included in your prior guidance?

Yes.

Okay. If you look ex that $0.06 impact, the growth is still over 10%, but it doesn't seem like your full year guidance is quite that high. Is there anything else driving the first quarter to be especially strong or do you expect a slowdown?

Good question. First of all, I believe our growth would have been 12%. If you consider the $0.06 a success, that’s fair to say. Consistent with what we described in our year-end call, we are still being conservative in how we look at the business because of the softness in the U.S. economy. We have exposure to tourism, which is impacting our average rent as you can see. We know there are a few tenants that may go bankrupt, but we have set our standards based on the broader economy.

Got it. And if you could comment just on the malls versus outlets versus mills, either in numbers or just a general feeling?

I'm happy to state that our comp sales were up nicely in the mall business, while they were down in the outlet business—a lot of that is due to high producing tourist centers and the traffic. We’ll anniversary that at some point this year, but we didn’t in the first quarter.

Good morning. I am here with Jeremy Metz. Hey David, I thought the fact that you guys put up nearly 4.5% base rent growth in the quarter was impressive, given the sluggish sales environment. Realistically, how long can that continue? The occupancy cost is up from 11.7% to 12.5%. Do you think we will be looking at occupancy costs for your portfolio pushing toward 13.5% a year from now?

We could argue endlessly about the correlation between retail sales and our ability to drive rents. I believe that it skews more toward supply and demand than retail sales because if a retailer is not performing well, we have the ability to replace them with one that is. Our comp sales are actually up in the mall business; it’s in the outlet business where we see reductions tied to the tourism picture. Hopefully, when that anniversaries, we will move forward.

Okay. Thank you.

Sure.

Yes, good morning. Thank you for taking my questions. A first one for you, David. I guess on the acquisition market: I'm curious what you are hearing and seeing these days in conversations with potential sellers. Are you getting approached more? Are people willing to engage in conversations more than a year or two ago, given concerns about the broader macro?

You know that’s interesting. I would have thought maybe, but not really. We are not actively scouring for new deals and the big deal business is not on our drawing board at this time. There’s a selective thing here, but it’s not that we are getting a lot of phone calls.

Got you. And I appreciate that. Then, one more if I might ask, did I hear you say that you would be putting a $500 million mortgage on The Shops at Crystal? If so, could you share your thoughts on the use of capital?

Well, simplistically it was a $1.1 billion deal. We’re going to put about a $550 million mortgage on it, which will have positive leverage. The balance of the equity required will be split between us and Invesco. It’s part of the purchase price financing sources and uses.

Got it. And just one last question, more of an accounting one. The other day, there was a big block floated by you guys on behalf of the DeBartolo of 4.4 million shares. Did Simon buy any of those shares?

To be technically accurate, we didn’t float it. It was part of the DeBartolo family estate, and we did not buy any stock. The shares were placed relatively quickly.

Got it.

We had nothing to do with the sale of those shares. That was all between DeBartolo and their advisor. They have been great partners, very supportive, and are still a significant owner.

Good morning, guys. First question is for Rick. As we head into ICS, are there any broad themes you are considering as we head out to Vegas? Any projects that are mission-critical for your team?

It’s interesting, because as David has said, our portfolio has never been stronger and we have significant demand for our properties. Where we are focused is maximizing the rent and productivity of our properties. Our theme is to ensure we get the right retailers in the right spaces and sizes to maximize revenue while spending time doing that.

And maybe just a follow-up or two. How do you think the pursuit of omnichannel ultimately plays out for retailers down the road? Is it true that bricks and mortar is the biggest channel today, with ecommerce impacting margins? Do you think lower margins are just the new normal for omnichannel retailers?

The issue is if stores don’t have a high sales per square foot, they could still generate lots of cash flow. Retailers that produce enough operating cash flow still need to invest in their operations, whether it’s for omnichannel or other projects. I don’t view it strictly as lower productivity leading to store closures; they need operational cash flow to reinvest.

Helpful. That's all I have.

Sure.

Hi, good morning. David, in light of your concerns on the macro and consumer, can Rick share some positive news regarding where we are seeing expansion, especially in the mall expansions and redevelopments you are doing?

First on the department store side, we have one vacant department store in the entire portfolio. We have around 441 of them. The narrative out there differs significantly from reality. We have significant numbers of anchors flowing into the portfolio, and that’s ongoing. We’ve added numerous retailers across all properties and international retailers are entering the market with successful concepts.

And we put in page 21 to show you the fruits of our efforts. The portfolio NOI, excluding our corporate activity, increased 7.8% for the quarter. That’s solid performance.

On the tenant segment, if we experience an increase in store closings, and many chains aren't producing sales at levels that match the portfolio averages, will there be a strong positive mark-to-market on that space?

If you look at last year's activity with Wet Seal, Cache, and Body Shop going out, we were able to re-lease that space at positive rents. There will certainly be downtimes, but we have shown an ability to replace outgoing retailers with better ones.

Yes, good morning everyone. Just two questions from us. First, on the development and redevelopment side of the business, I noticed a few yield changes. The yields for new development and the premium outlets went down a little bit, and expected yields on the mills redevelopment also went down. Is that purely due to mix?

Yes, yes. We added our Canadian deal, which changed the mix. No budget below; it’s all just mix changes.

Okay, that's helpful. Second, regarding Sears and Kmart's announcements about accelerating closures, what do you think the implications are for your portfolio or your JV with Sears?

None of those closures are in our assets, and if they make Sears a healthier retailer, we are all for that. It doesn't impact our JV or relationship with Sears.

The majority of those stores are K-marts and freestanding stores. I believe only one or two mall-based stores are part of that closure, none of which are ours.

Great. Thank you.

You’re welcome.

Good morning. Earlier in the call, you mentioned that some of the best opportunities for online retailers are opening physical stores. What feedback have you received from online retailers that have opened stores in your malls?

Very positive. The cost of customer acquisition is so high for online retailers that they view physical stores as a way to reduce that cost and extend their brand reach.

Are you starting to see some retailers looking to expand beyond the initial leases?

Yes, they are all looking to expand.

Thanks. For new leases signed, what do the occupancy costs look like? Last time you mentioned around 14% to 15%. Are we moving closer to 15% or 14% lately?

It’s retailer and space-specific. But our average base rent occupancy remains under 10%. It’s hard to provide a clear answer because it’s so specific on each retailer and mall.

On Tesla sales, will they be included in your report stats?

If they report sales, they are included. If they don’t, they aren’t. Given our vast portfolio, one retailer won’t materially alter our figures.

Thank you.

Sure.

Hey, just a couple of cleanup questions here. In terms of the other income, which is similar to fourth quarter but up significantly year-over-year, is that a decent run rate going forward?

You will need to get used to the fluctuations that will appear in that number over the year. We generated a lot of additional income from our portfolio, and we're hoping it will grow. Overall, that number will be around $200 million but could fluctuate.

Thanks. And on the 5.1% same-store NOI comp, it seems stronger than previous quarters. Any surprises this quarter?

Not really. We don’t update our comp NOI quarter-over-quarter. We hope for better performance, but last year we anticipated a little less due to decreased tourism spending.

Thanks. One last question on the anchor openings. I noticed several backstages were opened this quarter. What are you seeing from that concept?

Those backstages open in existing Macy stores. They create customer openings and brand opportunities. It’s too early to provide a sales impact, but it enhances the consumer experience.

Thank you.

Sure.

Hi. What was the dollar volume of dispositions, including the residential?

The total amount was around $65 million.

Okay. That was it. Thank you.

No worries.

Great. Thank you. I appreciate hearing some additional comments that helped answer my first questions regarding changes over the past year. David, would you consider disclosing the latest occupancy costs of sales for outlets?

We have always combined them for the last several years. I think the metrics manifest themselves in cash flow and comp NOI. We tend not to obsess over certain metrics, preferring to focus on cash flow growth and investment over the long term.

Okay. Sounds good. On your occupancy cost, any changes in tenant allowance?

Our allowance has been flat year-over-year, and there’s minimal allowance for renewal.

Great. That’s helpful. Thank you.

Sure.

Yes, it’s Michael Bilerman. David, I’m curious as you think about all the investments you are making in the mall of the future, do you think the return on that capital will come directly from the consumer or better sales, productivity, and margins of tenants, which leads to higher rents?

I think we are still in the early stages. We are hopeful that improving environments will lead to increased traffic and visits. I see it as creating a better environment that drives traffic, which leads to demand from retailers for space and will ultimately grow cash return.

Thank you, guys.

Sure.

Thank you for your questions and your interest. We really appreciate it. We look forward to talking to you in the future.