Simon Property Group Inc (SPG) — Q3 2018 Earnings Call Transcript

Thank you, Joel. Good morning, everyone, and thank you for joining us today. 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; Brian McDade, Chief Financial Officer; and Adam Reuille, 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 the risk factors relating to those 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.

Good morning. We're pleased to report another record quarter with continued strong operating and financial results. Our investment in our product remains unabated with a long-term view of creating compelling integrated environments with critical mass that serve the hub of retail, dining, entertainment, and socializing within their communities. We completed several significant new developments and redevelopments in the quarter or are under construction and announced more transformational mixed-use activities that will further enhance the value of our real estate and grow our cash flow. Turning to the results, highlighted FFO by $1.90 billion or $3.05 per share, an increase of 5.5% per share compared to the prior year. We continue to grow our cash flow and report solid key operating metrics. Total portfolio NOI increased 4.1% or approximately $188 million to date. Comp NOI increased 2.3% for the year-to-date period. Leasing activity remains solid. Average base rent was $53.88, up 2.8% compared to last year. The Mall and Premium Outlet recorded leasing spreads of $7.59 per square foot, an increase of 13.9%. We're pleased that retailer sales momentum continued in the third quarter. Our Mall and Premium Outlets achieved $650 compared to $622 in the prior year period per foot, an increase of 4.5%, and sales were strong across the portfolio in the third quarter. Retail sales productivity has increased each month over the last 12 consecutive months. Occupancy at the end of the quarter was 95.5%, an increase of 80 basis points for the second quarter and an increase of 20 basis points compared to prior years. On an NOI weighted basis, our operating metrics were as follows: retail sales would be $817 per foot compared to $650, occupancy would be 96.3% compared to 95.5%, and average base minimum rent would be $71.21 compared to $53.88. At the end of September, we opened Denver Premium Outlet. The center is fully leased. It's off to a great start. The center is another terrific asset within a great portfolio and a great location in a strong and growing market. Construction continues on two international outlets, expected to open in 2019, Queretaro, Mexico, and Malaga, Spain. We announced a 50-50 joint venture with Macerich to create Los Angeles Premium Outlets. This will be an exciting project on fantastic real estate and obviously one of the country's most attractive markets. At the end of the third quarter, redevelopment and expansion projects were ongoing across all of our platforms in the U.S. and internationally. We started construction on significant expansions of Paju Premium Outlets in Seoul and Tosu Premium Outlets in Japan. Last week, we held the groundbreaking of our landmark mixed-use transformation at Phipps Plaza that will include Atlanta's first Nobu Hotel and Restaurant, a Class A office building, a Life Time athletic resort, food hall, and outdoor community gathering space, all in the area of one department store that we reclaimed. We also announced our transformational vision for Northgate in Seattle. We're thrilled to collaborate with NHL Seattle, making their training center and corporate headquarters an integral part of the reimagined Northgate Community. This project is a prime example of our unique ability to repurpose our well-located real estate, creating compelling ways for consumers to live, work, play, stay, shop, and now skate at our destination. Over the last several years, we have reclaimed a number of our unproductive department stores in our portfolio. The reclamation of unproductive space, specifically some department stores, is an unprecedented opportunity for us to dramatically enhance the productivity of the space, our centers overall. We will continue to proactively recapture additional stores to further enhance our centers. The SPG portfolio currently has 33 Sears stores that have closed or announced they will be closed. Of those 33 stores, we have proactively controlled 22 of those 33, five of which are in our joint venture with Seritage. Of those 17 we control, Sears will no longer exist in 2019. They will be demolished, replaced, and redeveloped. In capital markets, during the first nine months, we closed on 13 mortgages, totaling approximately $3 billion, of which our share is approximately $1.3 billion with a weighted average interest rate of 3.83%, term of 8.4. We have the highest investment-grade credit rating in the industry. Our net to EBITDA was 5.4 times. Our interest coverage is 5 times, which is well in excess of both our peers. Our current liquidity is $7 billion. Today, we announced our dividend of $2 per share for the fourth quarter, a year-over-year increase of 8.1%. We're approaching the $100 per share dividend since we've been public, which we will celebrate in December. Our total dividend payment will be $7.90 in 2018, an increase of 10.5% compared to last year. Turning to guidance, we once again raised our full-year guidance to $12.09 to $12.13. This updated range reflects a growth of approximately 7.9% to 8.2% compared to our reported FFO of last year. We are ready for questions but before I turn it over, I want to reiterate that we had a very strong quarter, and we continue to grow our cash flow.

Thanks. Good morning, David.

Good morning.

I just wonder if you or Rick could talk about the leasing environment? As you sit here today, looking forward, could you reflect on the last year and how you felt maybe a year ago and just give us a flavor for the leasing environment?

We tend to take a longer term view. So we can talk about quarter-to-quarter or even year-to-year. As you know, we take a longer term view. Certainly, our long-term view has not changed. The activity has increased from 2017 to 2018. For the retailers that are investing in their product, there's increased sales. As you know, we showed you that. It's certainly generally better than last year, but again, you've got to take a longer-term view. We have more activity going on. There's more new concepts in restaurants, entertainment, and overall retail. You've got folks who start out on the Internet that want to own physical stores. So, generally, the environment is better. However, we were never overly concerned about the less robust leasing environment in 2017 because we tend to take longer-term views of this. I'm happy for Rick to add anything he would like to this.

The only thing that I would add is that I sense an acceleration. Last year at this time, people were talking, but there was a less aggressive approach to opening new stores. As David said, retailers that are well-positioned are now more encouraged to open stores. Obviously, sales are better, and profitability is better. We are very well positioned. Every day, every one of our properties is getting better because of the capital we're spending.

Okay, David, just secondly, I noticed on the leasing spreads information you provide on page 22 of the supplemental, there was a big jump in the square footage of openings and a sharp decline in the average rent per foot. I realize these are trailing 12-month figures, but it almost appears like a different set of assets is being compared. Do you have any comments on that?

Sure. The most important thing that I focus on is that when sales were going up, the operating metrics keep changing. We're recapturing these boxes that pay very low rent, and we're carving them up. Now we're showing growth metrics, which indicate the embedded growth in our business by recapturing these leases that pay very low rent. We put all of our openings and closings in that number so that you can see the market rent growth that we have in our business.

Okay, thanks. Lastly, in the other income, I know there were different components. Last year, you had some securities gains, and this year, you didn't. But there was a big jump in the other income. Any comments or things you can share?

Yes. Last year, we sold the Seritage stock at $48.49, which was a pretty good trade. In other income, we did receive our business interruption, not all of it, but some from Puerto Rico. That was always planned to get that, but you can't book that until you actually receive the cash according to GAAP. We got some of that BI in the third quarter.

Is there a number you could share with us embedded in that other income?

The big jump in it is the vast majority of that.

Okay, it's a vast majority of the $20 million increase.

Yes, that's correct. We always planned on getting to BI, and it does not flow through the normal minimum rent or CAM recoveries; it's accounted for as other income.

That's it for me. Thank you.

No worries. Thank you.

Hey. It's Michael Bilerman here with Christy. David, can you just elaborate a little bit on Sears? You were named to the creditors' committee yesterday, so maybe talk a bit about the role that you plan to play there. You went through a lot of different numbers in terms of the Sears boxes. Looking sequentially, you went from 59 down to 46, which includes the 17 that are closing. Can you provide some color?

Look, the thing to focus on is that we're putting Sears in our rearview mirror. While the situation is tragic, we see a unique opportunity to redevelop this space and drive positive momentum with our properties. We have 33 stores that are closing or in the process of closing by the end of this year. We control 22 of those, and 5 are in our joint venture with Seritage. Of the 17 we control, Sears will not exist in 2019—they will either be demolished or redeveloped. We're down to 29 operating stores; 8 are owned by us, 4 are owned by Seritage, and 17 are owned by Sears. We'll see what happens on the rest.

Right. Sounds like there were at least 11 that are controlled by others that closed during the quarter, right?

That's correct.

Can you talk about international opportunities? There have been some consolidation activities with European real estate.

I am very comfortable with our investment in Klépierre. They have a lot of redevelopment activity. Stocks go up and down, but we take a long-term view. We don't have any specific desire regarding where we need our international investments to be; we just want to make money with our investments there. We see value in our international partnerships.

Thanks.

Sure.

Thanks. Good morning.

Good morning.

Just going back to the Sears boxes, can you frame it out from a timing and capital allocation perspective on how much you think will go into redevelopment? What will the rough capital investment be?

The majority of the 17 that we controlled were already transacted to reclaim last November. Those plans are moving. For instance, we have a decent pipeline of projects going on. The capital of that effort is over $1 billion, which has always been in our plan. We intend to redevelop those boxes quickly and smartly.

Is it fair to assume you target the same yields you have been achieving in the 7% to 8% range?

Yes, that would be our goal.

Great. Are you starting to see this translate into lease terms as well?

Yes, our terms are within the norms we've established over the years, and we are actively seeing an acceleration in leasing as more tenants are eager to open stores.

Retailers are savvy, focused on their cost structure, and while negotiations can be tough, we have quality properties and can afford to be patient and selective.

Thanks for your time.

Sure.

Thank you.

Hi, Craig.

I noticed your redevelopment activity saw yields for Premium Outlet redevelopments went from 10% to 11%, and The Mills from 11% to 13%. What was driving those returns?

I would say it's a function of mix. Everything fluctuates. We certainly still have the ability to add value through our redevelopment and new development efforts.

So it seems construction costs are going up, but they aren't impacting returns?

There is no risk in what we're building today. We have contingencies in place, but while we see a potential rise in construction costs, it is not at levels that would prevent us from making the economics work.

Thank you. And with technology in retail, are there innovations you expect to see this holiday season?

We've been focused on payment systems, driving traffic, streamlining the checkout process, and improving parking ease. There is a clear bounce back in the physical world compared to pure online, thanks to advancements in technology.

Thanks.

Sure.

Hey, good morning. Two questions from us. First, you mentioned your international portfolio is underappreciated. How does it compare to your U.S. platform? As you expand into new markets like Thailand or the Middle East, do you see material improvement in operations as you gain concentration in those markets?

None of our international investments have the efficiency metrics we have domestically. They benefit from adding quality products, but they don’t have our overhead scale. We’re able to enhance value as we expand our footprint abroad.

Okay. And about converting retail to other uses, what's the balance of existing retail to increases in new uses?

I can't provide an exact number, but we believe the mall of the future allows us to reclaim department store space efficiently and densify properties. Redevelopment opportunities are quite significant, but we need to proceed thoughtfully.

Thanks for that perspective.

Sure.

Hi, good morning. Your dividend is up 10.5% this year, which is great. How are you thinking about prioritizing development and redevelopment versus increasing the dividend and potential acquisitions?

We expect to continue increasing our dividend next year, but our redevelopment is a high priority. Timing constraints related to permits do come into play, but we prefer to maintain our strong balance sheet while pursuing opportunities.

Is there concern regarding department store reclaims taking longer to find new uses?

Not with us. Our issue is execution and permitting, which is separate from market demand.

Lastly, you have a notable debt maturity in early 2019. How do you plan to address that?

We could use our cash reserves or go to the unsecured market as necessary. Our liquidity allows for several options on that front.

Great. Thank you.

Thank you.

Thank you. David, I can't wait for you to co-star in De Niro's next film. A question for you, Rick, and David. In cases where you've redeveloped anchor boxes, do you have stats on changes in foot traffic or sales since the new anchor opened?

We can certainly compile statistics, but we're seeing positive foot traffic and increased inline sales following department store closures. This may reflect a healthier mix of retailers.

The unambiguous result of replacing these anchors is that our total sales and footfall at properties is increasing. For instance, when we're done with Phipps Plaza, we will likely triple retail sales in addition to hotel and office traffic.

Thanks. Were you receiving rent prior to their bankruptcy filing?

We do not anticipate having a bad debt reserve. That's correct.

On the $1 billion of investment for the 22 boxes being redeveloped, how should we think about that in terms of a rule of thumb for redevelopment costs?

The $1 billion figure includes more than just those 22 boxes. It encompasses a range of projects across our portfolio to improve overall value, not solely focused on Sears.

Thanks, guys.

Sure.

Hi. Sales growth at The Mills has been similar to the rest of the portfolio, so I'm curious what is enabling you to drive spreads that are significantly higher there?

The Mills are well positioned in their respective markets and attract a unique mix of shoppers that contribute to their strong performance.

Is the occupancy cost notably different from other parts of the portfolio?

No.

Okay. That was it. Thanks.

Sure.

Hey, good morning, David. I want to go back to your comments on the international portfolio. I see you have a lot of focus there. As you think over the next five years, do you have a target percentage for international NOI?

We don't have a strict target for international investments. Our focus is on identifying and executing good deals rather than hitting a specific percentage of NOI.

Alright. Thank you for that clarification.

Sure.

Hi. My question is more focused on numbers. I'm just trying to understand the nature of the guidance change. Given the $0.05 beat in Q3, how comes the low end of guidance was raised rather than the high end?

There are lots of numbers involved, and we are a big company. One deal isn't going to change the overall guidance, and we tend to be conservative.

Any updates on lease accounting targets we should expect for 2019?

No change in the previous guidance regarding lease accounting. We'll clarify when we provide our guidance in February.

Thanks. Any information regarding the JV with Macerich?

It's a development JV focused on the Los Angeles Premium Outlet Center. We will take over the site about a year from now.

Great, thank you.

Thank you.

Good morning, David. A question on lease termination environment—are you still receiving early termination buyout offers from retailers?

We have received some offers, but it's down significantly this quarter compared to last year. While we're not keen on pursuing these often, we consider strategic reasons.

Any figures on the business interruption insurance or material income for 4Q?

We expect to receive more, but the bulk of it is what we collected in 3Q. We view it positively, and it aligns with our planned earnings.

What is your capital allocation strategy right now regarding stock buybacks?

We have a strong balance sheet and prefer to stay conservative. We have ample liquidity, so thoughtful deployment will be key.

Okay, last one. Can you provide same-store expense growth in Q3?

I'm uncertain, but Tom will follow up with you offline regarding those specifics.

Thank you.

Just to clarify the definition for leasing spreads, you mentioned a different pool is now being included. Do you have stats from the previous definition for comparison?

We included all opening and closing metrics to demonstrate the market rent growth and future opportunities. The previous metrics presented positive spreads, but we want to emphasize overall value.

Have there been discussions on offerings for online shopping on your platforms?

That’s a great question. We have initiatives in motion regarding that, so stay tuned for developments.

Thank you.

Good morning. How has the mixed-use redevelopment at Phipps Plaza reshaped your vision for the portfolio? Are there more large-scale repositionings within the malls?

We see this as an opportunity to reclaim department store space and densify properties. Several locations have excellent adjacent land that we can leverage for mixed-use transformations.

Any updates on initiatives with e-tailers?

The store experience is coming back strong, and we're seeing many digital-native retailers eager to open physical locations.

Excellent. Thank you.

Thank you.

Thank you all. We appreciate your questions, and we'll talk to you soon.