Simon Property Group Inc (SPG) — Q2 2022 Earnings Call Transcript

Thank you, Kyle, and thank you, everyone, for joining us this evening. Presenting on today's call is David Simon, Chairman, Chief Executive Officer and President; also on the call are Brian McDade, Chief Financial Officer; and Adam Reuille, Chief Accounting Officer. 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. Our conference call this evening will be limited to 1 hour. I'm pleased to introduce David Simon.

Thank you. I’m pleased to report our second quarter results. Second quarter funds from operations were $1.1 billion or $2.96 per share prior to a noncash unrealized loss of $0.05 from a mark-to-market and fair value of publicly held securities. Let me walk you through the big variances for this quarter compared to Q2 of 2021. Our domestic operations had an excellent quarter and contributed $0.13 of growth driven by higher rental income of $0.09, strong performance in Simon Brand Ventures and short-term leasing of $0.05. TRG contributed $0.04 of growth, and they were partially offset by higher operating costs of approximately $0.05. Our international operations posted strong results in the quarter and increased $0.10. Lower interest rate interest expense contributed $0.03, and these $0.26 of positive contributions were partially offset by the headwind from a strong U.S. dollar of $0.03 and a $0.19 lower contribution from our other platform investments, principally from JCPenney and a couple of brands within SPARC. These costs included costs associated with JCPenney's launch of new brands, the recent Reebok transaction and the integration costs associated with that and a softening of sales from our value-oriented brands due to inflationary pressures on that consumer. We generated $1.2 billion in free cash flow in the quarter, which was $200 million higher than the first quarter of this year. And we have generated $2.2 billion for the first 6 months of the year. Domestic property NOI increased 3.6% year-over-year for the quarter and 5.6% for the first half of the year. Portfolio NOI, which includes our international properties, grew 4.6% for the quarter and 6.7% for the first 6 months. Occupancy at the end of the second quarter was 93.9%, an increase of 210 basis points and TRG was at 93.4%. The number of tenant terminations this year has been at record low levels. Average base minimum rent increased for the third quarter in a row and was at $54.58. Leasing momentum accelerated across our portfolio. We signed nearly 1,300 leases for more than 4 million square feet in the quarter, have signed over 2,200 leases for more than 7 million square feet through the first half of the year, and we have a significant number of leases in our pipeline. Nearly 40% of our total leasing activity in the first 6 months of the year has been new deal volume. This is up approximately 25% from last year. Retail sales continued. Mall sales volumes for the second quarter were up 7%. Our reported retailer sales per square foot reached another record in the second quarter at $746 per square foot for the malls and the outlets combined, which was an increase of 26%, $674 for the mills, a 29% increase. TRG was at $1,068 per square foot, a 35% increase. We began our national outlet shopping day, which was very successful from shoppers and participating retailers offering a timely first-of-its-kind power shopping experience. More than 3 million shoppers visited our premium outlets and mills over the shopping weekend. Feedback following the event has been tremendous from both our retailers and consumers. We're already planning next year's event, which we expect to be bigger. So please stay tuned on that. Our occupancy cost at the end of the quarter are the lowest they've been in 7 years, 12.1% in Q2 of 2022. Now our other platform of investments, let's talk about it. We were pleased with the results of our investments in the platform for the second quarter. They contributed approximately $0.21 in FFO, even though we were down from last year's terrific results, primarily, as I mentioned, continued investment and the inflationary pressures that have developed. Based on our distributions, we have no cash equity investment in SPARC and JCPenney. And in fact, we have parlayed our SPARC investment into our investment in ABG that is now worth over $1 billion. There will be a little more volatility from quarter-to-quarter when it comes to SPARC and JCPenney, but please keep this in the proper perspective. It's all upside from here. During the quarter, we completed the refinancing of 14 property mortgages for a total of $1.6 billion at an average interest rate of 3.75%. We reduced our share of total indebtedness by more than $650 million. And once again, our balance sheet is strong. We had $8.5 billion of liquidity. Today, we announced our dividend of $1.75 per share for the third quarter, a year-over-year increase of 17%. This will be payable at the end of the third quarter, September 30. During the quarter, we repurchased 1.4 million shares of our common stock for $144 million. And let me point out while other companies in our sector are paying little or no dividends and issuing equity, we are repeatedly raising our dividend and buying our stock back. We have now returned more than $37 billion of capital to our shareholders since we've been public. Given our current view of the remainder of the year, we are increasing our full year 2022 comparable FFO guidance from $11.60 to $11.75 per share to the new range of $11.70 to $11.77 per share, which compares to a comparable number of last year of $11.44 per share. This is an increase of $0.10 at the bottom end of the range and $0.06 at the midpoint of the range. The guidance comes in the face, obviously, of a strong U.S. dollar, rising interest rates and the inflationary pressures that are out there in the marketplace. So let me conclude. I'm pleased with our second quarter results. Our business is strong. The higher income consumer is in good shape, brick-and-mortar stores are where the shoppers want to be, outpacing e-commerce across the world and the broad retail spectrum. Demand for our space is extremely strong. Worldwide retailers need to grow, and they're doubling down on the U.S. International tourism is returning. Domestic tourism is strong. Our redevelopment pipeline is growing with exciting projects. And in addition to our newly announced premium outlet, new developments and expansions, we are experienced at managing our business through volatile periods, including leveraging our existing platform for operating efficiencies, allocating capital appropriately, managing risks. We are not over our skis in any aspect of our business. I encourage you to look at our track record. We outperform in these kinds of periods, and we also do some of our best work as well. So thank you, operator. We're ready for any questions at this moment.

It's actually Michael Bilerman here with Craig. David, I was wondering if you can talk a little bit about the inflationary pressure that's on the retailers that you're starting to experience firsthand and obviously, your knowledge base of the retailer environment is significant. But now actually being on both sides, what can you do as a landlord to help your tenants through this period of time where they are dealing with a lot of inflationary pressures and more inventory because arguably, I know from a landlord perspective, you want your rent to inflate and that just makes matters worse. So can you just talk a little bit about the things that you can do to take share and really leverage what you're learning on the retailer side for the benefit of shareholders?

Thank you, Michael, for your question. We're not here to tell any retailer how to run their business; that decision is entirely theirs regarding inventory management and other aspects. From our experience with SPARC, we've observed some softness in our value-oriented brands. The pressure on consumers related to food, housing, and gas has led them to be more cautious. However, it's important to note that we remained profitable and had a very strong year last year with Penney and SPARC. We are still projecting significant EBITDA growth for these companies. Despite the cautious sentiment among consumers, back-to-school is off to a positive start, with good traffic. The SPARC management team and JCPenney will likely follow the typical path of many retailers by limiting discretionary spending and monitoring their overhead costs. They tend not to close stores since they are profitable and will stay focused on marketing expenses, ensuring a good return on investment for digital spending. While we would never dictate to retailers what they should do, we are open to sharing insights if they wish. Additionally, this portion of our business represents a small segment of our overall operations, under 10%. I am discussing cash returns, and having received cash distributions from both SPARC and Penney, I essentially have no net investment. These businesses will face earnings fluctuations like any retailer, but there's potential upside. They are well-equipped to manage ongoing challenges, as illustrated by JCPenney's $1.3 billion of liquidity. I hope that addresses your question.

David, I have a question regarding the retailer platform income. This year's NOI was approximately $116 million, compared to $195 million last year. Is this some of the volatility you mentioned? I'm also curious about what factors contributed to this difference. Additionally, you mentioned that value brands in your retailer platform are facing challenges, while other brands are performing well. Could you provide more insight on that?

Yes, Alex, the quarterly figure was $0.19. While we could dive deeper into that, it's important to note that we have no cash investments in these businesses. I want to provide some context. For instance, SPARC, Nautica, Brooks Brothers, and Lucky all performed well, exceeding budget expectations. Eddie Bauer also did better than anticipated. The only areas where we noticed some weakness were in the team market at Arrow, the fast fashion business in F21, and a bit in JCPenney. Additionally, as we mentioned at the start of the year, we faced significant integration costs at SPARC related to the Reebok transaction, which affected the second quarter. We also experienced a management change in F21, which we believe will yield positive results. This change occurred early in the year, along with our new CEO at JCPenney, which also took place last year. Overall, we're in a strong position and are confident in our retail strategy. There will be fluctuations - $0.19 added to $2.96 is the arithmetic involved with no cash investment, just to clarify. I think that covers your question, but I'm open to discussing anything further that you'd like. So, Alex, feel free to ask what else you have.

Well then, I'll ask you one other question. You guys are always financially savvy and you buy back stock. I'm imagining that buying back debt is not attractive just given where your outstanding debt coupons are or has the disruptions in the debt markets given you opportunity to buy certain pieces of paper?

The reason we have lower interest expense is because we unencumbered assets, which gives us flexibility. Unlike some others, we don't prefer the mortgage market. We simply write a check, and that’s why our interest expense is lower compared to last year. I calculated the quarterly comparison because we can write a check and just unencumber it.

At a lower cost.

At a lower cost. So we look at that all the time. And that may not be buying debt back, but it's more or less the same thing. It ends in the same result.

David, I was wondering if you could provide a little bit more color on the leasing pipeline. It was nice to see the occupancy up as much as it was from Q1 to Q2. But could you talk a little bit more about the pipeline, the types of tenants? And when you sort of look at the demand, if you sort of were to try and bifurcate the portfolio maybe by sales, I guess, how different is the demand for the really strong centers versus maybe centers in the middle and the lower end of the portfolio?

Our lower end is not as strong as the higher end, which is a fair question since we don’t typically share these numbers. Our EBITDA weighted sales are $954 per square foot, and our average base rent rose by 70 basis points, moving from $70.287 to $73.41. This increase is driving our net operating income because it reflects the larger properties. We're seeing growth across the board, including in retail categories like restaurants and entertainment, particularly with higher-end consumers. We have value-oriented retailers that are aggressively opening new locations. The recovery is evident in places like Vegas, Florida, and California, while the suburbs are bouncing back as well. The Midwest has remained stable. This trend is consistent across different retailers, price points, and locations. Fortunately, we haven't seen any significant pullbacks from deals. As I mentioned last quarter, I continue to believe the U.S. is the key driver of global growth, especially when considering the challenges faced by China. Our economy remains resilient, consumers are doing well, and I foresee continued growth in the U.S., signaling a promising future ahead.

I just wanted to drill in a little bit more on capital allocation. Obviously, raised the dividend here again was active on the buyback in the quarter in just a couple of months. Put out these kind of press releases as well about some of the new and renewed development projects. So I just wanted to kind of maybe hear you kind of maybe rank or just kind of discuss the different options for capital allocation here. And I know external growth is always maybe an option as well. You talked about it last quarter, but maybe if you could just kind of rank the different options here with your capital and excess free cash flow.

As a REIT, the dividend will always be a top priority since we are required to distribute 90% to 95% of our taxable income. While there's a technical distinction between paying out 90% versus 95%, we must payout 95%. We're fortunate to have taxable income, allowing us to distribute nearly 100% of it, which is on the rise and will be paid out in cash. We’ve modified the dividend twice in our history: once during COVID when we had to shut down and again during the Great Recession. Therefore, the dividend remains our number one focus. Secondly, our stock is undervalued compared to other REITs and S&P 500 companies. Our balance sheet reflects that we're a cash flow company that generates cash and delivers a return on equity. Projects like SPARC allow us to recoup our investments and generate free cash flow. Despite challenges like e-commerce impacting malls and the residual effects of COVID, our business in enclosed malls is thriving, even if some remain skeptical. We believe in our potential, which makes our stock appealing, and we plan to continue buying back shares. Additionally, we focus on enhancing the efficiency and attractiveness of our properties for consumers. This involves a return on investment approach; we won’t invest in a property without expecting returns. We will pursue opportunities where we can improve our portfolio. External growth options are available, but I prioritize the dividend, buying back our undervalued stock, and enhancing our existing properties. Occasionally, we will take on new development projects, which are also a key strength of ours.

Yes. So on real estate, Phipps Plaza, slated for an October open or relaunch, let's say. So David, I believe you took roughly an NOI offline to develop. So upon stabilization, what NOI contribution from this project is expected? And really, should we look at this as one of the key earnings accretion blueprints looking ahead with other mixed projects?

Thank you. I'm pleased to discuss real estate. Phipps is an exciting project because we transformed an underperforming department store on a 14-acre site. We plan to invest about $350 million into it, expecting to achieve around $35 million in net operating income from that alone. Additionally, the leasing momentum we have generated through retenanting is impressive. While we don't disclose specific figures, I estimate that the existing property could see an increase of approximately 30% in net operating income once completed, not counting the added gains from the retenanting. We anticipate having all the top brands in the property when we finish, which will take time since some current retailers still have leases until 2024. We're revitalizing what was a quiet mall, aiming to make it a key activity hub in Buckhead, coinciding with positive developments in the Atlantic area. In response to your question, I hope we can replicate this success in Brea, Ross Park, and other locations. We have many opportunities ahead, especially with the mixed-use components, particularly residential, which greatly enhance the property's appeal. We look forward to continuing this trend.

David, hopefully, an easy two-part for you. But how is the broader economic environment adjusted the process for adding projects to development pipeline? And how have increases in construction costs and labor shortages impacted pipeline returns and timelines?

Let me discuss timelines. The main issue we're facing is in the restaurant sector, where some of the equipment needed to open new establishments is experiencing delays. The improvement of storefronts is on the rise. Tenants are focused on this, which isn't affecting timing, but we are monitoring it. Overall, it hasn't influenced deal flow or economics. The positive news regarding materials is that we are at a lower level than a few months ago. In terms of timing, the primary concern is the restaurant equipment. For our return development, while we have seen some incremental changes, nothing has shifted significantly enough to change a project from positive to negative. In many instances, we are planning for higher income, so the expected returns appear consistent. There hasn’t been any drastic change that would halt the project.

If I could just add just real quick to that. What about now that you have a lower-priced stock to invest in the stock versus redevelopment expense side?

I believe we can accomplish both objectives. We want our audience to recognize the differences within our sector. When you look at the bigger picture, we are repurchasing shares, not issuing new equity, and we are increasing our dividend. There are very few companies, defined however you wish, that are in a similar position. We operate differently even though we are in the same industry; our foundation is unique. This is a crucial point, and we strive to highlight it, much like we do with SPARC, to clarify the mathematical distinctions of our company beyond simply being in the same field. It's fundamentally about the numbers. Ultimately, we must manage our business to ensure the numbers align. I appreciate buying back our shares, and I believe it's our responsibility to keep investing in our portfolio, provided we see a suitable return on investment.

The year-over-year ABR per square foot looks pretty strong at about 5%. Is there anything out of the ordinary driving that?

I believe we've collaborated effectively, and our portfolio is performing well and contributing to growth collectively. Everything is positive.

Last quarter, you mentioned that your signed but not open pipeline was around 200 basis points, and it was somewhat higher in the malls compared to the outlets. Could you provide an update on that? Additionally, David, regarding your retailers, there has been a lot of discussion about excess inventory. Are you considering creating outlet stores for some of these retailers? Where else are you observing demand for outlets? Is there potential for more luxury items or homewares to enter the outlet market, or what other segments do you see expanding into the outlet business?

I'll let Brian address the first question, and then I'll respond to the second part.

Floris, we're still hovering right around 200 basis points in the second quarter.

The big retailers have excess inventory, but the luxury brands do not. The SPARC brands are available in various outlets, though not all are ours. There haven't been significant changes in plans, and while some brands have had pop-ups, overall, I don't see any notable dynamics at play. Most companies want to stick with their current inventory systems, and the higher-end brands do not have excess inventory either.

Could you drill down a little more on sales trends during the quarter? Did sales start to slow down at all in the back half of the quarter as inflation accelerated and recession period increased?

No, not really. In fact, we saw slightly better results in July in many cases. So, there isn’t any significant trend there, Vince.

That's good to hear. That's helpful. And then just maybe 1 follow-up to that. Are you seeing any difference in tenant sales performance between the higher-end and luxury tenants versus the more value brands, presumably the latter would be more impacted by the inflation issues?

We have definitely observed that value-oriented retailers are facing challenges, especially as consumers with limited discretionary income are struggling with high costs related to food, gas, and housing. This has led to reduced spending in those areas. However, we haven't noticed similar effects among higher-end brands. As mentioned earlier, brands like Brooks Brothers and the Luckies are performing well. The impact is more noticeable among value-oriented retailers and younger consumers who are feeling the strain from rising gas prices.

Domestic same-store NOI was up 3.6% compared to 7.5%. It looks like a lot of it was due to the tougher comps in the second quarter. And in that case, it seems like the comps only get more difficult in the third and fourth quarter. Is that why the same-store number might actually be going down for the second half of the year? Or is it the macro factors?

No. I mean, Craig, we were really clear. We're actually outperforming what we thought. Q1 of last year had the big benefit of going up against COVID, right? So now we were really, really clear what we saw overall, and we've been outperforming. I think we'll outperform our initial guidance of 2%, but that's nothing other than that or normal seasonality of the business, Craig. Yes. I mean this is better than our plan and is consistent with our plan, even though the trend is above our plan.

So your leasing year-to-date is strong enough that you think it has continued in July? And do you think you could maintain that performance despite some of the macro factors?

I have mentioned this several times. Yes, the pipeline is as strong as it has been. We are working on several new deals. Craig, as you know, when a lease is signed, the store doesn't typically open immediately. It's crucial for everyone to realize that we are very optimistic because many of the leases we've signed won't open until 2023 or 2024. We are not only outperforming our budget this year after a strong last year, but we also feel confident that as we open these stores that we've leased in the past 6 to 9 months, that will continue to drive positive comparable net operating income. Thank you, Craig.

On the guidance, the low end of the range has come up, the high end relatively flat at a time when you're seeing softening of sales at your lower income brand. So my question is, what's implied for the performance of the base business in the second half compared to what you saw in the domestic and international operations in the second quarter? Maybe said another way, how sensitive is your performance to the macro environment? And what's the outlook for percentage rents?

We feel very positive about our portfolio and the results it will generate. The higher income consumer is still spending money. Historically, our business and industry tend to outperform during recessionary periods, and even if we're in one now, the big ticket items usually shift toward the products we offer. This has historically served as a kind of insurance policy. Even during past recessions, with the exception of COVID when we were asked to shut down, our cash flow from our properties remained stable. If we enter a full-blown recession, we expect our cash flow to be positive, although it may not grow as much, and there could be some impact on sales. But we still anticipate that larger purchases will transition toward what we sell. Additionally, regarding SPARC, it's primarily a couple of the brands and is also compared to a very strong previous year. It's important to keep a broader perspective on the business.

Just wanted to ask regarding the month-to-month leases that are still on the books are a little bit higher than the historical average. Should we expect that to stay there? Or are you still comfortable kind of for higher rents? Or how are you thinking current context?

Yes. I think that's more a function of documentation than deal making in that we don't put down the leases until signed, and a lot of our bigger renewals have been done over the last 2, 3, 4 months, and all that's being documented. I would expect that, that number would continue to go down, but we have no fear in that number.

Dave, I have a follow-up question regarding the seasonality of NOI in the first half of this year. The second quarter NOI was lower than the first quarter based on the supplemental data from both periods, which is unusual. How are operating expenses affecting typical seasonality? Additionally, what is included in this year's profit?

Yes. We didn't gather your first question. Could you please repeat it?

We're not really seeing much inflation just yet in operating expenses. As you think about us, we've got long-term contracts that protect us from material increases.

We did increase our operating expenses $0.05. We did have a negative $0.05 for the quarter there.

Just a follow-up on Haendel's question. Your NOI from Klepierre and HBS also increased pretty significantly in 2Q over Q1. Also curious about how much of that is sustainable in a run rate perspective or if there are some one-time items?

Klepierre was shut down last quarter. Last year during this time, they faced many restrictions and closures in some areas. HBS is so small that it’s insignificant. However, there hasn't been any real change there. It's a lease that pays a specific amount of rent each month, so the growth is minimal aside from the usual step-ups. It's very small, but there is some change.

I actually meant sequentially. I actually meant that sequentially; it increased by, I think, $10 million as well.

We did a restructuring, so that's part of it.

And they're doing better, quite honestly. Their announced results were strong results. So I think you're seeing that starting to come through our results as well.

And I'm not sure if I missed it or not, but any kind of commentary you can share on what the lease spreads look like in 2Q? And given that you're close to 94% occupancy, as you continue to increase that, what kind of pricing power do you expect to gain when you start to reach 95% or 96% occupancy?

Well, rents are all moving in the right direction, and our spreads are moving in the right direction, too.

On the guidance, original guidance was domestic NOI of 2% growth and year-to-date, it's 5.6%. So is there any update to the 2%?

As we've said for several years, we do not update that. We give you our best guess at the beginning of the year. It's all part of our plan. We disclosed what we think the number is. We do not update it quarter-to-quarter other than as we've said, we're pretty confident we're going to beat our initial expectations.

And then can you talk about what you're most focused on from an ESG perspective in 2022? And what are some initiatives where we might see some progress?

I don’t have enough time to go through everything, but it's clear that our efforts are widespread across the enterprise. From an operating standpoint, much of our focus continues to be on reducing our carbon footprint while also giving back to communities in various ways. It's a detailed topic, so I encourage you to read our report. If you need access, I'm sure Tom can provide you with the link. The main emphasis is on our commitment to reducing our carbon footprint.

Okay. Thank you. I believe that's our allotted time. So thanks for everybody's questions. And any follow-up, please call Tom and Brian. Thank you.