The March selloff provided some opportunities to buy undervalued stocks. One of the stocks I scooped up was Simon Property Group, which on the surface appears to be a risky business. However, the assumption I’m making is that the majority of tenants will continue to pay their rent through this COVID19 crisis. Since this is a big assumption, I decided to dig into Simon’s financials, model what would happen if a chunk of their tenants fail to pay rent, and try to prove why SPG won’t go bankrupt.
Estimating SPGs Finances During COVID19
Now let’s do some back of the envelope calculations to model what SPGs finances may be this year. Simon Property Group’s simplified income statement and balance sheet are shown below. In this exercise, we assume a scenario where a large portion of tenants don’t pay rent, however we have to balance being conservative with being realistic. First, let’s say that there is a 30% reduction in revenue from tenants not paying or going bankrupt. Factoring in the 30% haircut from last year’s revenue, this would mean an estimated 2020 revenue of $4B.
| SPG 2019 Simplified Income Statement | (Dollars in Thousands) |
| Total Revenue | 5,755,189 |
| Expenses | |
| Property Operating | 453,145 |
| Depreciation and Amortization | 1,340,503 |
| Real Estate Taxes | 468,004 |
| Repairs and Maintenance | 100,495 |
| Advertising and Promotion | 150,344 |
| Home and Regional Office Costs | 190,109 |
| General and Administrative | 34,860 |
| Other | 109,898 |
| Total Operating Expenses | 2,847,358 |
| Interest Expense | (789,353) |
| SPG 2019 Simplified Balance Sheet | (Dollars in Thousands) |
| Assets | |
| Investment Properties Less Depreciation | 23,898,719 |
| Cash and Cash Equivalents | 669,373 |
| Liabilities | |
| Mortgages and Unsecured Indebtedness | 24,163,230 |
Breaking Down Expenses
Even though the revenues may be down because of the COVID19 crisis, expenses may be fairly fixed. The next line on the income statement shows SPG had operating expenses amounting to $2.9B in 2019. Operating expenses consist of property operating cost, real estate taxes, repairs, advertising, office costs, employee costs, and depreciation. Some of these expenses could be cut, but that would probably equate to a couple hundred million which won’t move the needle too much. Above all, the largest cost is depreciation, which is a non-cash expense. Depreciation spreads the cost of certain purchases over a period of several years, instead of charging the full cost upfront. Since we are primarily worried about cash flow coming in and out, we can add back depreciation, resulting in an adjusted operating expense of $1.5B.
Operating and Net Income
Now that we estimated expenses, we can find the operating income by subtracting the adjusted operating expenses ($1.5B) from the estimated revenue ($4B). This leads to an estimated operating income of $2.5B. Following the operating income are a series of line items that arrive at the net income. Examples of these items are income tax, income from unconsolidated entities, and unrealized losses on assets. For simplicity sake, let’s ignore these since they won’t change the outcome much. The last line item we care about is the interest expense, which amounts to about $800M this year.
Current Liabilities
A common metric used to judge a businesses credit worthiness is the interest coverage ratio. This is calculated by dividing the operating income by the interest expense. For instance, an interest coverage ratio below 1.5 indicates the company may have difficulties paying their interest if there is a bump in the road. Calculating the interest coverage ratio for SPG, with the estimated operating 2020 expense, yields 3.16. In short, Simon should be able to make its interest payments this year.
With the income and expenses tallied up, it is time to look at the liquid assets and liabilities on the balance sheet. So far we estimated the amount of cash coming into SPG this year, but we have to factor the cash already on hand. During the period ending in 2019, Simon has $670M in cash. There are some accounts receivables and payables, but let’s pretend they cancel each other out for simplicity.
Long Term Debt
The most important piece of info needed to judge SPGs financial strength is the amount of debt they owe. Currently, SPG has $24B in debt, with $6B of it in mortgages, and $18B in unsecured debt such as bonds, commercial. paper and credit facilities. As previously mentioned, interest on the debt is about $800M this year. Some of the bonds and the commercial paper come due this year, which means the principle needs to be repaid. Finally, the amount of debt coming due this year is $2.9B.
The big question is whether or not Simon can pay off the debt coming due this year, and make its interest payments with reduced revenue. The good news is that in March, SPG received an increase in their credit facility. They now have about $9B in credit they can tap into to pay their liabilities. Obviously it isn’t ideal to use debt to pay debt, but these are circumstances beyond their control.
Calculating SPG’s Deficit
Putting it all together, we can estimate how much of a cash surplus or shortfall SPG will have this year after paying its debts. The equation below shows that by adding the estimated operating income and the current cash balance, then subtract interest and debt coming due, Simon will approximately have a $500M deficit.
Estimated Operating Income + Cash – Interest – Debt Due = -500M
While it is not ideal that SPG will more than likely suffer a loss this year, they can easily cover this deficit with their credit facilities. Therefore, based on these rough calculations, I believe Simon Property Group will be able to weather this rough 2020.
Other things to consider are Simon’s debt covenants may be a limiting factor on how they can navigate this crisis. However, I couldn’t find much detail on their covenants. One can assume that if they had a large increase in their credit facility, then they must not be close to violating the covenants.
Simon’s Dividend
Another note is that this analysis did not take into account Simon’s dividend. REITS must payout a large portion of their profits, however I doubt Simon will be profitable in 2020. Although some investors would probably prefer SPG to maintain the dividend as much as possible, I believe the smart thing to do would be to cut the dividend if this year is indeed economically bad. In other words,I would be a bit disappointed if SPG tapped into their debt to maintain the dividend.
Conclusion
In summary, it appears that SPGs $9B credit facility can provide a life jacket during this pandemic. These calculations are based on a 30% reduction in rental income, which seems harsh but not out of the realm of possibility. If every retail company goes bankrupt or doesn’t pay rent, then I guess it’s force majeure and we must be in a depression. Therefore, in my view, there is a good amount of evidence to show why SPG won’t go bankrupt.
Let me know if I’m missing something crucial! I by no means claim to be a competent analyst.