Business context and reporting period
Simon Property Group, Inc. (NYSE: SPG) filed this Form 10-K for the fiscal year ended December 31, 2014. Simon is a self-managed REIT that owns, develops and manages retail real estate, primarily malls, Premium Outlets and The Mills. At year-end it held interests in 207 U.S. income-producing properties and international outlet and joint-venture investments. The filing also reports fourth-quarter results.
On May 28, 2014, Simon spun off 98 properties, including substantially all of its strip-center business and smaller enclosed malls, to Washington Prime Group (now WP GLIMCHER). Those properties are reported as discontinued operations; this transaction affects comparisons with 2013.
Financial and operating performance
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Total revenue | $4.871 billion | $4.544 billion |
| Operating income | $2.385 billion | $2.189 billion |
| Income from continuing operations | $1.622 billion | $1.367 billion |
| Net income attributable to common stockholders | $1.405 billion | $1.316 billion |
| Diluted earnings per share | $4.52 | $4.24 |
| Funds from operations (FFO), non-GAAP | $3.235 billion; $8.90 per diluted share | $3.206 billion; $8.85 per diluted share |
| Cash provided by operating activities | $2.730 billion | $2.701 billion |
| Cash and cash equivalents at year-end | $612 million | $1.691 billion |
| Mortgages and unsecured indebtedness | $20.853 billion | $22.670 billion |
Revenue increased 7.2% and common-stockholder net income rose 6.8%; diluted EPS increased 6.6%. Operating margin was approximately 49.0%, versus 48.2% in 2013. FFO per diluted share increased 0.6%; Simon cautions that FFO is a non-GAAP measure and is not a substitute for GAAP income or cash flow.
Fourth-quarter 2014 revenue was $1.297 billion, operating income $655 million, income from continuing operations $476 million, net income attributable to common stockholders $405 million and EPS $1.30. Compared with Q4 2013, revenue increased 3.7%, operating income 4.4%, common-stockholder net income 6.2% and EPS 5.7%.
Operating cash flow was slightly higher year over year. Investing activities used $897 million and financing activities used $2.938 billion. The year-end cash balance fell by approximately $1.105 billion. Simon reported about $5.0 billion of available borrowing capacity under its revolving facilities, net of borrowings and letters of credit.
Portfolio indicators were generally strong: U.S. malls and Premium Outlets were 97.1% occupied, up 20 basis points; average base minimum rent was $47.01 per square foot, up 4.4%; and sales per square foot were $619, up 0.2%. Comparable NOI for U.S. malls, Premium Outlets and The Mills grew 5.1%; Simon’s share of portfolio NOI grew 6.7%.
Material changes and unusual items
- The Washington Prime spin-off reduced Simon’s continuing portfolio and makes year-over-year revenue, earnings and balance-sheet comparisons less like-for-like. 2014 included about five months of Washington Prime results before the spin-off.
- Simon recorded a $127.6 million loss on extinguishment of debt from note tender offers and an early redemption, and $38.2 million of spin-off transaction expenses.
- Reported gains included $133.9 million from Klépierre’s sale of a portfolio of 126 retail properties and gains associated with property transactions; total gains on acquisitions and disposals were $158.3 million in 2014 versus $93.4 million in 2013.
- Interest expense declined $89.5 million. The effective borrowing rate fell to 4.41% from 4.80%, and average debt maturity increased to 6.2 years from 4.2 years.
- Simon repaid or redeemed debt and issued longer-dated notes, including $1.3 billion of notes at weighted-average coupon of 3.64%. Mortgage debt declined to $6.2 billion from $7.3 billion. Floating-rate debt was 8.8% of consolidated debt.
- Common dividends totaled $5.15 per share for 2014, up from $4.65 in 2013. A $1.40-per-share dividend was declared in January 2015.
Outlook, commentary and risks
Management expected positive operating cash flow in 2015 and stated that cash and available credit were sufficient for debt maturities and capital needs through 2015. It expects operating cash flow to cover recurring expenses, debt service, recurring capital expenditures and REIT-required distributions. Development and redevelopment costs may require additional financing or equity.
Simon’s share of development and redevelopment projects under construction was approximately $2.1 billion; management cited typical stabilized returns of 8%–12%. Three U.S. outlet developments were scheduled to open in 2015, alongside international projects. These are expectations, not guarantees.
- Key business risks include substantial debt and reliance on capital markets, refinancing and interest-rate exposure, tenant bankruptcies and anchor-store closures, weaker consumer spending, e-commerce competition, lease renewal and occupancy risks, and the illiquidity of real estate.
- Development, redevelopment and acquisition outcomes may differ from projections due to construction costs, approvals, financing, leasing or partner-consent issues. Joint ventures can limit Simon’s control; the Operating Partnership guaranteed $223.5 million of joint-venture mortgage debt, with $78.7 million recoverable from partners.
- International operations expose Simon to currency, political, regulatory and operating risks. International activities represented approximately 9% of 2014 NOI. Klépierre’s Corio acquisition was expected to dilute Simon’s ownership from 28.9% to approximately 18.3%.
- Environmental liabilities, inadequate insurance, cyber incidents, REIT qualification and changes in tax treatment are additional risks. Opry Mills insurance litigation sought up to $150 million of additional proceeds; management believed recovery was probable but gave no assurance.
- Simon reported ordinary-course legal proceedings that it did not believe would materially affect its financial position or results. It was in compliance with debt covenants at year-end. A 50-basis-point interest-rate increase was estimated to reduce future earnings and cash flow by approximately $9.2 million.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded internal controls were effective.
Most important facts for investors to verify
- Review the full 10-K’s debt maturity schedule, refinancing needs, covenant terms and the distinction between consolidated debt and Simon’s share of joint-venture debt.
- Assess the effect of the Washington Prime spin-off on comparable revenue, earnings, cash flow and portfolio growth.
- Separate recurring operating performance from the Klépierre/property-sale gains, debt-extinguishment loss and spin-off costs; reconcile GAAP results to FFO.
- Monitor occupancy, leasing spreads, tenant credit losses, sales per square foot and exposure to anchor and major retailers.
- Track development spending, projected returns, 2015 openings and the cash and financing required to complete projects.
- Verify the status and potential financial impact of the Opry Mills insurance dispute, joint-venture guarantees and Klépierre’s Corio transaction.