Simon's Situation Fragile as Malls are in the Crosshairs of the Coronavirus

In the crosshairs of America's response to the spread of the novel coronavirus, Simon (SPG) announced yesterday that all of its mall locations would close until at least March 29 (about two weeks).

Simon is now in an unprecedented situation with a wide range of outcomes and a high level of uncertainty.

It's anyone's guess how long stores will remain closed, though two weeks is likely optimistic. President Trump wouldn't offer a timeline today when asked by the media how long until Americans would be able to return to normal life. But already, AMC Theaters — not a tenant of Simon's, to be sure — has pledged to close its movie theaters for 6-12 weeks.

Moreover, when stores do reopen, it's unclear how quickly foot traffic will return. A lot depends on how hard consumers are hit economically during this period. Social distancing or fear of infection (which may grow as headlines cite increasing death totals) may keep some from visiting crowded places like malls, too.

Simon collects rent (an obligatory expense on the part of tenants), making the REIT one step removed from the financial health of its tenants. However, zero sales at retailers' physical locations for any extended period of time would put extraordinary pressure on tenants' ability to meet rent obligations.

Making matters worse, several of Simon's largest tenants were already financially stressed coming into this crisis. Prolonged closures could be too much for the financially-weakest retailers to bear, causing them to fold or decline to renew their leases. (About 10% of Simon's rent is from month-to-month leases or leases that expire in 2020.)

Either way, Simon would be forced to find new tenants, which could take longer than normal in this environment and put more pressure on the firm's occupancy rate.

As a result of these sudden developments and the uncertainty involved, we are downgrading Simon's Dividend Safety Score to Borderline Safe.

The risk to Simon's dividend hinges largely on how long store closures persist and how optimistic management is about retail performance once stores reopen. A further downgrade to Unsafe could be issued quickly if closures appear they will last longer or if widespread rent defaults become likely.

On the other hand, if stores reopen across the country in the next couple of weeks, and if mall traffic quickly returns to normal, then Simon's dividend may be safe.

Supporting Simon's dividend during this potentially rough stretch is the company's reasonable balance sheet, which has earned the REIT an A credit rating from Standard & Poors. Simon has some flexibility to borrow to plug short-term holes, and the company has access to $9.5 billion through its credit revolvers as well.

That said, management just recently took on debt to acquire Taubman, raising the firm's expected net debt to net operating income (NOI) leverage ratio to 6.1x, up from 5.3x in 2019 and its highest level in at least a decade.

Simon likely wouldn't want to risk a credit downgrade in this unusual environment by taking on much more debt. Even in 2009, when Simon's leverage and payout ratio were lower, the firm cut its dividend to conserve even more capital.

Balance sheet aside, as of February's earning release, Simon had a moderate payout ratio of 77%. Theoretically, the firm's cash flow could take about a 20% hit and still cover the dividend.

However, management had earmarked $1.4 billion this year to reinvest in improving Simon's mall properties to stay relevant in the era of e-commerce. For context, Simon's dividend costs about $2.6 billion annually.

If cash flow experiences a material decline or access to capital markets becomes strained, Simon may find it prudent to prioritize these redevelopment projects over maintaining the dividend given the threat e-commerce presents to malls.

All said, this is a fragile situation for Simon. Investors should weigh whether they're comfortable owning a stock with this much short-term uncertainty, especially given the mixed long-term outlook on malls.