Credit analyst says to continue to avoid Simon Property

By Ronda Fears

Nashville, Tenn., August 16 - Simon Property Group has made progress toward paying down acquisition-related debt but its leverage remains high and Felice Shiroma, credit analyst at Gimme Credit, said she would continue to avoid the paper.

"We do not expect meaningful improvements in leverage, as Simon has made only limited progress in recent years in reducing its burgeoning acquisition-related debt, and would continue to avoid this credit," Shiroma said in a report Friday.

Compounding the situation, she noted that credit spreads on REITs widened in recent weeks in sympathy with the corporate debt market and on renewed worries about a double-dip recession.

Second quarter results at Simon Property Group (Baa1/BBB) received a boost from the recently acquired Rodamco trophy properties, purchased in May for $1.6 billion in cash and assumed debt.

Since May, the company raised $322 million by issuing shares in conjunction with its recent addition to the S&P 500. Management said this was a response to the liquidity needs of index fund managers, but Shiroma wondered if there was also some pressure from the rating agencies.

And, on Thursday Simon priced a two-part $500 million debt offering with proceeds to be used to retire bank debt.

"Although the company has made progress in cutting acquisition-related debt, high leverage ratios remain a concern," Shiroma said.

Occupancy levels at 91.5% continue to inch up sequentially and year over year. Rental rates on new leases registered strong gains of more than 20% versus rates on expired leases. Leasing activity benefited from Simon's prudent decision to cut back on new development activity, allowing the leasing staff to focus on core properties.

"The hiatus in tenant bankruptcies probably also helped, although concerns remain about the financial health of the retail industry," Shiroma said.

Excluding the Rodamco portfolio, sales per square foot on a same-store basis declined slightly, continuing a yearlong trend. Including Rodamco, total sales per square foot edged up to $384. The improvement in occupancy levels and strong rent renewals led to 3.3% growth in same-store net operating income.

These statistics compare favorably with General Growth Properties (Ba1/BBB-) which had more modest growth in occupancy levels and rental rates, the analyst said. As demonstrated by these numbers, the new properties enhance the quality of Simon's asset portfolio and business risk profile. Revenues rose 6%, but operating margins were flat, as savings on maintenance and advertising were offset by increased insurance and depreciation expenses.

"Simon made substantial progress in reducing the $600 million acquisition facility to $100 million at July 31, using proceeds from asset sales and equity issuance, but it remains highly leveraged for its rating level," Shiroma said.

At June 30, the company had $743 million drawn on its $1.25 billion credit facility.

"Using June 30 numbers, debt as a percent of total book capital is in the low 70s, even with a pro forma adjustment for the new equity and the exclusion of the sizable joint venture debt," Shiroma said.

"Leverage is mitigated by the company's scale and a strong management team that has delivered consistent returns in a difficult operating environment."

Simon also continues to dispose of non-core assets and 2002 proceeds will be up substantially from the unusually low 2001 levels.

"We view Simon as a mid-BBB credit with limited debt capacity for further acquisitions," Shiroma said.

"We applaud the somewhat more conservative funding of the Rodamco deal than originally anticipated, but we are wary of the company's continued interest in acquisitions, as exemplified by the recent purchase of the remaining Copley Place interests for about $240 million."

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