Shares of real estate investment trust (REIT) Tanger Factory Outlet Centers (NYSE: SKT) are down nearly 60% from the highs they reached in 2016. It has been a brutal period for the retail landlord, which operates in the market most dramatically affected by the much hyped "retail apocalypse." The fears surrounding the long-term impact of online sales are likely overblown, but the difficulty of the transition that retailers and their landlords will have to make is very real.
Based on the stock action at Tanger, it looks like investors believe the REIT will have trouble surviving as consumers shift their buying habits. But giving up on Tanger could be a huge mistake right now. Here's why.
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1. The business is different
Tanger is a retail landlord, but it isn't an owner of enclosed malls. That's an important distinction, because the factory outlet properties it runs are inherently different. With an open structure, they are generally less expensive to operate. The generic nature of the space means it is easier (and less costly) to bring in new tenants when old ones leave. And there are no anchor tenants like department stores to worry about. Most of its lessees occupy smaller spaces that are, again, easier to fill. With the inherent advantages of the factory outlet model, Tanger may actually be in a better position than enclosed mall peers as it shifts along with end customers.
Yes, Tanger has seen its occupancy fall from 99% in 2012 to what it projects will be roughly 94% to 94.5% in 2019, and that is troubling. But Tanger's occupancy isn't materially worse than that of Simon Property Group (NYSE: SPG), an owner of both enclosed and outlet centers, which posted occupancy of roughly 95% in the first quarter of 2019.
Simon's shares, to highlight the discrepancy here, are up 10% over the past year, while Tanger's shares are down nearly 13%. That downbeat view doesn't seem appropriate given the similar occupancy rates at these two REITs.
2. Sales are holding up
Another factor to look at is how productive Tanger's assets are for its lessees. On that score, sales per square foot at the company's properties peaked in 2015 at $395. They dropped in 2016 and 2017, hitting a low of $380 per square foot, but they have picked up again since then, hitting $391 per square foot in the first quarter of 2019 (helped along by the sale of four less desirable properties).
The big picture is that Tanger's outlet centers remain very productive relative to their historical performance. That suggests that there's nothing going materially wrong at the properties themselves, which appear to remain desirable to consumers. And while it's true that Tanger pared its portfolio down to 40 properties via the sale noted above, that's just normal business for the REIT. It has long been an active portfolio manager, buying, selling, and building properties. Since 2014, in fact, it has sold 13 assets. The recent sale, while motivated by the changing shape of the retail sector, is not a move made out of desperation -- it's just par for the course.
3. Rock solid balance sheet
The company is well aware of the issues facing the retail sector, and is putting the $128 million in proceeds from the recent property sale to good use to reduce leverage. That should make the financially strong REIT even stronger. For example, Tanger has only used 3% of its line of credit capacity, so it has plenty of liquidity. And at the end of the first quarter Tanger's portfolio only had mortgages on around 6% of its square footage. That means that corporate debt is the main concern.
But there's not much to be worried about. Total debt to adjusted total assets was roughly 49% at the end of the first quarter, well below the 60% limit in the company's debt covenants. Interest coverage, meanwhile, was 5.1 times -- vastly better than the 1.5 times required by its debt obligations. And despite the retail headwinds Tanger is facing, it remains rated "investment grade" by S&P. The company's 2018 dividend, meanwhile, only represented 56% of funds from operations (FFO). So while FFO is probably going to be under pressure for a little bit, there's plenty of room for the REIT to support its hefty 7.8% yield.
4. Executing the playbook
With a strong business model, a strong financial position, and still-solid property-level operating performance, there's no reason to fear that Tanger is heading to the dustbin of history. That said, it is dealing with a difficult transition period as the retail world adjusts to online sales. In fact, after the sale of the four properties, Tanger is now expecting FFO to drop to around $2.25 per share in 2019 from $2.48 in 2018. (For reference, the dividend will likely eat up around 65% of FFO in 2019, a still reasonable number.)
While a drop in FFO sounds bad, you need to take the decline with a grain of salt. Tanger has the financial strength to execute the same game plan it has used through previous difficult periods, namely working with its retail partners. That means providing rent concessions and short-term leases when appropriate to ensure that Tanger's malls maintain high occupancy levels. That makes the properties more desirable for consumers and, in turn, lessees. Whenever a space is vacated, Tanger works to fill it by bringing in new, more desirable tenants. The focus is on adding stores that are resonating with customers today.
The problem is that these types of approaches take time to implement. Helping a retailer through a tough patch leads to better tenant relations and, assuming the retailer recovers, rents moving higher again once the trouble passes. Adding new and better tenants improves Tanger's properties, but you have to do the legwork to find the right tenants and then move them in.
Those things don't happen overnight. The REIT's results are going to be weak for a little bit as it works through this period with its tenants. There's no way around it, it's just how the process works -- but it's no different than what Tanger has had to do before.
Don't jump ship just yet
The retail apocalypse is a scary thing. It has taken down once-proud U.S. retailers, hitting the enclosed mall space particularly hard. But Tanger isn't an enclosed mall. Meanwhile, its properties appear to be holding up fairly well as it works to adjust to the changing retail landscape. And with a solid balance sheet, the REIT is working off of a strong financial foundation.
Yes, you need to keep a close eye on Tanger today. But no, the sky is not falling. Focusing on the wrong information here (the hype of a coming retail armageddon) would be a big mistake when the data suggest that Tanger is dealing fairly well with the impact of online retail today. Investors willing to take on a little uncertainty, meanwhile, can collect a yield that is well higher than what Tanger offered during the deep 2007 to 2009 recession and the roughly 2% yield you would get from the S&P 500 Index. That's worth the extra effort of examining the underlying numbers a little.
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