Tanger Factory Outlet Cuts Guidance, But That's Not What You Should Be Worried About

Summary

• SKT shares fell as management cut full-year guidance.
• Pressuring guidance were an uptick in retail bankruptcies and continued use of short-term leases to maintain their high occupancies.
• With their short-term leases having spreads of -25.9%, I am concerned that the situation is much more dire than many are implying.
• I am maintaining my "avoid" rating.

Thesis

Tanger (NYSE:SKT) fell on Wednesday after reporting disappointing earnings in which they cut guidance. While the cut to FFO guidance was rather minimal, I caution readers that Wall Street appears to be worried that this is the beginning of a new negative trend. Further, I am concerned with the aggressive negative leasing spreads seen in their short term leases. I am reiterating my “avoid” rating as the risk is not yet priced in.

Business Overview

SKT is a storied mall outlet REIT which owns 44 properties in the U.S. and Canada:

(2018 Q1 Presentation)

They have had a long history of same center net operating income (‘SS NOI’) growth (though the beginning of this year is so far negative):

(2018 Q1 Presentation)

They have BBB+ credit ratings from both S&P and Moody’s (Baa1) but I should note that the outlook at S&P was changed to negative on February 15, 2018.

Perhaps the most important fact is that they are a member of the esteemed “Dividends Aristocrats” index, as they have increased their dividend for the past 25 consecutive years:

(2018 Q1 Presentation)

With shares trading with dividend yields above 6%, is this the time to buy the dip? Is this a safe stock to pound the table on? I have my reservations, and lay them out below.

Guidance cut

SKT cut 2018 FFO/share guidance to $2.40-$2.46 from $2.43 to $2.49. This is only about a 1% decrease at the midpoint, but there is more. They also cut SS NOI growth guidance to (2.5%) to (1.5%), down from (1.0%) to 0%. These are in stark contrast with the other mall REIT I follow, Simon Property Group (SPG), which raised FFO guidance and came in strong with 2.3% SS NOI growth. Before we jump the gun and say these results are temporary and buy the dip, we should first examine specifically the factors causing the reduction in guidance.

Occupancy coming under fire

Projected occupancy is to fall to between 95% and 95.5%, down from 96%. Recall that high occupancy offsetting lower sales psf is a huge part of the SKT bull thesis. SKT did report slightly higher sales psf this quarter, but at $384 it is still very low:

(2018 Q1 Presentation)

It is this metric that has kept me on the sidelines and overall bearish ever since I started covering the stock in December of 2017.

In order to maintain their high occupancy, SKT continued to execute short-term leases (shorter than twelve months).

CEO Tanger commented in the earnings release: “A proven and successful strategy we have deployed to support this initiative is to selectively utilize leases of 12 months or less throughout various retail cycles in order to preserve potential revenue upside. The percentage of leases in this category today remains within our historical average.”

In Q4 2017, Tanger had approximately 15% of lease renewals come with under twelve-month lease terms. In 2018 Q1, they executed 338 total renewal leases and 1,568,408 sq feet, with 61 leases coming one year or under in length at 257,601 sq feet, representing 16.4% of total renewed space. But how were the leasing spreads?

Lease renewal spreads continue downward trend

In 2017 Q4, I commented that renewed space was released only 1.9% higher than expiring leases, down from 8.5% YOY. Leasing spreads for their overall leases came in at 3.6%, down from 10%.

2018 Q1 saw a similar downward trend. For this quarter, SKT did not break out the spreads on their short-term leases but did disclose that renewal spreads on their other leases was 3.7%, versus 9.9%.

The big lemon was that renewal spreads for total leases came in at (0.5%), down from 8.4% YOY. While this is consistent with the downward trend seen at previous quarters, the fact that they came negative is obviously less than ideal. With short-term leases accounting for only 16% of all activity, this implies that leasing spreads seen there must have been very poor.

We can calculate these spreads using information from their supplemental:

(2018 Q1 Supplemental)

From the 1,568,408 sq feet in lease renewals they had -0.5% leasing spreads. Contributing to this are 1,310,807 sq feet of leases with terms greater than 12 months with spreads of 4.5%, which implies that the remaining 257,601 sq feet of leases with terms 12 months or less had spreads of -25.9%. Yes, you read that right - their short-term leases were renewed at negative 25.9% spreads.

These low leasing spreads given to the short-term leases indicate very clearly the drastic measures management is taking to maintain high occupancy. I need to emphasize that this is definitely the right decision - it makes absolute sense to maintain high occupancy at all costs as otherwise they risk a complete collapse in tenant sales psf. A collapse in tenant sales psf would put serious strain on their long-term leasing spreads and send shares down even further. Investors must, however, realize that this is an indication that business is not as healthy as many would claim it to be, and question whether the valuation is really pricing in potential danger.

Lower volume of share buybacks

SKT purchased only 444,000 shares for approximately $10 million. It is unclear if this is due to just chance or if this is due to management wanting to retain more cash to reinvest into the business. But a better question is: should management be buying back stock? With shares trading around 8 to 9 times FFO, these buybacks probably will only help to keep FFO stable as management hopes that the recent retail struggles are temporary. However, the skeptic in me wonders: why should the retail struggles stop? What is the catalyst that would suddenly stop the retail bankruptcies and stop the decline in tenant profitability? I believe promotional activity will only continue to increase, and the impact of e-commerce will only keep increasing as giants like Amazon (AMZN) continue to improve their services. I wonder if management should instead be keeping cash and try to instead more aggressively recycle their underperforming assets and acquire higher quality outlet properties, perhaps even some from Simon Property Group.

Conclusion

The poor results and lower guidance are honestly not that horrendous, but the steep declines in short-term leasing spreads should be raising eyebrows. I suspect, however, that Wall Street is worried that this will not be just a temporary bump in the road and they may start seeing real pressure on leasing spreads moving forward. With shares not yet pricing in real risk of negative long-term leasing spreads, I still cannot recommend buying even a speculative position. For now, I will just stick with my SPG position.

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Analyst’s Disclosure: I am/we are long SPG, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am currently working with Rida Morwa of High Dividend Opportunities who has covered SKT in the past. This article however is my opinion only and does not reflect the opinion of Rida Morwa or High Dividend Opportunities.