Tanger Remains A Beautiful SWAN

About: Tanger Factory Outlet Centers, Inc. (SKT), Includes: OHI, STOR
by: Brad Thomas

Although I consider REITs more “buy and hold” driven, it’s important to rebalance portfolios to take advantage of opportunistic mispricing, or, get rid of a few ugly ducklings.

"Department stores across the country account for more than 350 million square feet of mall space." Lauren Thomas.

Tanger has no department store exposure, access to capital is still a critical differentiator.

The selloff (valuation) is unwarranted as Tanger’s business model is perfectly suited for the new paradigm in which “department stores are under attack.

In case you missed it, I recently wrote an article summarizing my 2018 Top SWAN (stands for “sleep well at night”) picks - and the weighted average total return for the basket of REITs (through November 2018) is 10.6%. And in this article today, I will be making a strong case for why I still stand behind Tanger Outlets (SKT).

It’s interesting to revisit this list of high conviction picks to assess the year-end results. As you can imagine, I’m very pleased with these picks, especially home runs like Omega Healthcare (OHI) +46.6% YTD and Store Capital (STOR) +19.6% YTD.

Although I consider REITs more “buy and hold” driven, it’s important to rebalance portfolios to take advantage of opportunistic mispricing, or, get rid of a few ugly ducklings.

Because of selective vetting, it’s rare that I would unload a SWAN, because, as a value investor, I am disciplined in my approach of surveying the list of opportunities. This typically involves considering the company’s history, its moat-worth attributes, and most importantly, how the company is able to maintain its long-term pricing power.

And I’m not surprised to see this collective basket of SWANs out-perform (+10.6% YTD), given the in-depth, almost microscopic, research that we undertake. (i.e. our portfolios returned around 5% on average).

Yet, there are always outliers to consider. I’m not referring to “something classified differently,” but rather, how Malcolm Gladwell uses the “outlier” term: “…an outlier is a truly exceptional individual who, in his or her field of expertise, is so superior that he defines his own category of success.”

Remember I said occasionally I have to “get rid of a few ugly ducklings?”

That’s true, but rarely I find one that eventually turns into a beautiful SWAN. At first, an “outlier” may appear to have little value, but eventually, competitive advantages are revealed - and Malcolm Gladwell’s “tallest tree” analogy proves this point: “the tree grew tall not just because its seed has some special qualities, but because of a confluence of various other external factors.”

Photo Source

Competitive Advantage #1: Low Cost Provider

Tanger Outlets is the worst-performing SWAN listed in my “2018 Top SWAN List” – the company has returned -6.0% YTD. While the Greensboro-based REIT has under-performed in 2018 (I actually picked SKT to be my #1 SWAN in 2018), I have maintained a STRONG BUY recommendation.

Most of you reading this article know that Tanger is not really a Mall REIT. While the company does lease space to many mall tenants, there are two obvious differences:

(1) Outlet centers are not enclosed and therefore occupancy costs are much lower for outlets than malls.

(2) Outlet centers have no department stores, and this means they’re much less capital intensive when it comes to redevelopment. Many of the B/C Mall REITs (like CBL and Washington Prime) are pressured because of unknown tenant improvement and leasing costs, however, outlet landlords aren’t faced with these challenges. In a recent CNBC article, Lauren Thomas (disclosure: my daughter) explains,

“Department stores across the country account for more than 350 million square feet of mall space. And that number is really scary to American mall owners.

Department stores are under attack as consumers instead opt to increasingly shop online or head to discounters and off-price retailers like TJX's TJ Maxx. Brands like Sears and Bon-Ton have filed for bankruptcy this year, closing hundreds of locations. But even those still surviving like Macy's or J.C. Penney are evaluating their massive real estate portfolios, which analysts expect will lead to more store closures.”

When a department store closes or vacates, the landlord must spend upwards of $20 million to develop the box, and densification projects could cost up to $50 million. In addition, in-line mall rents average around $35.00 per square foot (and higher), excluding CAM (common area) costs, while outlet rents are significantly less (as per SKT’s 10-K, their minimum rent on a straight-line basis in 2017 was $25.81 per square foot).

So two primary advantages for outlets – and of course, Tanger - are as follows:

  • Cap-ex spend is much more predictable (SKT’s spend in 2017 was around $60 million and is estimated to be between $37-40 million in 2018).
  • Occupancy costs are more attractive, as illustrated below (Tenant Occupancy Cost chart):

Source: Tanger Investor Presentation

Being a low cost provider in the retail brick and mortar sector is an important competitive advantage. More recently, as department stores close, we are witnessing many retailers seeking the most economical channels. The B/C mall locations are becoming much less-productive (due to Sears and JCPenney) and the retailers are seeking off-price distribution, versus the less productive B/C malls.

Competitive Advantage #2: Strong Balance Sheet

Even though Tanger has no department store exposure, access to capital is still a critical differentiator. Although the company has not had to spend $15 to $20 million to redevelop a Sears store, Tanger must maintain adequate resources to re-tenant vacant space and maintain the properties.

Over the years, Tanger has always maintained strict capital markets discipline, and during this cycle the company has elevated its discipline as evidenced by the 94% of square footage that is not encumbered by mortgages. This provides the company with superior flexibility and access to liquidity.

Source: Tanger Investor Presentation

Tanger has plenty of dry power, with only $203 million outstanding on its unsecured lines of credit, leaving 66% unused capacity (or approximately $391 million of availability). Tanger is rated BBB+ by S&P (negative outlook) and Baa1 by Moody’s and the strong ratings are indicative of the substantial interest coverage ratio (during Q3-18 of 4.5x). Tanger’s floating rate exposure represented 12% of total debt and about 5% of total enterprise value.

Tanger’s balance sheet is well-laddered with an average term to maturity of 6.4 years and a weighted average interest rate on outstanding debt of 3.5%. There are no significant debt maturities until October 2022.

Source: Tanger Investor Presentation

Because of Tanger’s exceptional balance sheet management practices, the company has been able to generate considerable free cash flow to pay down debt, purchase new shares, or reinvest into the asset base. Also, this demonstrates Tanger’s commitment to a well-covered dividend with an FFO payout ratio of 56% for Q3-18. To reiterate, Tanger does not have the uncertainty (like the B/C Mall REITs) to redevelop dark department stores (that puts tremendous pressure on the dividend).

Source: Tanger Investment Presentation

Competitive Advantage #3: Predictable Dividend Growth

Although Tanger has no department store tenants, the company is not immune to re-tenanting risks and maintaining (and growing) sales productivity. There is no doubt that the rate of SSNOI growth has slowed, albeit modestly. On an NOI weighted basis, sales for the consolidated portfolio were $409 per square foot in the trailing 12 months, up a 2.3% from the prior year period.

Colorado Wealth Management, and a shareholder in Tanger, recently explained,

“SKT's leasing results were improving from Q1 2018 to Q2 2018. In Q3 2018, the spreads weakened but the volume of leasing activity was exceptional. Remember that occupancy is a critical part of the equation for REITs in finding revenue. While the leasing spreads are not excellent, the volume of new leasing activity suggests SKT is doing a solid job at filling its centers.”

That’s correct, and as you can see below, Tanger raised expectations for average occupancy for the year to be between 95.5% and 96% and (as Colorado Wealth Management’s article also mentioned),“the company lowered store closure expectations for the year to a range of 125,000 to 150,000 square feet from the prior range of 150,000 to 175,000.”

Source: Tanger Investor Presentation

Also, Tanger’s same center tenant sales for the overall portfolio increased 1.1% in Q3-18 and the company believesthat the level of bankruptcies and restructurings that (IT) saw in recent years in our portfolio is tapering.”

Plus, based on a slightly better than expected third quarter and further visibility into the remainder of the year, Tanger raised the midpoint of its guidance range of FFO per share for 2018 to between $2.43 and $2.46. The company also raised the midpoint of its same-center NOI down 1.5% to down 2%.

Unlike the B/C Mall REITs, Tanger should have absolutely no problem paying and increasing its dividend. The company has successfully grown its dividend every year since going public in 1993 and is still well-positioned to do so (the dividend increased 2.2% in 2018 from $1.37 per share to $1.40 per share).

Source: Tanger Investor Presentation

My Oh My, Tanger Remains A Strong Buy

As I review my year-end “2018 Top 10 SWAN List,” I’m quite aware I included Tanger to be a top-performer in 2018. I have no regrets, and as we all know, diversification is the simplest way to obtain a margin of safety. I am standing behind Tanger because:

  • The company reinvests in assets every year
  • The company has no department store spend (for redevelopment)
  • Retailers will continue to feed the most economical channels and outlets serve a valuable purpose (SKT is a low-cost provider)
  • The company has done a great job of repositioning during this cycle and has a long history of managing risk (does anyone remember Liz Claiborne? …formerly a top tenant of SKT).
  • The company has maintained “brand integrity,” and market share should continue to increase (for outlets) as more department stores shut down.
  • The selloff (valuation) is unwarranted as Tanger’s business model is perfectly suited for the new paradigm in which “department stores are under attack as consumers instead opt to increasingly shop online or head to discounters and off-price retailers...” (L. Thomas)

Source: FAST Graphs

As the story goes, the ugly duckling “matures into a beautiful swan, the most beautiful bird of all” and that’s precisely my sentiment related to Tanger Outlets. While shareholders have endured a volatile market of retail closures and bankruptcies, I believe Tanger will eventually resurface… as shares now trade at a wide discount to the A-mall peers. As the retail cycle unfolds (and evolves), retailers will continue seeking the most productive channels - and Tanger Outlets is well-positioned.

My coming 2019 forecast (writing that up soon) will consist of more retail store closures, especially department stores, yet I consider that a catalyst for the Tanger platform. Happy SWAN hunting: My Oh My, Tanger Remains a Strong Buy.

Author's note: Brad Thomas is a Wall Street writer and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos and be assured that he will do his best to correct any errors if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.

Disclosure: I am/we are long OHI, SKT, O. 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.