Tanger Factory Outlet Centers: Superior Investors Strive To Behave As Contrarians

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About: Tanger Factory Outlet Centers, Inc. (SKT)
by: Brad Thomas
Summary

I have deep insights into most REIT property sectors that allow me to tip the odds in my favor.

Being contrarian has been the secret to my success as a REIT investor.

Howard Marks said that “Excessive risk aversion depresses markets, creating some of the greatest buying opportunities," and "superior investors recognize this and strive to behave as contrarians."

As many of you know, I've been writing on Seeking Alpha for almost 10 years now. And over this period, I've learned quite a few investing secrets.

Don't worry, I'm not going to tell you that I'm a magician. Nor do I have a crystal ball stashed away in my office.

Instead, my secret advantage is that I have deep insight into most REIT property sectors that allow me to tip the odds in my favor. This means, while I can't predict the future profits for any company, I can thoroughly research the fundamentals and calculate the true value in order to determine a suitable margin of safety.

As Howards Marks explained in his book, Mastering the Market Cycle:

"The superior investor resists psychological excesses and thus refuses to participate in these swings… I believe their unemotional nature is one of the greatest contributors to their success."

I can personally attest to this. Being contrarian has been the secret to my success as a REIT investor. Over the years, I've helped investors make millions of dollars in profits by maintaining strict discipline - in the good times and bad. Furthermore, it's the depressed times that make for some of the best investments.

To further quote Marks' book, "The fluctuation - or inconsistency - in attitudes toward risk is both the result of some cycles and the cause or exacerbator of others." The reason is that the defiance is almost "hard wired into most people's psyches to become... more worried and risk-averse when things go downward."

Marks adds, "Superior investors recognize this and strive to behave as contrarians."

On that note, enter the much-villified Tanger Outlets (SKT), which has become my strongest conviction (Strong) Buy. Due to all the negativity surrounding this stock right now, I've had to become almost robotic in my analysis of it and focus on fundamentals. I have to ignore the bears, including Goldman Sachs, which downgraded Tanger shares last week.

And I have to remember another thing Mark said:

"By definition, pronounced bargain prices are most likely found among things that conventional wisdom dismisses, that make most investors uncomfortable, and whose merits are hard to comprehend. Investing in them requires considerable inner strength."

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Photo Source

The Basics of Tanger

As its name suggests, Tanger Outlets is the proud provider of a number of outlet centers: A couple dozen to be precise. According to the corporate profile page of its website:

"Tanger Factory Outlet Centers, Inc… is a publicly-traded REIT headquartered in Greensboro, North Carolina, that presently operates and owns, or has an ownership interest in, a portfolio of 40 upscale outlet shopping centers. Tanger's operating properties are located in 20 states coast to coast and in Canada, totaling approximately 14.4 million square feet, leased to over 2,900 stores (that) are operated by more than 500 different brand-name companies."

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Source: SKT Investor Presentation

That basic data is important to recognize. Though, if you've followed me even for the last few months, you no doubt already know it. So let me get to the point. Or at least let me get to Tanger's point so I can make my own.

The website continues with, "The company has more than 38 years of experience in the outlet industry. Tanger Outlet Centers continues to attract more than 181 million shoppers annually." (Emphasis mine.)

Take note of that right there. Because that's worth highlighting all by itself.

This is a company that's been around the shopping block a time or two, walking through recessions and striding through economic upticks. It knows what it is, what it has, and what it can make going forward.

This puts it several points above its detractors.

"Yeah," you might argue. "But Toys 'R' Us was founded in 1948, and it had to shutter all of its stores. And how about Sears? It began in 1886, and look at what a mess it is today!"

Yet those are mall and traditional shopping-center anchor stores, not outlet placements. By their very nature, outlet centers have bigger baskets to fit more eggs that are much more evenly distributed across their respective spaces. So if one, two, or even three stores default on or otherwise don't renew their lease agreements, a business like Tanger is only going to suffer so much.

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Source: SKT Investor Presentation

It's easy to ignore that distinction, thinking that malls are in immediately better positions, whereas outlet centers stand a snowball's chance in someplace really hot.

However, we have some significantly-sized facts on our side. Let's get right to them.

What Harvard Has to Say

I'm not an academic researcher, so I'll happily turn to experts such as Donald Ngwe, Ph.D., an assistant professor of business administration at none other than Harvard Business School. He specializes in retail trends, both online and offline.

Publishing part of his dissertation last summer, Ngwe noted how his study - titled "Fake Discounts Drive Real Revenues in Retail" - looked at consumer reactions to being told they're getting a bargain… whether that bargain is real or not. Moreover, he included outlet centers in this study.

"The results show that list prices have significant effects on purchase decisions. On average, consumers may be thought of as assigning a monetary value to list prices at over 70 'selling price cents' to a 'list price dollar'…

"Findings from a laboratory experiment confirm that knowledge of a product's true original price attenuates the effect on purchase intent of a displayed original price. Strikingly, when subjects are informed of a product's true original price, their purchase intent is found to be completely invariant to displayed original prices. We find that subjects rely on products' prior selling prices in making inferences of product quality and that they regard sellers that display original prices higher than true original prices as dishonest."

Let me break that Harvard-speak down into something more bite sized. Essentially, Ngwe concluded that consumers see higher-priced items as being better buys, which means they're more likely to purchase those goods when they find them someplace that offers them at a stated discount.

Furthermore, outlets have evolved over the years, with an emphasis on engagement to increase relevance. Tanger owns many properties in tourist destinations that are strategically designed for outlet, value, food, and entertainment. These new age outlets can include "food offerings, landscaped promenades, children's play areas and outdoor gathering spaces for community events and performances," as TORG, The Outlet Resource Group, noted as far back as 2016.

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Source: SKT Investor Presentation

Trends from the addition of new retailers to the tenant mix - including the incorporation of experiential and food elements - continue to evolve as the outlet sector grows. On its recent earnings call, Tanger President and COO Tom McDonough said the company recently opened an Olive Garden (leased) in Fort Worth and is "opening new stores, are expanding, including Polo, Ralph Lauren, Columbia, American Eagle, Vans, and Adidas."

In addition, Tanger CEO Steve Tanger explained (also on the earnings call) that:

"The department stores that went out of other distribution channels (were) heavily weighted towards apparel… We're over 95% occupied, and we really don't have room or, frankly, the desire to put in restaurants that are a higher risk. But on the margin, we're looking at other opportunities that may be non-apparel users, but we haven't decided to install any of them yet. We still think that there is a lot of growth with apparel, and we're focused on that."

The point here is that Tanger's apparel tenants are enjoying increased market share as a result of department store closures. While the mall REITs are challenged with balancing department store redevelopment costs and dividends, Tanger doesn't have to worry about the pressure on redevelopment capital. Therefore, it's better able to maintain a healthy payout ratio. (More on that below.) At quarter's end, Tanger's consolidated portfolio occupancy was 95.4% vs. 95.9% in Q1-18 and 96.8% for Q4-18.

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Source: SKT Investor Presentation

Managing Risk Is What Tanger Does Best

I find comfort in the way that Tanger manages its balance sheet. Since December 2014, the company has sold 13 properties, produced $402 million in gross proceeds, and invested in more than $1 billion of new and redeveloped properties. The most recent sell was a four-property portfolio in which Tanger utilized $128 million of proceeds to pay down its unsecured lines of credit.

As viewed below, Tanger has 97% unused capacity (around $585 million) on the credit facility.

A close up of a logoDescription automatically generated Source: SKT Investor Presentation

As a result of these dispositions (referenced above), Tanger has extraordinarily strong credit metrics. These include an interest coverage ratio of 4.2x and net consolidated debt to EBITDA (earnings before interest, taxes, depreciation, and amortization) adjusted - excluding the sold properties - of 5.9x (trailing 12 months).

The company also has no debt maturities until December 2023, which means it has best-in-class balance-sheet metrics.

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Source: SKT Investor Presentation

On the recent earnings call, Tanger's CFO, Jim Williams, explained that, "since 2017, when the (share buyback) authorization was put in place," the company has "cumulatively repurchased approximately $69.3 million of (its) common shares." He added that the board recently "approved an increase of the remaining authorization to $100 million and an extension of the authorization by two years to May 2021."

In the Q&A segment, Steve Tanger then added that:

"Share buybacks are only one of the ways we allocate capital to try to add value for our shareholders. We expect to continue to take a thoughtful approach among the various different priorities. And since the authorization was put in place in May of 2017, we have allocated over $69 million to buy back our stock. But I think you'll find that, during the balance of the year, we will implement share buybacks as we will some of the other capital allocation priorities that we've announced previously."

The company also is studying a possible new development in Nashville, which Steve Tanger also had a few things to say on:

"The master developer of the Century Farms project is continuing with the balance of this permitting. The interchange is fully funded and actually under construction now. This will be a large multi-use project, of which Tanger outlets will be the hub. This will be a void in Nashville market south of us, where people can live, shop, play. There will be thousands of apartments (and) major office buildings... It's an exciting project, but it's still premature to give you more color, since it probably won't open for another two to three years."

According to Tennessean, "Century Farms already has... inked deals with office tenants Asurion, Bridgestone Americas, TriStar Medical Group, Community Health Systems, and car-parts maker LKQ."

Tanger always has maintained a strict discipline with its development practices, always locking down at least 60% to 70% pre-leasing before commencing construction. Although Tanger has not broken ground on a new project in a few years (I attended the last grand opening in Fort Worth around two years ago), the market opportunity for outlets in the U.S. is strong.

Tanger estimates there's only 70 million square feet of quality outlet space, which represents less that 1% of retail space.

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Source: SKT Investor Presentation

The Latest Scorecard

Tanger was one of the last mall REITs to report first quarter earnings. I already was guessing the outlet REIT would perform well, given the results from its closest peers:

  • Kimco (KIM) grew same-property net operating income (NOI) 3.7% over the same period in 2018.
  • Taubman (TCO) saw same-store (SS) NOI grow 2.3% year over year, with growth from both the U.S. and Asia.
  • Simon's (SPG) SS NOI growth rose 1.6% year over year.

Certainly, Tanger's key performance metrics reflect the improved overall quality of the portfolio after the above-referenced asset sales. Its Q1-19 tenant sales (per square foot) are higher compared with 2018, as shown below. And year-round occupancy was 110 basis points (BPS) higher for the portfolio after the four-pack was sold.

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Source: SKT Investor Presentation

Also, the company's rent spreads were substantially higher for leases that commenced during 2018. Cash spreads were 950 BPS higher than the new portfolio (less the four-pack) and 930 BPS higher on a straight-line basis.

As I explained back in early April, "Tanger's same-center NOI growth has been positive since well before the Great Recession, which caused 2018's 1.3% decline to shock the markets."

As such, I wasn't surprised to see Tanger's same-center NOI down just 50 BPS in Q1-19. The company had already telegraphed store closings that included 82,000 square feet in Q1-19 and 86,000 square feet in April.

Management said it "continues to expect same-center NOI to be down to 2% and 2.75% from 2018, reflecting the impact of prior year's store closures along with projected 2019 store closures of up to 200,000 square feet of the consolidated portfolio, some of which are unknown at this time."

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Source: SKT Investor Presentation

Tanger's funds from operations (FFO) in Q1-19 was $0.57 per share vs $0.60 in Q1-18. Again, this is no big shocker given the fact that it sold off 5% of its portfolio by way of lower-quality assets. The company estimates that "FFO per share will be between $2.22 and $2.28. The update from our initial guidance range reflects the previously disclosed $0.09 dilutive impact from the sale of the four non-core assets."

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Source: SKT Investor Presentation

My Strongest Conviction Buy

Every week, we scan our REIT Lab screening for companies that appear to be trading at cheap valuation levels. As Howard Marks reminds us if we're only willing to listen: "Bargains are most often found among those things that are hard to comprehend, uncomfortable and easily dismissed by the crowd."

As most know, Tanger shares have declined considerably since July 2016. They returned -47% during that period, as viewed below.

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Source: FAST Graphs

Next up is how Tanger has substantially underperformed the broader REIT sector in 2019 - as compared with Vanguard Real Estate (VNQ):

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Source: Yahoo Finance

It's also underperformed these select retail REIT peers year to date:

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Source: Yahoo Finance

However, Tanger is the ONLY mall REIT that increased its dividend through the so-called Great Recession:

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Source: SKT Investor Presentation

Isn't that interesting?

Tanger is the ONLY mall REIT that managed to increase its dividend during a time in which almost all other REITs were forced to suspend or cut their dividends. So does Mr. Market fear a dividend cut for Tanger today?

Hardly.

The stalwart REIT continues to generate free cash flow of around $100 million per year. And it offers a well-covered dividend, currently at a 61% FFO payout ratio in Q1-19. On its recent earnings call, the company's CFO had this to say:

"We don't anticipate a meaningful increase in capex spend(ing) to complete our planned leasing. And, therefore, we feel comfortable in our ability to maintain a strong balance sheet, with low leverage and with the safety of our dividend."

Once again, Howard Marks manages to sum this up nicely. As quoted by Real Clear Markets:

"… things that perform poorly for a while eventually will become so cheap - due to their relative depreciation and the lack of investor interest - that they'll be primed to outperform."

In closing, let's turn back to "Mastering The Market Cycle" one more time by noting how, "... excessive risk aversion depresses markets, creating some of the greatest buying opportunities," and "superior investors recognize this and strive to behave as contrarians."

As such, we maintain a "Strong Buy" on Tanger Outlets.

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Source: FAST Graphs

Author's note: Brad Thomas is a Wall Street writer, and that means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free, and the sole purposes for writing it is to assist with research while also providing a forum for second-level thinking.

Disclosure: I am/we are long SKT, KIM, SPG, TCO. 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.