Tanger's Solid Fundamentals Make It A Buy
- In this article, I take on the task of writing about a "Battleground" stock/company - Tanger Factory Outlet.
- I consider the company a buy, and during the Coronavirus drop, I added more as it fell. While problems exist and risks are there, I argue for the long-term quality.
- I find both extremes of sides (Bull/Bear) as being too far out and focus on the fundamentals of the business in relation to the valuation we're having.
- SKT is a "BUY".
I rarely write about these types of businesses. However, when I see valuation that "bothers" me, it's hard to stay silent. I want to preface this article by saying that Tanger Factory Outlet (NYSE:SKT) is a stock with a higher risk level than your typical, "safe" dividend stock. However, it also comes with a proportionally higher sort of reward - and I argue that the risk is far smaller than some bears would make it out to be.
I come into the stock not having bought at $40/share, nor at $30, nor $20. My first position was initiated at around $15/share, and I've been averaging down since. I'll show you why I've done that in this article (the valuation portion) and why I'll keep doing it as we go forward.
Tanger Factory Outlet is one of my very few REIT picks. Others include Simon Property Group (SPG), which is my largest (over 3.5% of my portfolio), as well as small positions in Macerich (MAC) and Public Storage (PSA).
So, let's go through this step by step. Since many of my readers don't typically read about American REITs, I'll take this from the ground up.
Tanger Factory Outlet - what does the company do?
Tanger Factory Outlet is Real Estate Investment Trust - a REIT. This particular REIT invests in shopping centers specifically containing outlet stores. The stores are focused primarily along the east coast NA, and SKT is headquartered in North Carolina.
(Source: Motley Fool)
Some quick stats on the location include:
- 39 locations in 20 states + Canada
- 14.3M sqft of retail space
- 88% are located in Top 50 MSA leading tourism destinations
When looking at a REIT like this, part of the focus should be on tenants and occupancy as well as the later focus on finances. We should also be looking over company leases.
SKT provides a fairly diversified tenant base, with predictably high exposure to clothing retail - which also is part of what is driving things down here.
(Source: SKT 4Q19 Presentation)
The largest tenant is, as you can see, The Gap. However, this is the only current tenant with a 5%+ annualized base rent portion. The other larger tenants include Ascena and PVH Corp., but following this, it quickly drops off below 3% base rent. I characterize this as well-diversified, barring The Gap.
(Source: SKT 4Q20)
With occupancy and sales actually showing positive growth, SKT is in a strong position, both financially and in terms of its properties.
The company doesn't have reportable segments, per se. One could argue that each of the centers/malls constitutes a segment, and a deep dive includes also looking at individual locations such as Savannah, Atlantic City, Jeffersonville, as each of these locations come with their own characteristics.
(Source: Tanger Factory Outlets Supplemental Presentation 4Q19)
So, the company is fairly simple in that it earns money through:
- The owning and operation of mall/outlet properties and leasing portions of these properties/spaces to interested parties.
- Minimum base rent levels from the aforementioned parties.
- Payments of operational costs/expenditures (including taxes on property).
What this means is that it's crucial for the company to maintain an ideally high (100%) occupancy ratio across all of its properties to maximize its base income (preferably with a wide variety of customers with high-quality credit ratings), but also to be able to - again ideally - increase customer lease levels when the contracts are renewed.
- Maintain high occupancy.
- Re-lease properties at higher rates than previously.
- Maintain an appealing diversification of high-quality tenants.
- Invest in or maintain/own appealing, high-quality properties in appealing geographies.
These are things that could/would heavily impact SKT's ability to profitably run its business and pay shareholders the generous dividend we're looking for, while also maintaining growth.
Tanger Factory Outlet - How has the company been doing?
With these things in mind, just how has the company been doing, given that it reported 4Q19/FY19?
Results for the full year were better than expected/guided for. They included:
- AFFO (Adjusted funds from operations) used to pay the dividends was $2.31/share. This also included some one-off effects from asset sales and the like.
- Debt reduction of $143M, resulting in an FY19 net debt/EBITDA of 5.7X TTM.
- Interest coverage ratio of 4.3X
- Tenant sales up 3% on an average basis, up to $395/sqft.
- Same-center net operating income decline of 70 bps for the full year due to closures and bankruptcies, but better than expected/guided for.
- 337 leases signed on a TTM basis, showing a 1.3% cash basis loss for all leases commenced in 2019. This is expected to continue going into 2020.
Here we start seeing some of the issues in SKT. While certain fundamentals, such as AFFO, income, sales, and traffic through SKT properties are still solid, we're starting to see cracks and striations in the company's lease spreads and, as a result, NOI.
What's worse, the company is expecting these to continue, as SKT continues to fight for the aforementioned crucial high occupancy ratio which delivers its base-level profits. In terms of all new leases, the new initial rent per square foot has dropped to $32.28, at over a full percent negative for the year. Putting some color to this - most of these new leases (302 out of 337) had terms of more than 12 months. For these new leasing contracts, the company managed a new rent per sqft of $33.75, which means that for long-term leases it only dropped 0.2%. However, this is still a problem, as only one year ago the company was able to increase leases by 3.1% for the long-term leasing contracts.
So again - cracks are starting to show.
The reasons for these are pretty self-evident. There's a decline in brick-and-mortar retail, which is acting to weed out the weaker companies with insufficient margins or weak balance sheets/safeties.
Following Forever 21, one could make an argument for Ascena (ASNA) being in serious trouble in the longer term.
This brand includes premium brands like Ann Taylor and Loft, but also Kids Fashion and Plus Fashion brands. The stock action would certainly suggest that something along the line of restructuring or even bankruptcy is possible. The company does not have the cash on hand to pay its upcoming debt in 2022 unless it starts selling off some of its brands. If Ascena was to sell even one underperforming brand, it's likely we'd see a situation where Tanger would have to re-lease spaces once again, which could put further pressure on leasing spreads and NOI. However, it's too early to make any definitive guidance about this, and currently, the company still has liquidity to make its payments. Still, it's something to consider.
Guidance for 2020 isn't all that great either. The company expects the decline to continue as it focuses on maintaining high occupancy rates, at the potential detriment of leasing spreads, impacting company NOI while possibly increasing tenant sales. Guidance is for a diluted FFO of $1.96-2.04/share going forward.
(Source: SKT 4Q19 Presentation)
I think it important to highlight both sides here. On one hand, we have quality management which during a time of trouble has managed to maintain and even increase occupancy to satisfying 97% for the year. AFFO payout ratio for the company stands 61.9% for FY19 and, based on estimated diluted FFO per share in the low range, is set to increase to 72.9% in 2020.
However, this increase in payout also takes into consideration the 2020 NOI decline of $0.26/share, more asset sales, SG&A and other items. It is, as I see it, a very conservative number from a very conservative company (in terms of guidance).
So - the question, "How has the company been doing?"
Some people seem to be expecting companies like Tanger Factory Outlet to come up with some sort of miracle when compounding factors work to influence an entire business negatively. REITs and malls across the world are experiencing the pressures associated with a decline in brick-and-mortar retail. In Sweden alone, perhaps a dozen large retailers went bankrupt in 2019 alone, and many more are struggling. This isn't national - it's international. It's a weeding out of the unprofitable and those incapable of surviving in a future retail landscape.
So what could SKT be doing, besides what they have been doing? The fact that occupancy is up, tenant sales remain high and earnings are still impressive tells me that Tanger Factory Outlet has class-A management at the helm. Leasing spread negativity aside - and it is significant - I see a continued decline as SKT struggles to maintain its occupancy, but I also see it stabilizing somewhat as we go forward into 2020-2022.
Let's go forward.
Tanger Factory Outlets - What are the risks?
There are plenty of risks here.
- The continued decline of retail could no doubt influence SKT more as we go forward. This is hardly over, and retailers like Ascena show us that there's plenty of companies still struggling to maintain the status quo. In 2020-2023, we might see more of these bankruptcies, and this would, of course, influence the REITs whose properties hold these stores.
- Leasing spreads/increases are poor, and likely to remain poor. Steven Tanger himself addressed this in the last earnings call, and was quoted as saying, "Looking ahead, as we progress through 2020, we anticipate increased pressure on spreads as we continue to make maintaining a high occupancy a priority." (Source: 4Q19 Earnings Call, Steven Tanger). This is, as I see it, pretty much saying, "They're going down - deal with it."
- Coronavirus impact: A new risk. People are less likely to frequent malls and shopping centers when there's an overhanging risk of imminent influenza and death. While this could be said to be short/medium term until we're vaccinated and everything's fine, it could still weigh on Tanger's tenants and, as such, on tenant sales and tenant stability.
- Economic Cyclicality: Admittedly, this is less of a risk to a company whose lifeblood is basically offering customers a bargain - but it could still affect sales and tenant performance and, as such, stability.
- Rating cuts: SKT is currently at a Baa1 with negative at Moody's, while S&P is giving a BBB with stable for the company. S&P cut their rating on SKT back in early 2019, and Moody's revised it on March 12th of last year. The risk I see as prominent here is that S&P goes to a negative outlook (with BBB) given SKT's outlook for 2020. To put it simply and without being in the know-how of the intricacies of how such ratings are made, the combination of the risks SKT is facing may warrant a negative credit rating outlook.
Those are a lot of bearish factors - and I actually agree with many of them. I invite you to read this excellent article by Brad Kenagy where he delves deeper into many of these points.
This isn't a risk-free investment.
Tanger Factory Outlets - What is the valuation?
The past portion was all about potential risks. Now we move onto my favorite segment.
In truth, I care little about short-term stock price movements, beyond what sort of discount they give me. They are indicative, but even my relatively short experience in the stock market has taught me that the market is pretty bad at "fairly" valuing the fundamentals of a company, instead tending toward either excess or undervaluation.
So, the bears are telling us that as far as Tanger Factory Outlet is concerned, "The sky is falling!"
So how has the stock market reacted to that, valuation-wise?
(Source: F.A.S.T Graphs)
We evaluate REITs on the basis of cash flows. Operating cash flows, equivalent to FFO, and FCF, equivalent to AFFO. Both pictures should make you consider two questions rather seriously.
First, is Tanger Factory Outlet about to go bankrupt?
The answer to that question is, I believe even most bears would agree, no.
Secondly, is Tanger Factory Outlet in danger of going bankrupt over the next few coming years?
Again, I think most would agree that the answer here is no.
Yet despite this, the market currently values these at a 5-6X multiple in terms of OCF and FCF (or FFO/AFFO).
Here are some more facts, namely what the market believes the company's tangibles and price/BV per share should be. Note that over the course of 15-18 years, the company has never been valued like this in terms of this metric. This is starting to get interesting, isn't it?
So, the question becomes, does Tanger's current valuation fairly and accurately represent the company's forward earnings potential and dividend yield?
(Source: Evidence in motion)
Now, given that I'm writing a bullish article on Tanger, you can guess where I stand here. I believe that the market as latched onto the negative views which, while valid to some extent, have depressed valuation for SKT to a level where it starts approaching ridiculousness.
It's nearly impossible for me to say exactly where the fair value "should" be, given that there are risks involved in investing here. If you choose to invest in Tanger, you're basically betting on management's ability to handle the coming risks and problems mentioned here. The thing is, management has a pretty solid track record of doing just that, and while leasing spreads are a bit worrying, Tanger has managed to maintain its competitively-high occupancy ratio despite all the industry challenges.
What's more, tenant sales figures and trends would not agree with the assessment that SKT is in trouble. Me, I don't care much about the nominal stock price - I care about valuation and fundamentals in relation to risks. Prior to below $20-30/share, SKT was too risky a proposition for me, given the potential risk of further bad news (even considering strong fundamentals). It wasn't a "bad" buy as I see it, but it's certainly not as undervalued as we're seeing now.
(Source: F.A.S.T Graphs)
The worst case that I see is a continued valuation at this level of 5-7X AFFO until 2022, which would yield a barely 10% Annual RoR, based on a small capital loss and the high, well-covered dividend. However, these predictions do include:
- Continued leasing spread pressure during 2020, 2021 and 2022.
- Continued NOI declines during these years.
- Continued declining FFO/AFFO.
While this is possible, I feel that it unfairly treats the skills of management, who've proven themselves to be able to handle a multitude of situations with grace and skill. Tanger is doing new things now as well - such as adding home decor and furniture stores, off-price stores, and restaurant concepts. The company is doing business development works and have several cases of temp stores that have become long-term tenants.
So in these forward assumptions, people seem to disregard what Tanger is doing at this time. Either that or not believe that it matters/that it will succeed.
But again, they are ignoring some facts. The fact that Tanger has already recaptured 303k sq.ft related to Dressbarn and Kitchen Collection, as well as F21 and Destination Maternity. Management is simply good at what they do.
Let's go ahead and move on.
So again, facts. Because these points about management, while accurate, are also somewhat presumptive and speculative going forward. The fact is that in recovery to historical market valuations, the potential upside for Tanger Factory Outlet at a price of ~$12/share is over 30% CAGR until 2022. What could cause such a recovery? I'm not sure - but part of it will be handling closures, leasing spreads and continues to handle occupancy dropoffs.
More importantly, the fact is that Tanger Factory Outlet is a profitable business that over the course of decades, including the last recession, has proven itself, with management, capable of handling a myriad of market situations. The company's dividend streak of over 25 years proves this. Management's "resumé" proves this, at least up until now.
Some bulls will tell you that this is a sure thing. That the company will not only manage to re-lease these properties but lease them at higher lease rates than previous tenants. That, I think is being somewhat too optimistic. (But feel free to correct me here!)
I feel it is equally flawed to essentially say that Outlet malls are dead, and SKT is uninvestable. Clearly, the fact is that they are not dead, because the company is quite profitable, and according to some metrics, it's in fact best-in-class.
Even if we see an NOI dropoff and a drop in diluted FFO according to low-range expectations, the fact is that the company's dividend is covered in 2020E based on any current FFO/AFFO guidance.
In times of panic, it's easy for investors to become spooked and no longer to focus on the fundamentals of a business - which, I strongly feel, is what matters in the end.
Earnings are what matter. Profit. Cash flows. FFO and AFFO.
Regardless of e-commerce, traditional malls/outlets such as those that Tanger operates will, I believe, be an essential component of the future retail landscape. While we've seen earnings/FFO/AFFO drop off in 2019 and are likely to see more in 2020, this degree of overreaction in the market is, as I see it, ridiculous.
To put it in simple terms, since 2016, the company has gone from being valued at 19.86X P/AFFO to 6.31X in P/AFFO to date. While there have been drops in earnings, I see this as an extreme overreaction, given the quality of the company, its earnings (which were $2.02/share in 2016 and $1.95/share in 2019) and the quality of its management.
So, here's what I've been doing as a result of the fundamentals of this business.
I've been adding SKT to my portfolio in steps down to the current share price - and I intend to continue adding to my position to a maximum exposure of 1.5% of my total portfolio. It ain't risk-free, that's for sure - but the risks are, I believe, overplayed (as is the extreme bull thesis). I believe the truth of the matter will turn out to be somewhere in the middle: SKT will manage to re-lease properties and manage its occupancy with its new strategies, but it will suffer from higher leasing spreads and lower NOI in doing so. Going forward, it's entirely possible that margins may be permanently lowered for the company as a whole.
However, given fundamentals and potential upside, that's something I can easily live with - and I not only expect my generous dividend to be well-covered, I expect long-term capital appreciation as the market wakes up to these potential realities.
Thank you for reading.
Due to extreme undervaluation in terms of cash flows and earnings, Tanger Factory Outlets is a "BUY".
This article was written by
Mid-thirties DGI investor/senior analyst in private portfolio management/wealth management for a select number of clients. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.
I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.
Analyst’s Disclosure: I am/we are long SKT, SPG, PSA, MAC. 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.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
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