Tanger Factory Outlet Centers (SKT) is the largest factory outlet center REIT in North America. In this report, we analyze the company’s growth profile, market dynamics and dividend. We share our opinion on why this company’s big sturdy dividend may not be enough to offset its share price declines in the years ahead. And finally, we share two attractive big-dividend REIT ideas that we like more than Tanger.
Tanger Overview:
Tanger owns and operates factory outlet centers in the United States and Canada. The company earns revenue in the form of base minimum rents, a percentage of sales volume generated by tenants and reimbursement of operation and management expenditures including property taxes. As of FY 2019, SKT owned or had interest in 39 income-producing properties having a gross leasable area of more than 14 million square feet.
The factory outlet centers are different than typical mall stores as retailers generally sell excessive stocks or old inventory at discounted prices in their factory outlets. Tenancy cost, which measures rental as a percentage of sales generated in the stores, is also low for factory outlets as compared to shopping mall stores. In fact, SKT offers a tenancy cost ratio of 10%, which is lower than most other mall REITs however typically outlets are located far from cities so the comparison with traditional malls is not truly apples to apples.
The largest tenant for SKT is The Gap, Inc. which occupies 96 stores at SKT properties. Almost 6% of the total annualized base rent is generated from The Gap and it occupies almost 8% of SKT’s gross leasable area. The Top 5 tenants based on percentage of annualized base rent have been listed below:
(Note: Ascena Retail Group’s brands include Ann Taylor, LOFT, Lou & Grey, Lane Bryant, Cacique, Catherines, and Justice. PVH brands include Calvin Klein, Tommy Hilfiger and Heritage Brands).
Secular decline in brick and mortar retail
There have been fears surrounding the death of offline retail over the last decade. Online retail has taken significant share from offline retail as consumer behavior evolves and the value proposition of online retail improves. The rise of online retail has led to store closures and bankruptcies of various big retail outlets such as Forever 21, Fred’s, Payless and Toys-R-Us. As a result, investor sentiment pertaining to the mall REIT space has gone sour. While stronger players will reinvent themselves and successfully manage through the broader trends, weaker retail REITS will increasingly find it difficult to compete.
Not surprisingly, mall REIT valuations have receded significantly. In fact, at the end of FY 2019, retail REITs were yielding 5.1%, much higher than the overall REIT space. While valuations do look appealing at these levels, we believe investors need be highly selective about investments in the space focusing only on high quality retail REITs.
Retail bankruptcies are taking a toll on SKT too. The company announced 2.5% of total GLA or 303,000 sq. feet of known closures in January 2020 relating to all the Dressbarn and Kitchen Collection stores, and certain Forever 21 and Destination Maternity stores. It has also identified 322,000 to 372,000 square feet of potential additional closures that may take place during the year. Both these items add up to approximately 5% of the total gross leasable area. Finally, please note that the company’s properties primarily cater to merchandize based transactions and it will not be easy for it to reposition its properties to cater to entertainment and food establishments.
Rent per square foot under pressure
In 2018, the average rent per square foot at Tanger was $25.5. Average rentals have been declining for the last 3 years and the trend is expected to continue in FY 2020 since Tanger will be forced to re-lease vacant properties from bankruptcies immediately to maintain occupancy levels and therefore may have limited bargaining power. On the Q4 2019 earnings call, the company’s CEO said,” Looking ahead, as we progress through 2020, we anticipate increased pressure on spreads as we continue to make maintaining high occupancy a priority.”
Declining occupancy and rentals put pressure on same center NOI growth
For the last 25 years, Tanger has consistently reported occupancy level of more than 95%. In 2019, it had an occupancy level of 97%, but the recent bankruptcies of its tenants and subsequent closing of stores have taken a huge toll on occupancy levels. For the year 2020, Tanger has given an outlook of occupancy levels of around 92%, which is much below its historical average. A decrease in occupancy level will have a direct negative impact on the net operating income and FFO (funds from operations) of the company. Even as the company re-leases vacant properties, lower rental spreads across portfolio will put pressure on NOI. In 2019, same center NOI was down 1% YoY primarily because of the impact of tenant bankruptcies, store closures, and lease modifications. Management estimates that 2020 same center NOI will likely decline around 7.5% which is a significant deterioration relative to historical averages.
Weak operating conditions hurting cash flow
Naturally, declines in NOI are expected to impact FFO per share and management expects 2020 FFO per share to be around $2.00, which is a 12% decrease on a YoY basis. Between 2016-2019, FFO per share has been essentially flat, however heightened retail bankruptcies are finally leading to substantial declines in FFO.
Low leverage, high interest coverage and comfortable dividend coverage ratio are bright spots
The company has a high-quality balance sheet providing management with considerable room to weather a storm in the near to medium term. The company’s Debt to FFO of 6.9x is one of the lowest in the sector and FFO to interest expense at 3.6x is above average.
SKT’s dividend payments have been insulated from the underlying business trends, SO FAR!
Tanger’s dividend per share has grown at a CAGR of 8% over the last 5 years. In FY 2018, the company declared $1.39 dividend per share which has risen to $1.42 in 2019, a growth of 2.2%. Typically, increases in dividends are a reflection of strength in the underlying business however as mentioned earlier in this report the company’s NOI trend has been flat to declining since 2017.
The growth in dividends has primarily been a function of increasing payout ratios from around 50% in 2014-15 to close to 70% of FFO per share expected in 2020, given the 12% decline expected in FFO during the year. Having said that, a 70% payout ratio in terms of FFO is still healthy and dividends look safe in the near term however clearly the underlying business will finally dictate the trajectory of dividends in the long term. During the Q4 2019 earnings conference call, CFO of Tanger, Mr. James F. Williams mentioned:
“We anticipate this year (FY 2020) to have free cash flow after the payment of our dividend of around $75 million. We anticipate continuing to upgrade our shopping centers of greater co-tenancy, raise our dividend, and we feel we have -- and start our new development in Nashville, all with internally generating cash flow. And we have $16 million of cash on hand. We anticipate that the cash flow and the cash on hand will be adequate to fund our capital needs in 2020 without changing our leverage profile.”
Dividend yield is high but sometimes value is value for a reason!
Tanger’s valuation has taken a major beating over the last 3-4 years as investors worry about the ongoing offline to online retail share shift and Tanger’s business fundamentals deteriorate as a result of the unfavorable secular trends. The stock has lost 70% of its value in the last 4 years despite consistent growth in dividends. The company’s dividend yield has risen to 10.9% as a result.
While the high dividend yield may be attractive and the expected payout ratio of 70% doesn’t lead to concerns around any dividend cuts in the near to medium term, it is important to note that valuation multiples of the company could continue to contract over the foreseeable future as underlying business trends deteriorate. Below is the store growth trend of the top 2 tenants of the company:
In the recent conference call, Teri List-Stoll, CFO of The Gap, Inc. said “We remain on track to close about 230 specialty stores by the end of 2020, with about 130 store closures completed in 2019”
Ascena, in its 2018 10-k, had the following commentary:
“Over half of our leases have terms that either expire, or have upcoming lease action dates available to us within the next two years, which provides us the opportunity to aggressively negotiate new lease terms while continuing to shorten our overall portfolio average lease life.”
The above commentary indicates that business fundamentals are nowhere close to bottoming out and there will be continued downward pressure on occupancy and rental yields.
What could go right for SKT shares?
M&A transaction involving Tanger: Simon property (SPG) recently acquired Taubman (TCO) group at a 51% premium to Taubman’s prevailing stock price. As the broader environment weakens for brick and mortar retail, stronger players are buying attractive assets selectively at appealing prices to improve their competitive positioning. A larger player could acquire Tanger at a premium however the probably is low given the company’s positioning as a mid-tier outlet player with limited repositioning potential.
Our Conclusion on Tanger
Tanger is facing a difficult macro backdrop given the offline to online share shifts. Further, the company’s properties cater to the low to mid-tier end consumer looking for bargains on brands. As such, it will be difficult for the company to diversify away from retail to entertainment/food tenants in the near to medium term. While the company’s dividend yield is attractive and we do not expect a dividend cut in the near term, weakening fundamentals will continue to erode the long term earning power of the company which will lead to further derating of the stock and that may offset any income potential from dividends. In plain English, Tanger’s dividend looks safe in the near-term, but its share price appears in great danger. In our view, Tanger has the makings of a classic value trap.
Two REITs we like more than Tanger.
CyrusOne (CONE), Yield: 3.0%, Likely Buyout Target
It is possible that (similar to what happened to Taubman) Tanger may get acquired by a larger REIT at a big premium. However, that seems very unlikely considering Tanger’s positioning as a mid-tier outlet player with limited repositioning potential. One the other hand, CyrusOne is an attractive REIT, and it seems likely that a larger REIT will acquire it at a healthy premium price. We recently wrote a detailed full report about CONE for our members-only, and here are a few key points and takeaways from that report:
CyrusOne specializes in owning, operating and developing enterprise-class, carrier-neutral, multi-tenant and single-tenant data center properties. It has a geographically diverse portfolio with a high quality customer base. And its strong development pipeline provides growth visibility. Further, it has robust leasing activity and has been expanding its European footprint to capture growing demand. Further still, it is financially strong and trades at an attractive valuation. It only yields 3.0%, but the dividend and price have been increasing, and it is a potential buyout target. As we wrote in our full CyrusOne report:
“CONE is a potential buyout target, and this is a good thing for investors. Specifically, scale is an advantage in the data center world, and CONE is still relatively small relative to some peers (for example Digital Realty and Equinox). And as larger peers look to grow, they look to smaller players as acquisition targets. For example, the share price of CONE got a strong bump months ago when it was reported as a potential buyout target, but the shares have since declined in value again, thereby adding a margin of safety for investors in our view. Given the competitive environment, we expect that CONE will eventually get acquired at a premium price by a larger peer, whereby shareholders would receive a significantly higher price for their existing CONE shares. And even if CONE doesn’t get acquired, it remains an attractive, long-term, dividend-growth investment.”
If you are looking for a very strong and growing dividend with attractive price appreciation potential, CyrusOne is worth considering, especially since (unlike Tanger) it has a relatively high chance of getting acquired at a large premium.
CoreCivic (CXW), Dividend Yield: 10.4%
CoreCivic is a “private prison” company, and political rhetoric has created an attractive buying opportunity. The shares have sold off hard despite solid cash flows and a high demand business with long-term visibility. It is a mission-critical business and there is a strong lack of alternatives (i.e. very good for demand). The dividend is safe and well-covered. We concluded that full members-only article by saying:
“Political rhetoric has created an attractive buying opportunity as the shares of this big-dividend-paying, steady (and growing) business, have sold off. Even in the worst case scenario, CoreCivic’s properties and capabilities will remain in high demand. And in the meantime, the dividend yield is very high, strong and well supported. The discounted share price presents and extremely attractive buying opportunity in this 10.8% dividend yield REIT.”
Bottom Line Takeaways:
Tanger’s dividend is safe and will likely increase again within the next year (as management indicated on the call, as noted earlier in this report). However, Tanger’s share price is not safe, and could decline more than enough to offset any dividend payments. Tanger’s business is in decline, 2020 will likely be a bad year, and SKT is shaping up to be a classic value trap. While some investors hope for Tanger to get acquired at a premium (like we just saw for Taubman), a better acquisition bet is data center REIT CyrusOne. If CyrusOne gets acquired, it’ll likely be at a healthy premium. And if it doesn’t get acquired, it’s still an attractive growing REIT, with a strong growing dividend, and the potential for powerful long-term price appreciation. Further, if it is pure big yield that you are after, CoreCivic’s 10.4% dividend yield is a much safer and more attractive REIT than Tanger.