Real estate investments turned problematic following COVID-19, with even quality names such as Simon Property Group (NYSE:SPG), Federal Realty Investment Trust (FRT), AvalonBay Communities (AVB), and Realty Income Corporation (O) falling like stones in the midst of an ongoing, global pandemic. This wasn’t that big a problem for me. I didn’t actually hold any position in most of them prior to the pandemic, and the drop in valuation in March became the trigger to even start a position in Realty Income, AvalonBay, and Federal Realty. I did have a modest stake in SPG but proceeded to substantially increase it to my largest non-European holding during the crisis. Most of the positions mentioned above are performing well.
The worst performer in real estate in my portfolio, at least at a non-trivial position size (Macerich (MAC) is only at a starter, 0.04% stake), is Tanger Factory Outlet (SKT), a 0.3% stake. I didn’t buy the company near the valuation espoused by some during pre-pandemic valuations, seeing some of the risks there, but I did increase my stake before the company reached truly appealing valuations. As a result, the stake is down quite substantially (around 40%) even from my relatively “good” valuation – at least I considered it such at the time.
In this article, we’ll take a deeper dive into Tanger Factory Outlet to see where I believe we should view the company going forward.
Tanger Factory Outlet – How has the company been doing?
2Q20 is the last quarterly report we have. While the company hasn’t moved substantially in either direction as a result of this report (though some other things are affecting the sector), there are some items to pay attention to.
- First of all, SKT liquidity is at a level of $564M at the point of 2Q20, following pausing of the company dividend, pay cuts for management, deferrals of ongoing projects, and COVID-19 cost reductions. The company also has no significant maturities until 2023, three years from now.
- Secondly, 95% of SKT’s stores are open again as of July 31st – although there is of course some reduced capacity and distancing rules impacting exactly how “open” they can be considered to be compared to pre-pandemic levels. Still, it’s important to note that opened stores has gone from 1% in April, to 95% in July – less than 4 months.
- The company hasn’t furloughed or laid off any employees as a result of the pandemic.
- The company has worked extensively with its tenants to provide rent support, through interest-free deferrals until early 2021.
(Source: SKT 2Q20 Presentation)
During 2Q20, the same center NOI decreased nearly $40M YoY, and blended average rental rates decreased by just north of 1% YoY. Obviously, the primary factor influencing SKT is the substantially lower, currently just over 70%, rent collection which is currently pushing company income down. Any situation where Tanger Factory Outlet didn’t trade at these sorts of levels would be a situation I would consider disconnected to the market and facts – especially when considering how higher-quality (credit rating, size, payout ratio) REITs have suffered during the same time period. No matter where you land on Tanger, it’s not at the same quality, has higher risk, and as such, it should suffer more. And it has.
However, at the same time, SKT has taken the opportunity during the pandemic to show how the company handles a crisis. Thus far, I view these responses as being positive, as they cover both working with tenants, allowing for financial flexibility, but also leveraging available space and using the situation to sign both temporary and permanent new rental contracts.
At the same time, there is significant pressure coming from retailer closure, which in Tanger’s case represents a significant percentage of their rent base. Ascena (ASNA) is the largest of these, representing almost 5% of SKT’s portfolio. The company does, however, hold some brands which are also experiencing trouble under its wing, meaning the negative assumptions for parts of Ascena is already included in the prospects that Ascena becomes bankrupt.
Aside from these closures, there’s also a significant negative impact in the quarterly rent collections. While SKT does collect above 70% of rents for the period, the company only actually collects 43% of billed, defers 26%, and seeks resolution for 6%. SKT expects to not collect 11% due to closures, and 14% to non-recurring concessions. Those are big numbers.
Further color shows, however, that on a month-by-month basis, the company has increased its billed rent collection to 72% for July – which means that these numbers, as dismal as they are, seem to really only be temporary. The same trend continues into August of 2020.
(Source: Tanger Factory Outlet)
The question of COVID-19 impact upon Tanger is undeniable. The impact has been brutal. As of 2Q20, there have been 14 bankruptcies which heavily impact not only current collection rates and profit, but will likely grow worse as things go forward. The current impact is over 12% of SKT’s currently rentable space, which is an impact that’s almost unheard of in the company’s history.
At the same time, it can’t be said that Tanger is “unattractive” to its customers or leasers. The reasons for this is much more than just the fact that while malls are overrepresented, outlet centers across the USA are rather few (compared to the number of malls).
With over 30 new permanent store openings, 35 pop-up store openings during one of the roughest quarters on record, as well as many more deals in the works, the signals are clear in that SKT is still an attractive prospect, and may grow more so as we move forward. Pottery Barn and West Elm have opened – so the expectation seems to be that part of the apparel-related challenges will be weighed up by the introduction of home furnishing. These are some of the positive signs seen in 2Q20.
However, it’s completely undeniable that COVID-19 has only made worse the occupancy trends that have been going on for years. This is further added to by currently negatively-developing leasing spreads. Tanger is essentially rowing against a strong current. I believe that some of the stores which have now declared bankruptcy – around 12% of the portfolio – would have declared bankruptcy regardless of COVID-19, at least sooner or later.
In the end, I don’t see that the very long-term end result for Tanger would have been materially better than it has turned out to currently be.
The difference is that COVID-19 has forced the “weak” tenants to a premature termination/bankruptcy, which has completely removed Tanger’s ability to counteract this negative occupancy trend on an ongoing basis (over the course of several years). It has also significantly worsened (this is an assumption, though I believe it accurate given the market climate) the company’s bargain position and lease pricing power with regards to new tenants – and we cannot forecast what sort of deals SKT could be making at this time. Any such forecasts would be speculative.
Concluding 2Q20, the quarter was better than I expected in terms of the company’s reactions to the pandemic as well as its recovery in terms of foot traffic and store openings. However, things are worse in terms of bankruptcies (Ascena and beyond). The quarter hasn’t pointed to any ultimate direction for the company long-term over the next 2-5 years. However, I do see trends that should be considered by investors over the next few quarters.
Tanger Factory Outlet – What is the valuation?
It shouldn’t be surprising that Tanger Factory Outlet, on the face of it, trades at an extremely appealing valuation below $6/share. My cost basis for my position is just south of $10/share, after having filled up at times during COVID-19, but is lower as a whole due to unfavorable FX (my base currency being the SEK, and given current USD weakness).
The company’s valuation is now materially better compared to when I invested last.
(Source: F.A.S.T Graphs)
I believe it can be clearly stated that SKT doesn’t deserve any type of market premium considering the trends over the past few years. At the same time, it’s a long way from saying that SKT deserves to be trading at a weighted average P/FFO of 3.5X – the lowest of all investment-grade REITs. I believe you’ll have a hard time finding anyone who with conviction states that the company will be bankrupt in either the near term or the long term. At worst, we’re looking at a significant dividend cut and reduction of its operating size – but the model of outlet centers is something I do believe will survive.
If this is the case, the question is what sort of discount you’re looking for prior to investing.
This sort of bottom-feeding valuation speaks its own language, when you try and forecast it, but bear in mind that any forecasts here are at the very best, speculative.
(Source: F.A.S.T Graphs)
We can say that SKT trading at the current valuation for the next 2 years will still bring a 12% annual return, but this is based on forecasts which have missed the mark 27% of the time with a 10% margin of error, and a dividend which in all honesty is hard to forecast at this time. FactSet analysts forecast a 0.72/share dividend during 2020, which would amount to a ~12% yield at today’s valuation. Given the trends that the company currently experiences, any such forecast needs to be taken with an amount of salt so large that it can no longer be said to be relevant to a conservative investor.
I believe two things can be stated, as things are.
1.) Tanger Factory Outlet is undervalued in the long term, based on its operating cash flow and what sort of valuation the market is assigning its properties, compared to peers and other REITs.
2.) At the same time, it’s difficult to say what sort of recovery period we’re looking at for the company, given the very real issues and headwinds Tanger is facing. I do forecast a return to somewhat more normal FFO during the coming quarters/years, but at the same time, bankruptcies are going to start influencing company results. Therefore, the current forecast is uncertain.
The conclusion from these two things is, to me, clear – take care.
An undervalued company with underlying quality is a rare find. At the same time, the near-time trouble spells out a warning. This will later bring me to my rather complicated thesis for Tanger.
Let’s look at the collective bull and bear stances for the company.
Tanger Factory Outlet – Bulls and Bears
SKT Bulls come in many varieties – both those who believe in a short-term massive reversal to the mean for Tanger, which would bring double-digit return in the 50-60% range. Then there are cautious bulls who would say that Tanger at some point will return to a more fair and representative value of its earnings and payouts – though when this is, that’s a different question.
I land somewhere between the two.
The pressure I see upcoming from bankruptcies is mostly short and medium term – stretching over the next few quarters as the world reels from COVID-19 and slowly tries to recover its momentum. While there is no doubt that foot traffic numbers and “parking lots are filled” does indicate at least some modicum of customers returning to Tanger, this in itself isn’t enough to convince me to be more bullish than I currently am.
The issues hounding this time-tested REIT go somewhat deeper than simple sales numbers and same-store NOI now that 12% of the company’s portfolio is in danger – a serious blow to occupancy. While the signs of a recovery are positive, I can’t help but consider the short- and medium-term effects of the ongoing bankruptcies, releasing and the company’s success or failure rates here.
Any bullish view that’s not peppered with caution is, at this point, one that could be far too optimistic as I see things. The combination of a lack of bargaining/pricing power, upcoming bankruptcies, tenant trouble, and lingering COVID-19 effects should temper even the most die-hard bulls.
The question isn’t, as I see it if Tanger will return to a positive position in terms of results. The question is when. Because of a combination of these negatives and the two simple facts that:
a) There are better alternatives in the real estate space out there, at this very minute. These have upsides similar to Tanger, and also a far better market position/situation.
b) You’re not really missing out on much, given the near-complete lack of forward clarity at this point and the now-paused previously-attractive dividend.
These facts mean that even the Bullish thesis for Tanger at this time should be laced with patience and caution. A convincing case for why Tanger will ultimately grow back up and why trends are reversing can be read in this article by Brad Thomas.
The Bear thesis for SKT falls into one of two camps. Those who believe that SKT is still valued too high given the risk and the upcoming headwinds, and those who believe the outlet models and REITs overall are doomed to failure as people generally move away from physical shopping to online shopping exclusively.
The first camp here is simply a variation on the bull thesis that the company will eventually get back to fair value – with the bearish version being that SKT hasn’t actually reached any sort of appealing valuation yet, but they may going forward.
There is some validity to this argument, and I myself currently represent a stance somewhat like this, given that I believe there are superior alternatives to Tanger (though not necessarily due to the current valuation). A great wrap-up of the bearish side can be found in this article by Brad Kenagy.
The second camp is a stance I find more difficult to counter, given that it assumes a complete shift in consumer behavior that’s prevailed for over a century and more. While I do believe that trends will shift towards more shopping online, I also believe that retailers will be able to meet these changes and perhaps even grow from them.
Still, the bear stance here is that the coming decade or century will bring about such change that normal models of operating stores – including outlets and outlet centers – will no longer be relevant at all, and as such, the operators like Tanger will fall to ruin.
There is, I believe, a misconception that Tanger seems to be wholly unable to respond to an e-commerce/retail landscape – something the company has already responded to, in opening Tanger Virtual Shopper, which is the beginning of introducing an outlet store e-shopping model.
There are in fact quite a few expectations and forecasts that seem to base their entire premise on the notion that companies like Tanger Factory Outlet will sit on their hands while their market share drops due to a continued shift towards online shopping tendencies. Either that or that the companies, wholly unable to change and adapt, will simply fail at everything they try to meet these new tendencies.
First, the people these bearish stances are addressing have been in the business for decades and weathered financial storms the likes of which you or I probably can’t fathom. This is the management quality argument which I’m sure you’re familiar with.
Second, while I don’t live in the USA, I know for a fact that there are many people who do not want to buy X or Y online but instead prefer to physically visit a store. For me personally, these categories include clothes, shoes, furniture, and building supplies. Most friends and most people I know do not shop their clothing online, and this is especially true for female shoppers, which make up the majority of SKT’s customer base.
Sure, you may order shoes on Zalando or perhaps a pack of socks or a deal on Amazon (AMZN), but for the most part, you visit stores – often in malls – to buy your things. Recent shopping trends pointed out by authors looking into the trends at Tanger outlets confirm a return towards normal-level foot traffic, with a NAREIT-reported number of 80% of normal. This is the reversion-to-normal argument.
Third, while fundamentals show some serious problems for the short-to-medium term, and Tanger needs to show its capabilities as a business to re-lease the space that will now be vacated, the signals coming from the company are far from “all talk.”
While there will no doubt be a dent in the company’s prospects and income over late 2020 and early 2021, I believe many to be ignoring the overall positive fundamentals we can see here, even with that situation. As a result of this, they mistake short/medium-term challenges with fundamental/secular ones and risk landing in the extreme bear camp.
All that being said, I wouldn’t, and won’t invest in Tanger Factory Outlet at this time.
My reasons for this stance are:
a) Quality REITs with better metrics and prospects than Tanger (though not necessarily with a higher yield) are available at multi-year lows at this time. These offer safer investment prospects.
b) While you may be missing out on a potential upside by waiting for the full 2020 effects to materialize, you’re also safeguarding your portfolio from a significant amount of risk that could happen if the prevailing market sentiment regarding Tanger remains rather negative. In terms of a risk/reward ratio, I, therefore, see alternative investments as a better choice at this time.
It’s not so much a valuation-related thesis, given that the company is trading where it is compared to its peers and in terms of history. The valuation is already extremely low. To say whether it will drop further is a hard call to make. What can be said, I believe, is that the potential for further, significant negative news items during a time when the company has announced nearly 12% of portfolio bankruptcies and with the overall market spelling out challenges in terms of finding new tenants or a lack of bargaining power in renegotiation.
During a time where trends spell such troubles, I would prefer to look at REITs that share few or none of these negatives. Because of that, my stance for Tanger at this time is a “HOLD.”
Once things clear up and once effects materialize, I’ll likely buy more at the right price.
Thank you for reading.
Further near- to medium-term headwinds and challenges suggest money is better invested elsewhere, in REITs with fewer issues and stronger balance sheets. Tanger is a “HOLD.”
Disclosure: I am/we are long SKT, FRT, O, AVB, SPG. 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.
Additional disclosure: 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.