This article was coproduced with Williams Equity Research (WER).
As many of my readers know, I’m long on Tanger Factory Outlet Centers (SKT) and was before the shutdowns began.
With that said, I’ve been underweight malls for over four years now. And, at iREIT on Alpha, all of our Buys or Strong Buys in this sector are considered speculative.
Tanger and Urstadt Biddle Properties (UBA) are by far the most beaten-down “outdoor” retail REITs. The former is approximately 25% below the top of our fair value estimate. The latter is 35% below.
No other REITs come close to those kinds of comparative valuations.
While this may generate alarm – and justifiably so – keep in mind that most REITs were in the exact same situation earlier this year.
Besides, as long-term investors, our goal is to engage in opportunities with a high probability of success going forward. We’re confident that both SKT and UBA fall squarely into this category… albeit for different reasons.
Can Tanger Weather the Storm?
We’ll start with a section from our recent analysis of Tanger’s Q2 earnings provided to subscribers immediately after its release:
“Tanger is certainly one of the more interesting REITs to analyze for Q2 of 2020. It’s not a question of if it’s a bloodbath, but rather if the bloodbath is better or worse than expected.”
Let’s evaluate the recent past: Q2 2020 and the data management provided in July. Given September is only a few days old, we wouldn’t expect more current data than that even if we worked for Tanger.
Despite headlines like the renewed lockdowns in California, 95% of stores in Tanger’s portfolio were open as of July 31.
That’s 36 out of 38 stores, which is the first of three layers we want to analyze. Each component needs to be satisfied before the next comes into play.
Given the current environment, Tanger easily passes the first assessment. The second layer is understanding how many tenants are active at these open stores.
Naturally, stores open without tenants don’t do us any good.
(Source: Tanger Q2 Supplemental)
In this case, Tanger ended Q2 at 93.3% occupancy, which is 300 basis points (bps) below its long-term average. While that’s worth paying attention to, It isn’t a crisis. Tanger’s distribution and interest coverage has way more than enough cushion to cover that long-term.
Which brings us to rent collections. This area can be divided into two segments: New leasing spreads and rent collection on existing leases.
For the first item, Tanger’s straight-line spreads declined only 1.1%, which is better than we or the market expected. And even if it was worse, it wouldn’t be significant in the near-term since only 5% of average base rent is up for renewal for all of 2020.
More Good News and Bad News About Tanger
Let’s begin with some bad news. Namely that core funds from operations (FFO) were $2.48 and $2.31, respectively, for full years 2018 and 2019. But it was only $0.60 for the first half of 2020.
To be sure, that’s a big drop on an annualized basis.
(Source: Tanger Q2 Supplemental)
It’s data like that – or assumptions of such – that has led to the stock suffering so much as of late. Yet its balance sheet hasn’t matched that fate.
Tanger’s weighted-average effective interest rate was 3.1% at the end of last quarter – within 200 bps of the best number in the entire industry. And it maintains $538.8 million in cash and liquidity from its lines of credit.
For context, Tanger’s market capitalization is currently $567 million. That means it has one of the strongest ratios of liquidity to market cap in the industry, if not the best.
It effectively maintains no secured debt and has total debt to adjusted total assets of 53% versus the covenant limit of 60%. REITs with A rating tend to be closer to 40%, but Tanger is otherwise in a decent position.
(To be clear, management hadn’t quickly reacted to the crisis by paying down $200 million in June and $320 in July. If it hadn’t, Tanger could have breached the 60% covenant thanks to the unexpected devaluation of its asset base.)
As such, it maintains a BBB rating from S&P with a negative outlook, which was last revised on March 27. This was a reasonable assessment given the sensitivity of Tanger’s business model to foot traffic. And the fact that it suspended its development projects to preserve liquidity lowers the near-term probability of a downgrade.
One weakness is the 4.4 weighted average years to maturity of its 2024 senior unsecured notes. That’s on the shorter term – and therefore riskier side – of its investment-grade peers. This strategy has worked out well considering recent interest rate trends but shortens the period Tanger can follow the current “wait and see” approach.
The first half of 2020’s FFO was $59 million, and the distribution payout ratio has climbed to 119.3%. Be it be a retail REIT like Tanger, a mortgage REIT like Starwood (STWD), or a business development company (BDC) like Ares Capital Corp (ARCC), we want that average figure below 100%
And for mature equity REITs, we prefer a cash flow payout ratio in the 65%-75% range. That said, context matters. And Tanger’s ability to almost cover its distribution during the trough of the coronavirus shutdowns remains respectable.
We calculated the overdistribution in the first half of the year, and it came out to 1.7% of its total liquidity. That’s perspective worth keeping in mind.
In line with most of its peers, Tanger has withdrawn guidance for 2020. We understand why that worries some people. But, for our part, we don’t rely on management’s expectations alone to make our decisions.
So this just isn’t too important for us right now.
Instead, we need to ascertain the probability of outcomes and establish a risk-adjusted entry point that makes sense. California notwithstanding, the country is far more open economically today than during much of Q2.
For those who missed it, we discussed this in more detail in our UBA article. We also have an array of foot traffic data – including proprietary/pay-only sources – that show how outlets were the fastest to recover of all retail property types.
(Source: Tanger Q1 2020 Presentation)
A Closer Look at Tanger’s Tenants
Outlets also have the lowest cost to tenants, an important characteristic as retailers struggle to reduce expenses. And Tanger specifically provides one of the most cost-effective means for retailers to establish a successful brick-and-mortar business.
(Source: Tanger Q2 Supplemental)
We’d need a series of articles to comprehensively review Tanger’s top 25 tenants, but we’ll touch on a few key members.
Ascena Retail Group‘s (ASNA) bankruptcy, for one, made headlines last month. A major driver for Tanger’s long-term resiliency is its geographic and tenant diversification.
Despite being the outlet group’s second-largest tenant by gross leasable area and – unsurprisingly – annualized base rent, neither metric is more than 4.7% of the portfolio. On average, Ascena represents about one out of every 20 Tanger properties.
That’s a big hit, but there are several mitigants.
First, not all of Ascena’s stores will close. The retailer’s negotiations with lenders are pointing toward at least 60% of stores remaining open, and Tanger provides among the lowest-cost options.
Second, Tanger’s re-leasing track record is up there with the best in the business. We saw it work through the Dress Barn closures recently and a litany of other retailers that went out of style and/or business over the years.
There’s no doubt many of Tanger’s top tenants are struggling, including:
But isn’t brick-and-retail dead and Amazon the future?
We Focus on the Data
For the record, we’ve been hearing the demise of all traditional retailers since at least 2014.
Also for the record, we own stock in a few retailers on a valuation basis but otherwise have no skin in this game.
With that established, there’s no doubt e-commerce growth has outperformed traditional retail sales and many other segments of the economy too. At the same time, traditional retail sales grew from $2,985 billion in 2016 to $3,043 billion in 2017, a 2% increase.
E-commerce, meanwhile, grew 16% year-over-year, setting a trend that’s continued ever since.
Looking at the most current data available, the U.S. Department of Commerce shows July 2020’s retail and food services sales increasing 1.2% over June and 2.7% vs. July 2019.
Again – that’s an increase. Moreover, carving out retail alone, sales were up 5.8% compared to 2019. Plus, of the top 50 online retailers, effectively all operate traditional stores.
Let that sink in as the doom and gloom subsides.
More Determining Data to Dwell On
It’s too early to accurately estimate full-year 2020’s retail sales or the distribution of brick-and-mortar to e-commerce. Forecasts from Techcrunch and eMarketer state that e-commerce will rise 18% in 2020, while total retail sales will decline 10.5% to 2016 levels.
2020 matters, to be sure, but not nearly as much as 2021 and beyond. Given what we’ve seen for July, it’s reasonable to assume the rest of 2020 will be in line with the last half of 2019.
While it’s natural to be skeptical of these figures given the GDP and employment numbers we heard in Q2, don’t forget that global governments spent over $10 trillion for economic stimulus in just two months of 2020.
That’s three times the amount spent during the entire financial crisis of 2008-2009.
The same proportion applies here in the U.S. Consumer spending is likely to end up much stronger than the financial crisis for a multitude of reasons, including aggressive stimulus.
(Source: Tanger Q1 2020 Presentation)
Let’s put out three possibilities…
Scenario I: Store openings are very close to or at normal levels next year. Since 93.3% of tenants were open in Q2, we’ll stick with that number for now. We’ll also assume that 2021 normalizes in the lockdown department but sales remain depressed at $360 million. For reference, that’s approximately what was achieved coming out of the financial crisis in 2010. Retail sales nationally, however, are expected to hit 2016 levels this year and recover back toward 2019’s in 2021.
For rent collections, Q2’s value isn’t rational given:
- The bulk of rent allowances and incentives occurred in this quarter covering the next 12 to 18 months
- The rapid recovery that’s already taken place in July
So we’ll average the first half of 2020’s performance with expectations regarding the remainder of the year instead. July’s data – much of which was provided in the Q2 10-Q and supplemental filings – suggests the second half will generate funds available for distribution of $75 million.
Source: Tanger Q1 2020 Presentation
That’s the midpoint between the first half of 2019 and 2020’s FAD. We especially prefer FAD over FFO in these circumstances since it takes into consideration tenant allowances, lease incentives, and capital improvements.
Sometimes the variance is immaterial, but that’s not the case for Tanger in recent quarters. Our conservative estimate is for FAD of $49.3 million plus $75 million or $124.3 million for 2021, or a 4.6x FAD multiple at today’s $571.6 million market capitalization.
That’s between one third and one fourth of investment-grade retail REIT averages. We assume rents are flat indefinitely.
Scenario II: Occupancy for 2021 moves up only slightly to 94% and remains 3% below Tanger’s historical average. Rent collections improve moderately, resulting in FAD that’s 15% lower than 2019’s in the first half of the year and 10% lower in the second.
This equates to $175.0 million in FAD in our neutral scenario, putting Tanger’s stock at an eye-opening 3.26x FAD multiple. And we’ll attach a very modest 1% growth rate in rents from there.
Scenario III: Tanger’s operations normalize at 95.5%, or 1.5% below their recent figures. Cash flow, measured using FAD, is 10% lower than 2019 – but the better metrics permit rents to increase by 2% annually in the future, which results in approximately $185 million, or a 3.09x FAD multiple.
Conclusion and Valuation
As we’ve mentioned many times before, generally accepted accounting practices (GAAP) don’t accurately depict what occurs during a period of deferred or negotiated rents.
This significantly overstates Tanger’s Q2 FFO. Our analysis, however, is concerned with future activity. And it’s not expected that 2021 will be impacted in this manner.
That’s why we didn’t need to make any significant adjustments for this variable.
In Scenario I, Tanger’s cash flow stabilizes between 2019 and the first half of 2020’s numbers but doesn’t increase, negatively impacting value. Using a highly depressed 8x FAD multiple, $10.35 is fair value – 73.9% higher than today’s close.
For Scenario II, the situation improves but all key metrics remain well below historical averages. We modestly increase the FAD multiple to 10x here, resulting in an $18.25 fair value, or a 207% capital gain from current levels.
Scenario III gets closer to the firm’s averages. But it still implements a 10% discount to the cash flow compared to 2019 and conservative growth estimates for 2022 and beyond.
This “optimistic” scenario incorporates a 12x multiple, or approximately half that of Tanger’s long-term average, resulting in a $23.11 share price, or triple from today’s close.
Applying Tanger’s average multiple from 2010-2019 generates a stock price way above Scenario III’s output. But we’re incorporating substantial implications from 2020, an action we believe is best practiced.
As most of us already know, Tanger suspended the dividend due to its board of director’s acknowledgement about the remainder of 2020’s operating environment. For that reason and the others we’ve discussed, Tanger is a Speculative Buy…
Albeit one that presents a highly attractive risk-adjusted return opportunity.
The iREIT IQ score for Tanger is 47.3 (peer average is 49.7):
Author’s note: Brad Thomas is a Wall Street writer, which 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: Written and distributed only to assist in research while providing a forum for second-level thinking.
Disclosure: I am/we are long SKT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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Disclosure: I am/we are long SKT. 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.
Originally published on Seeking Alpha