How Is Tanger Dealing With the Retail Apocalypse?

Tanger Factory Outlet Centers (SKT +2.10%) is unique among real estate investment trusts (REIT) in that it is the only one focused exclusively on outlet centers. Investors don't appear too pleased with this niche approach today, with the stock down 26% since the start of the year and the yield up to around 10%. Management is telling investors that it's working through the headwinds -- store closings and retailer bankruptcies -- and that it's just a matter of time until things get better.

But will the old playbook be enough to deal with the so-called "retail apocalypse"? 

Tanger financials look solid

Looking at the metrics, Tanger has been holding up reasonably well as online shopping slices an increasing share of the retail pie.

For example, occupancy rates are still strong and hover in the mid-90% range. That puts it among the highest of its enclosed mall peers (which isn't a perfect comparison group, but it is the one that fits best). Basically, it is keeping its malls filled.

Sales per square foot, meanwhile, has remained between $380 and $395 over the last five years or so, with an uptick over the last six months to the high end of that range. While this sales-per-square-foot range would be low for an enclosed mall, Tanger's outlet-focused business model is different and the actual number isn't the most important takeaway. The big story is that consumers are still coming to Tanger's outlets and shopping at similar levels despite the retail apocalypse. And occupancy costs for its tenants remain low relative to other options, suggesting it remains a good place for companies to put a store. 

So, despite the stock price weakness, Tanger's business is hardly dying.

Image source: Getty Images.

Also important is the fact that Tanger remains financially strong. It has an investment-grade-rated balance sheet. Total debt to adjusted assets is 49%, well below a 60% debt covenant. Only 6% of its square footage is encumbered by mortgages (largely related to joint venture assets). It covers its interest expenses five times over, meaning that debt costs aren't an issue. And it's used just 3% of its credit facility, suggesting that it has ample liquidity.   

Despite being financially strong and performing reasonably well, investors remain concerned: Can Tanger's business model stand up to the continuing flow of store closures as consumers shift to online shopping? One of the sectors that seems to factor into investors' concerns is fashion. Clothing has long been one of Tanger's biggest focus areas.

Tanger management's attitude is "We got this!"

So far, Tanger has been telling investors that it has handled headwinds like this before and survived. That this time is no different and that the same playbook it has used in the past will work again. Effectively, it is granting rent concessions to tenants to keep occupancy high (and, thus, its outlet centers desirable for lessees and consumers). Meanwhile, it is working to add new tenants to replace ones that are leaving, largely due to bankruptcies. 

CEO Steve Tanger noted during the second-quarter conference call: 

Look, we've always had tenant turnover every year. It's a fact of life and 10 years from now, we still will be talking about tenant turnover. But the names of our major tenants are totally different today than they were 10 years ago.   

Here's the thing, that's not "totally" true. If you go in and look at Tanger's top 10 tenants in 2018 and compare the list to 2008, there are notable differences. But they aren't as big as they may at first appear. Some names have fallen off the top-10 list and some have been added, but a lot of the movement is with the underlying brands -- many of which have simply changed hands. Essentially, the lists are roughly similar and (perhaps just as important) both are heavily focused on fashion:   

Data source: Tanger Factory Outlet Center company filings.

Tanger has been stepping outside its comfort zone to try new concepts, like adding discount fashion stores to the mix. Since customers can often find the same clothing in an outlet store as in a discount store, it chose to test the concept before going all in. It took the time to open one TJ Maxx store in one outlet center to ensure that it didn't affect other tenants before looking to expand the relationship. It didn't jump in with both feet and risk hurting its overall results. Tanger is also adding more health- and food-related stores to expand further beyond the fashion niche.   

Tanger's approach bends conservative

These efforts are largely at the margins, though. That's not surprising given the conservative nature of the company. And Tanger is not being nearly as aggressive with "densification" as other mall REITs. This is the rental concept of bringing in hotels, rental apartments, and healthcare facilities to fill empty space. Tanger prefers to let the adjoining retail space around its outlet centers evolve over time, with the areas organically adding such things without the need for the REIT to take on the risk or cost of the effort. The end result, however, is similar (an increased customer base), but the timing is less certain and likely more drawn out.

The big question then: Is Tanger doing enough? When Tanger has been faced with challenges in the past they have been around recessionary periods. What it is dealing with today is a shift in the way customers are shopping, largely taking place during an expansionary period. This time may, in fact, be different. But is it different enough to require a totally new approach? That's not clear just yet, and investors who own Tanger are basically betting that it can make this transition with the same slow and steady approach that it has always used before. 

The worst-case scenario

With a strong balance sheet and a business that appears to be holding up reasonably well, the risk of Tanger's going out of business is very low. It will likely survive the "retail apocalypse," even if it manages only to muddle through. So the real risk today is the dividend, which was well covered in 2018, eating up only 56% of funds from operations (FFO), in line with typical earnings for a REIT. If there is a recession or more fashion stores hit the skids and close up shop, Tanger's fat dividend could be at risk of getting cut. And that potential is what is causing the stock price drop we've been seeing. 

Slow and steady Tanger looks like a decent value play, but go in with your eyes open to the risks it is facing. The playbook it is using may need to be updated a little to deal with the hit from the growth of online shopping. I own the stock, am losing money on my position, and have no plans to sell it at this point ... but I'm not adding more. What I am doing is letting that fat dividend reinvest and looking at other REITs in the deeply out-of-favor mall space with more diversified portfolios.