Tanger Factory Outlet Centers (NYSE:SKT) is one of the most heavily shorted stocks on Wall Street at the moment. A big piece of the negative sentiment is due to the fact that an ETF that owned a massive amount of Tanger shares has been forced to sell the stock due to a decline in the company's market cap. However, the ongoing changes in the retail sector are the real driving factor behind this event -- and the company just announced that 2020 will be another tough operating year. Here's what investors need to know.
There's blood in the retail streets
Tanger's stock has lost roughly a third of its value over the past year. It is down by two-thirds from its 2016 highs. The dividend yield is a heady 10%, despite the fact that the real estate investment trust (REIT) has increased its dividend annually for 27 consecutive years and had a very reasonable funds from operations (FFO) payout ratio of around 62% in 2019 (FFO is like earnings for an industrial company). Notably, Tanger's balance sheet remains strong, with total debt to total adjusted assets at roughly 50%, well below the 60% required by its debt covenants. It also covers its interest costs by a solid 5.1 times, much higher than the 1.1 times debt covenant target. And it has a largely unused $600 million line of credit available to it if the need should arise.
But regardless of the positives and the deep stock decline that's already occurred, investors are still expecting trouble ahead.
The retail transition is far from over
There are a few reasons for investors' concerns. For starters, Tanger, as its full name implies, owns factory outlet centers. Retail landlords like Tanger have been hit hard by the headline-grabbing retail apocalypse. Although the impact of consumers shifting toward online shopping is likely being overhyped, it is having an impact on retailers and mall owners like Tanger. Retailers are going bankrupt, even stronger retailers are closing stores, and landlords are giving rent concessions to help keep their malls filled. The transition taking place in the retail sector is definitely not over.
Tanger, unfortunately, is right in the line of fire because it is heavily focused on fashion-oriented stores. That subsector has been particularly hard hit, as consumers are increasingly buying clothing online or at discount shops. Investors aren't wrong to think that Tanger could have a tougher time than other REITs as it looks to change its outlet centers along with consumer tastes. While the REIT has been working to remain relevant, that isn't a process that finishes overnight. Tanger needs to get space back and then identify new tenants, which (unfortunately) takes time.
Tanger guidance goes from bad to worse
The big gut punch, however, is that the company's 2020 guidance proved that the storm is far from over. For example, despite hitting an occupancy rate of 97% at the end of 2019, it expects occupancy to fall to between 92% and 93% in 2020. If that actually happens, it would be the first year since Tanger went public that occupancy has dropped below 95%.
The reason for this dismal outlook is that Tanger knows it will see 303,000 square feet of its retail space vacated in 2020. That's roughly 3.5 percentage points of its same-store net operating income. The tenants tied to that drop are already known to investors, however -- the bigger concern is that Tanger disclosed that it could see another 322,000 to 372,000 square feet go dark as well. These are situations that it knows about but can't talk about yet because it is still working with the retailers involved. Although that means that it might not be as bad as projected, there's really no way to tell, and investors have to assume the worst. So that's another 3.5 percentage points or more of same-store net operating income that's at risk.
The company is calling for FFO to be between $1.96 and $2.04 per share in 2020. That would mean that FFO fell 8.5% in 2019 and could fall another 12% (using the midpoint of guidance) this year. The FFO payout ratio would increase to roughly 72% based on the current dividend run rate. While that's not unreasonable, it's a lot worse than the 62% FFO payout ratio seen in 2019.
Without any question, Tanger is telling the world that its situation will be getting worse in 2020. No wonder investors are downbeat on the REIT.
Stay away or time to buy Tanger?
There are two sayings on Wall Street that are relevant here. The first is that you shouldn't try to catch a falling knife, and Tanger certainly looks like a falling knife right now. The second is that the time to buy is when there's blood in the streets -- and Tanger looks very bloody today.
This is not a great investment choice for conservative investors because a lot of uncertainty remains, and the outlook looks like it's getting worse, not better. However, the positives here are notable if you can see past the negatives. In fact, they're interspersed throughout the above comments -- including a solid balance sheet, ample access to capital (the unused line of credit), and a reasonable payout ratio even taking into account a difficult 2020. Put simply, Tanger is working off a solid foundation and should be able to weather the storm. If you can stomach the ups and downs while Tanger works through the process of finding new tenants, now could be a good time to buy. Just go in knowing that you'll have to stomach some more bad news as the new year unfolds with this contrarian play.