The past several years have not been very kind to investors in Tanger Factory Outlet Centers (SKT 0.24%). The owner of outdoor outlet malls has seen its shares lose more than two-thirds of their value from the 2016 peak, and now trade at 10-year-lows. Moreover, the sell-off in its shares has pushed the dividend yield up to almost 11% at recent prices.
On one hand, this may look like a classic dividend trap, with a super-high yield that looks appealing but will almost surely end up getting cut. Moreover, there's plenty of reason to expect that to be true without even researching the company. After all, it owns malls, right? There aren't many worse businesses to be in right now, as the convenience of e-commerce lays waste to the traditional retail landscape.
However, a closer look at Tanger's business, and the reality of brick and mortar retail, paints a different picture. Its business is in remarkably strong shape considering the beating that its stock has taken, and the "retail apocalypse" story makes for great headline fodder, but doesn't really tell the whole story. And when you factor in the positives retail is experiencing, along with Tanger's great properties and strong balance sheet, investors would do well to consider buying at recent prices.
The "brick-and-mortar retail is dying" story sounds compelling. In 2020, people can buy almost anything they want and have it delivered to their home or business, probably more cheaply than it would cost in a store. Dozens of America's biggest retailers are paying the price, with companies that many of us grew up with, at best, a shadow of their former selves and, at worst, completely gone.
And it's easy to come to the conclusion that the second-worst business to be in right now is being a mall owner. After all, it's the big-box retailers who are faring the worst, and when a mall loses a so-called "anchor tenant" like a J.C. Penney or Macy's, overall mall traffic falls, which hurts every other store. Then there's the added cost to retenant these giant 30,000 square foot stores, during a time when there's a sharp decline in demand for these spaces. It's a vicious cycle that's hard to break, and has seen hundreds of indoor malls close in recent years.
But there's hope for the American mall, because there's actually a lot of growth happening. As my colleague Dan Kline pointed out, for every retailer that's closing stores, there are 5.2 other retailers opening new locations. In other words, the retail apocalypse may make for great copy, but it's doesn't fully reflect the reality no the ground. It actually creates a bit of a false narrative that companies like Tanger are headed to financial doom.
Tanger's short-term (and short) problems
Yes, the retail landscape is in better shape than the headlines may make it seem, but Tanger does have problems. They're very real and very material. The company's full-year outlook for funds from operations -- an earnings measure for REITs like Tanger -- makes it clear that things are getting worse before they get better. 2020 FFO is expected to be between $1.96 and $2.04 per share. If Tanger hits the midpoint of that range, that would be a 12% decrease from last year.
The company is basing this decline on expectations that it will see multiple tenants close stores in 2020. It has already identified more than 300,000 square feet from tenants that are known to be closing stores, but that only accounts for about 4% of Tanger's net operating income. In other words, there's a substantially large amount of "unknown" baked into the company's low expectations.
Moreover, plenty of investors have taken notice, and are betting heavily against the company.
What does that mean? It means that 63% of Tanger's entire share count has been sold short, and 124% of the shares held by non-insiders and large investors is sold short. That's a massive amount of investors betting that Tanger's stock is headed lower.
But Tanger is built to win in the future of retail
I'll make no bones about it. Tanger, like many other retail property owners, continues to deal with a changing retail landscape. As noted above, 2020 will be a year of continued change and some pain for the company as it works through the loss of more tenants. However, the company is structurally in a much better shape than most other mall operators to ride out the loss of those tenants, and to quickly retenant its vacant properties.
That's because Tanger doesn't own indoor malls with high overhead and doesn't rely on large anchor tenants to draw traffic to its properties. Tanger's outlet malls are outdoor malls (meaning significantly lower overhead) and feature formats that are both smaller and easier to renovate at lower expenses, something that makes them appealing to a broader cross-section of potential tenants. These are the types of retail spaces that are growing in demand.
Even after what looks likely to be a step backwards this year, Tanger expects to end 2020 with an occupancy rate of 92% or higher. There are plenty of mall owners who would love to have a year that "bad".
Taken a step further, Tanger's strength extends beyond the quality of its properties, with a strong balance sheet, and strong earnings. At the low end of 2020 guidance, Tanger would cover its dividend substantially, with a payout ratio below 75%. Its balance sheet is strong, with adjusted debt to assets of around 50%, and Tanger's times interest earned ratio, a measure of its ability to meet its interest payments, is regularly above 2.
Putting my money where my mouth is
With such a giant portion of its shares sold short, and some real challenges ahead to retenant stores as they are vacated, Tanger isn't a sure-fire investment. The company must execute well to keep its occupancy rate (and cash flows) high, and only time will tell whether the assumptions about its properties being compelling and in-demand proves true.
Even with the risks, the rewards could be tremendous, with a double-digit dividend yield and prospects for the stock price move much higher (particularly if short sellers start buying to cover their positions) if the company can meet its own minimum expectations.
I'm not just convinced it's a good idea to write about, either. I recently more than doubled my own investment in Tanger and intend to hold for the long term.