Just a few months ago, before COVID-19's full impact was buffeting it, the U.S. economy was running at a high level. But even in that environment physical retail stores were having trouble making ends meet. Now, with forced closures and social distancing in full effect, the retail sector's problems are even worse. Landlords like Tanger Factory Outlet Centers (NYSE:SKT) are going to take a hit, and it won't be pretty.
Here's how investors should be thinking about this real estate company.
The good old days
Although it may not seem like a long time ago today, at the start of 2020 the U.S. economy was humming along at a solid clip. Employment was high and wages were strong. The interesting thing is that even in that environment retailers across a broad spectrum were facing material headwinds. The big story was, and still is, the increasing prevalence of online shopping among consumers. Retailers with physical stores were closing locations, or even falling into bankruptcy. It was a multi-year trend dubbed the "retail apocalypse."
That term always seemed a bit hyperbolic, but it seems less so now that economies around the world have been shut down in an effort to combat COVID-19. The story is no longer about muddling through a period of changing consumer buying habits by rightsizing store portfolios and expanding online -- today retailers are fighting for their survival, and only the fittest are likely to make it. This is not good news for Tanger Factory Outlet Centers, or any other mall landlord.
Financially-strong Tanger could easily manage through a slow drip of store closures without too much difficulty. But no company can handle the complete closure of its operations for very long. And the situation is grim, with some owners of retail properties saying that rent is only being paid by a small portion of tenants (Tanger has not provided an update at this point). The rest are either refusing to pay or in a position where they simply can't afford to. Rent concessions are likely to be widespread, and in some cases, they might even be considered a best-case scenario as more and more retailers consider declaring bankruptcy.
The situation will improve once the coronavirus impact is better contained, but the effort to fight the virus is highly likely to lead to a global recession. So while stores will be open again, shoppers may not have the financial strength to go to the mall. And then there's the lingering social impact of COVID-19 to consider, since consumers may not want to go to a mall even if it is open.
That's a terrible backdrop for Tanger Factory Outlet Centers. At this point, only risk-tolerant investors should be in the stock at all. The situation is clearly bad today, and it could get worse before it gets better. However, there are some positives to consider.
For example, the vast majority of Tanger's centers are open-air, so shoppers don't have to walk around in an enclosed space, and social distancing would likely be easier (even if it isn't required anymore). Moreover, the cost of operating in an outlet center tends to be relatively low for retailers, and that helps to boost tenant profitability. Thus, retailers may be more likely to keep their outlet shops open even if times are tough when COVID-19 containment efforts soften. In addition, there's probably going to be a lot of inventory that needs to be sold off, and factory outlets could be a vital venue for that effort. Note that the spring selling season has basically been missed this year, and all of that inventory will need to go somewhere. Put simply, there are good reasons to like the outlet center model as the United States comes out of the COVID-19 crisis.
Then there's Tanger's balance sheet, which is one of the strongest in the mall space. The real estate investment trust's (REIT's) financial debt-to-equity ratio of roughly 1.1 times is lower than those of all but one of its mall peers. Prior to COVID-19, Tanger was able to cover its interest expenses by roughly 2.5 times -- again, better than all but one other competitor. Virtually all of its debt, meanwhile, is at the corporate level, so it has few mortgages to deal with that would increase the financial strain.
Still, to ensure it has ample liquidity, Tanger recently drew down most of a $600 million line of credit. That line was largely untapped before COVID-19's forced closures. The money should give the REIT ample breathing room to survive this incredibly trying period.
However, investors should be expecting a dividend cut at this point. Tanger's funds from operations (like earnings for an industrial concern) payout ratio was an impressively low 62% in 2019. But the total shutdown of its outlet centers, and the likelihood of a lingering impact even after COVID-19 restrictions are lifted, suggest that a steep drop in rental revenue is likely in 2020. At this point, Tanger is no longer providing financial guidance, since there's no way to tell when coronavirus containment efforts will be removed, and thus no way to tell how bad the hit will be. Still, there's no way around the simple fact that Tanger will have a hard time maintaining the dividend as it works to deal with a vastly different retail landscape.
Adding to the concern here is the fact that Tanger has recently hired a new chief operating officer, who is scheduled to take over as CEO at the end of 2020. The new hire has strong credentials, having been head of mall giant Simon Property Group's outlet center operations. However, a new CEO has the leeway to make dramatic changes, like a dividend cut, that an existing CEO might not want to make.
A new game
At the start of 2020 Tanger's goal was to muddle through the changing retail landscape. It simply needed to curate its portfolio, filling vacant stores with new tenants. That can be a slow process, but one that Tanger was easily capable of handling without too much difficulty.
Now, however, the situation is very different. The effort to contain COVID-19 has essentially shut down Tanger's centers, and already struggling retailers are going to be hard hit. The REIT is likely to see vacancies tick higher and get a flood of rent concession requests. It should be able to get through this period, based on its business model and financial strength, but it won't be easy, and the dividend may need to be reduced.
Tanger is now best viewed as a turnaround situation. Only investors with strong stomachs should be investing here.