This research report was jointly produced with High Dividend Opportunities co-authors Jussi Askola and Philip Mause.
The market is expensive today. The low interest rate environment has resulted in much capital flowing into the stock market, causing some equity sectors to become increasingly expensive. This is especially true for many Technology, Growth and Momentum Stocks.
This is also true for some “blue-chip” growth stocks such as Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP), Procter & Gamble (NYSE:PG), or Johnson & Johnson (NYSE:JNJ), to name just a few. These are companies that are characterized by a generally lower risk profile, a significant track record and a well-established market positioning. It is no surprise, then, that blue chips are rather expensive and that opportunities are rare.
There is no free lunch at Wall Street, and in this sense, a lower risk is supposedly rewarded with a lower risk premium and, ultimately, a lower return.
But is the market really that efficient? We doubt that. Rather, we think the market often fails to correctly assess the risk aspect by letting emotions take over fact-based reasoning. This is well reflected in how share prices of relatively stable companies keep fluctuating over a wide range over short time periods. One quarter the market feels a company is safe, just to do a complete 180 degree and change its risk premiums drastically a few quarters later.
Sometimes this is well justified, but in other cases much less so.
We feel that one company in particular that has suffered from such unwarranted change in market perception is Tanger Factory Outlet Centers (NYSE:SKT), a blue-chip REIT with solid fundamentals but with a very negative market perception.
In less than 12 months, the share price was almost cut in half despite achieving growth in FFO, dividend, and asset value over the same time period.
Tanger ranks among the highest-quality Real Estate Investment Trusts (REITs), as it combines:
- A unique portfolio of assets with superior business economics.
- Best-in-class management with a significant track record of overachieving.
- Adequate balance sheet with conservative leverage ratios.
It is rare to find a REIT that incorporates above-average qualities in all 3 areas; it is even more rare to find one selling at an opportunistic valuation.
Lower-Risk, Internet-Resilient Retail Portfolio
One of the key reasons why we favor Tanger relative to other large retail REITs such as Simon Property Group (NYSE:SPG), Macerich Company (NYSE:MAC), GGP Inc. (NYSE:GGP) and Taubman Centers (NYSE:TCO) is that we prefer the risk/reward potential of outlet centers compared to regular malls.
We believe retail properties cannot all be put into the same basket when talking about risk. Some are much more affected by e-commerce than others, and it is hence crucial to identify the relatively more defensive segments.
In this sense, we consider good quality outlet centers to be more defensive than the average mall because of the lower price point of the offered goods which makes outlets more competitive with Amazon (NASDAQ:AMZN)-type companies. Everyone likes a bargain, and this is exactly what outlets are here to offer. As the CEO of Tanger likes to put it:
“In GOOD times people LOVE a bargain, and in TOUGH times, people NEED a bargain.”
– Steven Tanger
By allowing manufacturers to directly sell their merchandise to the public, outlets are essentially cutting out the middlemen, resulting in discounted prices and unique offers that can hardly be found online.
Therefore, we believe outlet centers to be better positioned to stay relevant in a digitalized world where everything can be ordered online. Just like T.J. Maxx (NYSE:TJX) or Ross (NASDAQ:ROST), outlet centers provide a sense of treasure hunting… a shopping experience that e-commerce cannot replicate.
This is why outlets have grown in number and achieved great success. People enjoy spending an afternoon here and there walking through an open-air outlet and hunting for bargains. Regular malls, on the other hand, are unlikely to offer great bargains – making their pricing less competitive and the shopping experience less differentiated.
Don’t get us wrong – we are bullish on malls as well, and we don’t consider them to be greatly endangered by the growth of internet; we just think outlets may be even more resilient. Tanger is so confident about its pricing that it offers its shoppers an instant cash refund of the difference if they should find an item purchased at Tanger advertised for less. The Best Price Promise gives its customers confidence that they are getting a great deal each and every time they shop. Most malls just can’t compete here.
The company has understood this at an early stage and truly pioneered the market by building the country’s first outlet center. Today, Tanger’s portfolio of outlet centers has continued to expand and includes 44 outlet centers in 22 states coast to coast and in Canada.
Here are a few random pictures of Tanger outlet centers to give you a better idea of what we are talking about.
Tanger Factory Outlet Centers – Myrtle Beach:
Tanger Factory Outlet Centers – Savannah:
Tanger Factory Outlet Centers – Grand Rapids:
Tanger Factory Outlet Centers – National Harbor:
A lot can be learned from this small sample of pictures. First off, it is clear that outlets are to the most part open-air properties rather than enclosed malls. Believe it or not, this makes a pretty big difference in terms of performance and future prospects.
In a Washington Post article, Badger notes that for the most part it is enclosed malls that are suffering from the growth of e-commerce. On the other hand, open-air properties are thriving:
“Today, malls that are doing well aren’t simply those that cater to the wealthy; they’re outdoor “town centers” and “lifestyle centers” that much more closely resemble the old urban downtowns – community centers with sidewalks, public spaces, outdoor restaurants – that the original indoor mall decades ago helped kill. The mall that’s dying is, in fact, a specific kind of mall: It’s enclosed, with an anonymous, windowless exterior, wrapped in yards of parking, located off a highway interchange. It’s the kind of place where you easily lose track of time and all connection to the outside world, where you could once go to experience air conditioning if you didn’t have it at home. The mall that’s viable now is different in some notable ways that go beyond the quality of its brands: It’s open-air instead of hermetically sealed, its stores turn outward instead of in…” [emphasis added]
We are far from being so bearish on enclosed indoor properties, but this illustrates well one point: outdoor open-air properties such as Tanger’s outlets are desirable and here to stay.
Tanger properties do not only offer bargains, they offer a unique shopping experience that is very qualitative with a big selection of first-quality, in-season merchandise, for the latest fashion trends from the favorite brand names and designers. Just looking at the above pictures, we can already identify trends, with typical tenants being strong retailers such as Under Armour (NYSE:UAA), Nike (NYSE:NKE), H&M (OTCPK:HNNMY), Calvin Klein (NYSE:PVH), Ralph Lauren (NYSE:RL) and Michael Kors (NYSE:KORS), to name a few.
The point that we are trying to make here is that outlet centers do not lease space to struggling department stores, and rather, are occupied by highly desirable brands. Look at the pictures yourself… you’ll not see any Sears (NASDAQ:SHLD), J.C. Penney (NYSE:JCP) or Macy’s (NYSE:M)…
Outlets are Very Desirable… Strong Evidence in Numbers
The high desirability of outlets is very well reflected in their financial performance. This is the real evidence that the internet is not “killing outlets,” and that people (lots of them) are actively shopping at them.
Tanger has historically achieved strong internal growth, as tenants are literally lined up to lease space at its properties. The results are that first off, the occupancy has never dipped below 95% since 1993:
And that the rental increases have been very significant:
Such numbers are not reflective of a “struggling property owner,” which is the common perception of the market today. Tanger’s share price has massively sold off due to fears over the growth of e-commerce; yet, looking at the fundamental performance, we see a thriving company that is able to consistently increase rents, maintain a sky-high occupancy and grow NOI.
In addition to the attractive internal growth potential, Tanger has also a very favorable track record of external growth by new property development and acquisitions. The REIT completed two new projects last year in Columbus, OH, and Daytona, FL, and very recently opened a new outlet in Fort Worth, TX, and completed a major expansion in Lancaster, PA, this year. It is expected to generate accretive external growth, and management notes that the tenant demand for outlet space remains strong.
Being by far the largest outlet center owner of the US, Tanger benefits from a large competitive advantage, as it can utilize its massive scale to source new properties, attract tenants and access low-cost capital for its investments. This is a great risk-mitigating factor, in our opinion, but also a significant return-enhancing factor at the same time:
This chart is just beautiful. It really speaks for the superior economics and execution of the company. Over the last 20 years, Tanger has been one of the strongest performers of the entire REIT market and massively outperformed the broad REIT indexes (VNQ).
It also speaks for the best-in-class management of Tanger. No REIT can outperform so significantly without a superior team that is highly motivated and well-aligned with shareholders’ interests.
The sharp focus of management on creating shareholder value is also well reflected in the following graph:
Tanger is a constituent of the S&P High-Yield Dividend Aristocrat Index, having increased dividends every year since 1993, and this even includes the Great Financial Crisis. Moreover, the increases have historically been very substantial and even accelerating in recent years, with a CAGR of 12% in the past 3 years.
The difference in share price performance and fundamental performance is very substantial in the case of Tanger. Despite having kept posting solid results, the share price has sold off very significantly.
In fact, the cash flow, dividends and even net asset value have kept increasing during the same time frame. Such clear divergence in pricing and fundamentals is, in our opinion, what makes Tanger so opportunistic today.
The stock did not sell off due to poor results, but rather, on fears that are yet to be realized. The market has grown increasingly worried about the future prospects of retail real estate in a world where everything can be ordered online, and therefore decided to reward retail REIT investors with higher risk premiums.
We, however, consider these fears to be misplaced to a large extent. It is clear that the growth of e-commerce creates some disruption in the retail marketplace, but this is nowhere as significant as the market is implying today.
We think the market is mistaken in the case of Tanger and is creating market inefficiency due to the following 3 reasons:
- The market may be overestimating the disruptive power of e-commerce against traditional retailing. We believe retail properties are attractive assets to our society, and that their utility is not in danger. It is clear that e-commerce will keep on growing and certain tenants will suffer. Names including Sears, Macy’s and J.C. Penney may even disappear. That said, retail REITs are not retailers, they are landlords. If tenants vacate, the REITs can replace them with other ones that may be more resilient to e-commerce. Some of the large tenants that we know today will go bankrupt, but others will come replace them. It is just a part of retailing.
- The market seems to put Tanger in the same basket as other mall REITs despite not owning malls but outlet centers, which differ in their risk profile. As we noted earlier, we believe outlet centers have high staying power in a digitalized world, perhaps even more so than malls. Outlets are resilient due to their “value orientation” and the “treasure hunting” feeling that they create. It leads to a differentiated and more competitive shopping experience, reducing risks along the way.
- The market may also fail to realize that Tanger has no exposure to department stores. Not all retailers are created equal, and while some are greatly affected by the e-commerce, others are doing just fine. Today, for the most part, it is really the department stores that are struggling, but this hides a great majority of retailers which continue to perform well in a digitalized world.
This last point is especially evident in that Tanger has shown strong price correlation with department store retailers such as Sears, Macy’s and J.C. Penney. When such retailers sold off on poor results, so did Tanger, often by up to 5% in a single day. This makes no sense, and yet, it is exactly what has happened.
We conclude that the market is reacting to emotions rather than reasoning based on real facts, creating market inefficiency in the share pricing. The emotions are tied to the fears over certain struggling tenants, but the facts show that the occupancy, sales per sq. ft., NOI, FFO, dividends are all at or close to record high levels. Most importantly, Tanger does not have any exposure to the struggling department stores. These are the facts.
Tax Reform Plan to Benefit Retailers
The Wall Street Journal recently ran an article after the Senate tax bill passed, and in the article was a table comparing the House and Senate bills side by side, and the 20% expected corporate tax rate stood the test of both Houses of Congress.
The drop from an effective corporate tax rate of 30-35% currently to an expected 20% will be a big win for retailers or companies with the majority of revenues in the US and will push 2018 Earnings Per Share estimates up sharply when it happens.
The current negative perception for retail companies and stocks (including Retail and Mall REITs) may not last long and could easily change investors’ perception when these companies start posting better-than-expected earnings reports.
Bargain Valuation Results in Strong Risk/Reward Outcome
For a blue-chip name, Tanger has lots of value to offer to investors today. Despite being one of the highest-quality REITs out there, it trades at a large discount to peers and broad markets.
The company is currently expected to earn $2.54 in FFO per share in 2018. Currently trading at $25, we calculate an FFO multiple of about 9.8 times, which is significantly discounting the intrinsic value of Tanger, in our opinion. REITs trading at such low FFO multiples typically are affected by some sort of issues, such as conflicted management, a low-quality portfolio or excessive leverage. In the case of Tanger, it is quite the opposite. All fundamentals check out, and the REIT did not miss a dividend payment even during the financial crisis.
NAREIT includes Tanger in the Shopping Center peer group, but we believe the best peers are the Class A mall REITs. Simon Property Groups sells for 12.8 times, Taubman Centers at 12.1 times, Macerich at 13.3 times and GGP at 13.3 times expected 2018 FFO. We consider all the mentioned names here to be widely undervalued by the market, and yet, Tanger trades at a large discount even to them.
Compared to the broad REIT market which trades at about 19 times FFO, it appears to be a great bargain as well. Simply put, Tanger is an above-average quality REIT selling at a sizable discount relative to many lower-quality names.
The 3rd Quarter Performance Remains Strong
As long-term oriented investors, we do not put too much emphasis into the appraisal of quarterly results, which may have some earnings fluctuations. We usually prefer to look at yearly results.
Nonetheless, here are what we consider to be the main highlights of the last quarter:
- Despite being affected by the hurricanes in August and September, with eight centers being closed for a total of 22 days during the quarter, Tanger still managed to beat consensus estimate for this quarter’s AFFO and raised its year-end occupancy guidance to a range of 96.5-97%.
- Hurricanes cause a significant reduction in traffic during and after the storm, leading us to believe that Tanger would have posted extremely favorable results if there had not been any hurricane.
- Portfolio NOI, which includes NOI for non-comparable centers, increased 7.9% throughout the consolidated portfolio during the first nine months of 2017 and 3.8% during the quarter. This is very significant when you consider how pessimistic the market is. Again, this is proof to us that the market perception does not coincide with facts.
- Tanger completed a $300 million, 10-year bond offering with a 3.875% interest rate, which it used to redeem $300 million of 6.125% debt that was due on June 1, 2020. This transaction, in addition to a few others, will increase cash flow by about $6 million annually and AFFO available to common shareholders by about $0.06 per share on an annualized basis.
- The company repurchased 1.9 million of its shares during the year at a weighted average price of $25.80 per share, for a total consideration of $49.3 million, most of which was funded by asset sales. This leaves $75.7 million remaining under its $125 million of share repurchase program for future periods.
The takeaway for us is that our original thesis remains intact. Nothing dramatic has changed since July that would force us to reconsider our opinion. On the contrary, the news is overwhelmingly positive, and therefore, we remain very confident in our thesis.
12-Month Price Target – $32 / share
We believe SKT should trade at similar valuations to Simon Property Group at 12.8 times FFO, Taubman Centers at 12.1 times FFO and Macerich at 13.3 times FFO. At 12.5 times FFO, SKT would trade at roughly $32/share, or 27% higher from here. A $32 price target within 12 months is not unreasonable, as SKT traded above $42/share in 2016.
Readers should note that the entire Retail/Mall sector has taken a hit recently, including SPG, TCO, MAC and SKT, due to general negative feeling about the sector. We believe the sell-off is overdone, and that the average valuations for all the sectors are likely to move higher in 2018 to levels above 15 times FFO. At 15 times FFO, SKT would trade at $38 (or 50% higher from here). This is our longer-term target for SKT, which could be achieved in 2019.
What is the right recipe for achieving good investment success? Some would say a solid track record, others good growth prospects or simply an extraordinarily low share price combined with share buy backs and/or a high yield.
With Tanger, you pretty much get it all in one stock. It is a high-quality firm, as measured by its superior assets, best-in-class management, solid track record and adequate balance sheet. Moreover, it is a Dividend Aristocrat that has increased its dividend each year since its IPO and is expected to continue doing so. Finally, it is being offered at a deeply discounted valuation despite strong fundamental performance, and company management is aggressively buying back its own stock.
What else could one really ask for?
This is why we consider Tanger to be one of the best high dividend opportunities in the market today.
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Note: All images/tables above were extracted from the Company’s website, unless otherwise stated.
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.