Tanger factory outlets still a speculative buy – tanger factory outlet centers, inc. (nyse skt) seeking alpha treating chest pain

In my previous article on Tanger Factory Outlets ( SKT) I emphasized that, while it’s undoubtedly a high-quality REIT offering income investors the complete package, it was still a speculative bet on management because there were clear signs of business performance deterioration that management had no clear-cut answers to other than gut instinct that things would get better eventually. After Q1 results rolled in, resulting in slightly reduced fiscal year guidance, my investment thesis remains unchanged as Tanger’s direction remains similar and management continues to be optimistic about their ability to right the ship. Given their strong balance sheet, large free cash flow generation, and long track record of success, management deserves time to prove itself. In the meantime, I recommend maintaining a risk-appropriate (i.e., speculative sized) position in the company, and possibly even utilize options, to guard against further downside in the event that fundamentals continue deteriorating in the coming quarters.

The Good

Despite the disappointing guidance downgrade, SKT remains in strong shape. Moody’s and SP both maintained their high credit rating during the quarter, though SP did change their outlook to negative. They maintained plenty of distance from their key bond covenants, with a particularly secure 5.1x interest payment coverage ratio. This interest coverage ratio is particularly secure given that only 13% of its debt is floating rate.

While management blamed it partly on excessive snow removal and weather-related center closures, the company also experienced faster than expected store closures and numerous tenant bankruptcies. With the company’s pricing power with tenants clearly eroding, where the company sees stable expirations in its future, I see significant risk to further occupancy declines. While only 4% of ABR is expiring this year (and they are forecasting negative NOI and some of the lowest occupancy levels they have ever experienced), the next five years will see a whopping 54% of expirations, with double digits of both ABR and GLA expected to expire each year.

Management may be able to patch leaks in the ship right now with relatively few expirations, but the deluge coming in the next several years will test Tanger’s model in a much more thorough way. Clearly, management must right the ship and avoid having to offer significant rent concessions very soon, or it will begin experiencing significant NOI declines similar to the likes of Washington Prime Group ( WPG) and CBL Associates Properties ( CBL). The Ugly

With downgraded guidance, the stock tanked ~10% following the results. Since then it has bounced back some, as investors were encouraged by other reports throughout the retail sector and perhaps some value investors moved in to take advantage of one of the company’s cheapest share prices and its highest yield in the past decade.

While shares have lost more than half their value in what has been a near-constant descent from 2016 highs, as we have seen with other retail REITs, further pain could be ahead if management underwhelms in handling its significant renewal burden in the coming years. Investors holding and buying the stock should be prepared for significant further pain if the bearish thesis continues to play out. Investor Takeaway

Tanger has a long, storied history of building wealth for its shareholders. The dividend is a cherished part of that story, with management just announcing its 25th straight year of dividend increases. With a low payout ratio, fortress balance sheet, and share buybacks decreasing the total payout burden, the dividend is well protected, and assuming relatively stable performance, should continue to grow for the foreseeable future.

However, Tanger clearly has some issues and the pressures on the foundation of its business model will only increase in coming years as it faces a steady stream of lease expirations. The caveat here is that Tanger enjoys not only significant resources to keep its properties fresh and attractive as a valuable component of the retail industry, but its management also has vast experience in this business and has successfully navigated challenging environments in the past.

They also enjoy higher quality tenants than many big-box mall REITs and have already flushed out many of their weakest tenants while only experiencing a slight downtick in NOI for one quarter thus far. The question that will be answered in the coming quarters and years: Is SKT a high quality REIT with a secure niche in the future omnichannel retail landscape that’s simply experiencing some tremors from earthquakes felt elsewhere in the retail space, or is its outlet model outdated and set for long-term decline?