Tanger Factory Outlet Centers (SKT): A Beaten-Down, High-Yield REIT Paying Safe Dividends

Real Estate Investment Trusts (REITs) are an appealing way for income investors to benefit from rental properties without any of the liquidity or landlord hassles that come with actually owning physical properties.

 

Many REITs are generally far less volatile than the rest of the stock market as well, making certain REITs a reasonable way to help you live off dividends during retirement.

 

Tanger Factory Outlet Centers (SKT) is arguably one of the highest quality retail REITs in America. However, SKT’s stock has slumped by nearly 40% since mid-2016 and now offers a 5.2% yield.

 

With a 24-year dividend growth streak and a healthy outlook for continued payout growth, let’s see if Tanger Factor Outlet Centers deserves a place in a low-risk, high-yield income portfolio.

 

Business Description

Founded in 1981 in Greensboro, North Carolina, Tanger Factory Outlet Centers is America’s largest REIT specializing in discount outlet centers. It owns or has 50% stakes in 44 centers in 22 states and Canada, representing 15.1 million square feet of leasable retail space (21% of all outlet center space in the U.S.).

 

It leases its 3,100 premium store locations to over 500 high-end retailers, including Coach, Brooks Brothers, Michael Kors, and Ralph Lauren. No tenant accounted for more than 6.2% of Tanger’s 2016 rental revenues.

 

 

Business Analysis

It’s no secret that many big U.S. mall-based retailers, such as Sears (SHLD), JC Penny (JCP), and Macy’s (M), are facing an existential crisis thanks to the rise of e-commerce and changing consumer shopping preferences. In fact, the number of U.S. store closures is currently on track to hit an all-time record this year, worse than even during the Great Recession.

 

 

However, the spike in store closures and continued shift from brick-and-mortar shopping to e-commerce doesn’t mean that all malls are equally at risk. Tanger Factory Outlet Centers has several competitive advantages that provide it with a moat. For example, the REIT focuses exclusively on premium outlet centers, where high-end retailers offer deeply discounted clearance items.

 

In addition, the company has invested into turning its malls into experience centers, via embracing the latest in technology, the creation of a loyalty program, and upscale lounges that offer customers a luxury experience that Amazon (AMZN) can’t match.

 

 

This focus on a premium customer experience, combined with the tantalizing allure of discounted luxury items, has made Tanger Factory Outlet far more recession resistant than many other mall retailers, resulting in impressive steady growth over the years. Even the most recent spate of mall retail troubles haven’t stopped Tanger from continuing to generate solid top line results.

 

 

Even more impressive, Tanger’s luxury moat has helped the company maintain one of the industry’s best occupancy rates while consistently raising rent on expiring leases. This has helped Tanger generate strong same center net operating income (NOI) growth.

 

 

The combination of rental increases, high occupancy rates, and continued same center NOI growth has helped Tanger generate high and consistently rising margins and returns on shareholder capital, a testament to the company’s experienced management team.

 

 

Another aspect to Tanger’s competitive moat is the fact that management is highly disciplined in its growth efforts. For example, unlike traditional mall retailers, which are suffering through a massive oversupply in retail space, Tanger has been slow to open new factory outlet center locations.

 

 

That’s because management doesn’t invest shareholder capital unless it’s very confident that it can maintain very high occupancy, with long-term leases that make for both high profitability and very stable cash flow.

 

In fact, thanks to the small size of the factory discount outlet industry (70 million square feet, less than the retail space in Chicago), this niche retail industry continues to be able to generate very high profitability.

 

And Tanger, as the best-in-breed operator, is able to generate even more impressive returns, including a a very high adjusted funds from operation (AFFO) margin that has allowed it to grow its dividend at one of the best rates of any REIT.

 

 

This long-term focus on highly disciplined and profitable growth has in turn resulted in some very impressive total returns, far better than its industry peers, the REIT industry as a whole, and the S&P 500.

 

 

Tanger also continues to invest in its future growth, with one center under construction and another being renovated and expanded. The high cash yields (8-11%) on these investments are further evidence that Tanger remains committed to its “quality over quantity” approach to growth, which bodes very well for future dividend growth.

 

Investors will also be happy to know that Tanger’s liquidity (cash + remaining borrowing power) position remains excellent, with $455 million available; likely enough to fund growth for the next two to three years.

 

 

Thanks to Tanger’s industry-leading track record of compounding shareholder income and wealth, the REIT also enjoys one of the lowest costs of capital in the industry. That’s thanks to its high percentage of retained cash flow, as well as its plentiful access to very low cost debt.

 

This very low weighted average cost of capital (WACC) provides the third component of the REIT’s competitive moat and ensures that Tanger is able to grow profitably over time.

 

 

That’s because the REIT business model requires constant infusions of fresh debt and equity capital. If a REIT’s return on invested capital (ROIC) isn’t higher than its WACC, then growth isn’t actually profitable and shareholder value is being destroyed.

 

Tanger’s very high ROIC-WACC spread means that AFFO, the REIT equivalent of free cash flow and what funds and grows the dividend, continues to rise on a per share basis as the REIT expands, making for strong long-term income growth.

 

Key Risks

The factory outlet center business is one of the few bright spots in retail, because even struggling retailers such as The GAP (GPS) are looking to discounted outlet stores as growth opportunities while they close traditional mall locations.

 

This, plus the fact that shoppers view outlet shopping as a unique “event” experience (often driving up to 100 miles to visit a center), means that the industry is likely to prove less vulnerable to being disrupted by e-commerce.

 

However, the success of outlet centers is also a source of risk. That’s because while currently the outlet industry represents just 0.9% of U.S. retail space, the positive aspects of the industry are starting to attract more competition from other large retail REITs, including Simon Growth Properties (SPG), Taubman Centers (TCO), Macerich (MAC), and CBL & Associates Properties (CBL).

 

In other words, the growing popularity of Tanger’s niche business model could result in the same kind of oversupply situation that is now killing the low quality mall industry, resulting in falling profitability and numerous dividend cuts among highly leveraged mall REITs.

 

You can see that the U.S. has much more shopping center space per person than any other major developed country in the world, making this an important risk to remain aware of as shopping center operators increasingly scramble for different opportunities for profitable growth.

 

 

Next, while Tanger’s premium  list of tenants makes it less vulnerable to e-commerce, that doesn’t mean it’s totally immune. After all Amazon and outlet stores are competing for the same customers, those that value deep discounts.

 

Tanger’s investments into a luxury shopping experience offers a way to differentiate from online retail, but customer preferences can still shift over time. That means that it’s possible that in the future the value and convenience proposition of Amazon may eventually overcome even Tanger’s moat.

 

For example, one of Tanger’s largest tenants Ascena Retail (ASNA), which operates such stores as Lane Bryant, Anne Taylor, and Dress Barn, recently slashed its guidance, citing large loss of foot traffic in its stores due to shifting consumer sentiment. This shows that even the kinds of premium luxury brands that are the core of Tanger’s business model aren’t totally immune from the growth of online retail.

 

Finally, we can’t forget that Tanger, like all REITs, can be highly sensitive to interest rates. That’s not just because the REIT business model is highly capital intensive and requires a lot of external debt financing but also because higher interest rates generally cause a REIT’s share price to decline and its yield to rise.

 

The good news is that Tanger’s interest rate sensitivity has been lower than most REITs (its yield rises by 0.41% for each 1% increase in 10-Year U.S. Treasury Yield, according to the data below). However, with the Federal Reserve guiding for a 2.25% increase in rates by the end of 2019, Tanger’s dividend yield could still end up rising to around 6.2% in the coming years, all else equal.

 

 

While that’s great news for long-term investors who are looking to buy this high-quality REIT at the highest yield possible, more risk averse investors, such as retirees living off the 4% rule, need to keep in mind that they might be forced to sell at a loss in such a situation.

 

In addition, we can’t forget that, like all REITs, Tanger is frequently tapping the equity markets for growth capital. A higher yield (and a lower share price) means a higher cost of equity that can raise the company’s WACC and make it harder to find profitable growth opportunities.

 

That’s especially true if increased competition from rival retail REITs opening new outlet centers of their own results in lower returns on invested capital.

 

 

While Tanger’s large percentage of internally funded growth (via retained AFFO) means that it will be able to continue growing profitably even in a higher rate environment, the potentially decreased profitability means that its ability to grow the dividend quickly might decline in the years ahead. That’s especially true as its asset base grows and each new center built contributes less marginal AFFO.

 

Tanger Factory Outlet’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Tanger Factory Outlet’s Dividend Safety Score of 89 indicates that its dividend is very safe and dependable today. That shouldn’t come as a surprise given that Tanger Outlet has raised its dividend for the last 24 consecutive years, meaning that it would become a dividend aristocrat in 2018 if the company was large enough to be a member of the S&P 500 Index.

 

This impressive streak is due to several traits that give Tanger very stable cash flow with which to pay its steadily growing dividend. Note that the decreased dividend from 2015 to 2016 was a result of a special dividend paid in 2015 in order for the REIT to maintain its beneficial tax status.

 

 

 

The first such factor is Tanger’s very diversified, high-quality premium list of tenants, which means that its rent is more secure than lower quality traditional mall REITs.

 

 

The next supportive factor is Tanger’s business model, which is built around long-term, triple net leases. This means that the tenant pays the maintenance, insurance, and property taxes, creating highly profitable and predictable cash flows.

 

And because Tanger’s leases are staggered, the amount of its rental income up for renewal in any given year is small enough to not threaten the dividend’s security.

 

 

Next is the fact that, due to Tanger’s decision to retain a lot of its AFFO to fund growth internally, the dividend’s AFFO payout ratio is very low. This means there is plenty of excess cash flow to protect the payout and allow it to grow, even during severe economic or industry downturns that could result in a significant fall in AFFO per share.

 

 

In addition to very steady cash flow and a low payout ratio, Tanger’s dividend security is helped by the company’s low relative debt levels. Now at first glance you may not think so, given the high leverage ratios and low cash balance.

 

 

However, due to the capital intensive nature of the REIT industry, these metrics need to be looked at in context with Tanger’s industry peers.

 

When we compare Tanger’s leverage ratio (Debt/EBITDA) with its peers, for example, we can see that its debt load is actually below average. Meanwhile its high interest coverage ratio and cash-rich business model mean that it continues to enjoy one of the highest investment-grade credit ratings of any REIT in America.

 

 

Further protecting the dividend is the fact that Tanger’s credit metrics are nowhere near violating its bond covenants. That’s important because a violation of any of these would allow the REIT’s creditors to immediately call in their loans and could result in a liquidity crisis that forces a dividend cut or outright suspension.

 

 

 

Tanger’s large amount of stable, excess cash flow, conservative AFFO payout ratio, and strong balance sheet mean that its dividend appears to be very safe and the company should have plentiful access to cheap debt, which is a major competitive advantage in a rising rate environment.

 

Tanger Factory Outlet’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Tanger Factory Outlet’s Dividend Growth Score is 54, which means that dividend growth investors can likely expect around average dividend growth going forward, relative to other blue chip dividend stocks in the S&P 500.

 

 

That makes sense given that, ignoring the artificially low one-year figure above (again a result of the 2015 special dividend), Tanger has an excellent record of consistently growing its payout at one of the best rates of any blue chip REIT.

 

While investors shouldn’t expect the kind of strong dividend growth we’ve seen in the last five years to continue given the industry’s maturity, the REIT should be able to continue generating steady 4% to 6% AFFO per share growth, which means that its payout should grow around the same pace.

 

Valuation

Over the past year the retail REIT sector, and mall REITs in particular, have been hammered due to concerns over e-commerce disruption permanently impairing the business model. This has caused Tanger’s stock to underperform the broader REIT industry and the S&P 500 by a staggering amount.

 

Tanger Factory Outlet is currently trading for just 10.9 times 2017’s AFFO midrange guidance, about half of its historical P/AFFO (the REIT equivalent of a PE ratio) and far below the S&P 500’s forward P/E of 17.3.

 

Tanger’s 5.2% dividend yield is trading near a five-year high and is far above its 13-year median norm of 3.2%. Given the stock’s relatively low valuation metrics relative to history, investors are clearly not expecting much, if any, growth from SKT going forward.

 

SKT appears to be a more timely opportunity to consider for income investors interested in playing the role of contrarian in the retail space, but some of the long-term challenges facing the industry are worth remembering.

 

Concluding Thoughts on Tanger Factory Outlet

The current correction in retail REITs just goes to show that no matter how high the stock market soars, something is always potentially on sale. Tanger Factory Outlet Centers appears to be one of the beaten-down high quality REITs that is likely to survive for many years to come thanks to its conservative management team, strong balance sheet, low cost of capital, and quality property portfolio.

 

Future growth is a bigger uncertainty, but the stock’s recent slide and discounted valuation metrics relative to history suggest that now could be an interesting time for value-focused yield investors to give Tanger a closer look as part of a well-diversified dividend portfolio. In addition to Tanger, income investors might be interested in reviewing 30 other high dividend stocks for new ideas.