Tanger Factory Outlet Centers (SKT)… yay or nay? I’ve stayed out of this debate on Seeking Alpha up until this point. However, as I’ve gotten very deep in the weeds on REITs heading into my attendance at REITweek in less than two weeks, I figured it was worth my time to throw my thoughts out there as well. Contentious as the stock is, my hang-ups here are not financially driven. The balance sheet is fine: there are a lot of levers to pull if metrics continue to erode. My primary issues lie with the outlet center model and the apparent stagnancy of the management team when it comes to addressing the very real shifts in retail. While not out here setting low price targets or calling for dividend cuts, I do take a very skeptic take on overall corporate direction. With so many great opportunities out there in the REIT universe, it’s tough to get on board with a firm that doesn’t appear to be taking its recent issues seriously.
Observations on Retail REITs, The Outlet Model
First off, I want to make a broad observation. Most REIT analysts on Seeking Alpha have dipped their toe into retail-exposed areas of this market in some form or fashion. Personally, I like shopping centers and first started recommending stronger players in the sector like SITE Centers (SITC) two years ago. Including dividends, my recommendation there is up just 2% on a total return basis assuming reinvestment. Just pulling a few more examples, CBL & Associates (CBL) collapsed 84% over that period, Pennsylvania Real Estate Investment Trust (PEI) is down 34%, Taubman Centers (TCO) is down 13%, Tanger Factory Outlet is down 26%. Rather than pat myself on the back for relative performance, let’s keep it real: if I parked that money in the S&P 500 index (SPY) I would be up 17%. That’s a marked difference. It doesn’t matter if an investor went with shopping centers, junky suburban malls, high-end class A urban malls, outlet centers, etc. Nearly universally, anyone entering this space has lost unless they have traded it far better than I have. Outside those fringe cases, it has paid to just stay away. I think there are some deep lessons to be had here on why avoiding these kinds of contrarian bets that run against strong macro themes (e-commerce, overbuilt retail, constant tenant bankruptcy headlines) makes a lot of sense.
*Source: Tanger Factory Outlet in Mebane, NC. This is the closest location to me personally.
Getting back into Tanger specifically, it suffers quite a bit more from those macro themes than most. While Tanger does try to push the recession resiliency angle of “in good times, people love a bargain, and in tough times, people need a bargain,” I think this needs some historical clarification. While certainly not my bread and butter, I have followed retail apparel for quite some time. Personally, I think this angle and how it has hit the outlet centers hard has not really been approached well – at least on Seeking Alpha anyway. Most readers know that sales per square foot at Tanger has flatlined between 2015 and 2019 (See Slide 13 on the most recent presentation deck). That’s actually real losses due to inflation even after selection bias (sale of weaker properties has improved these trailing metrics). Outlet centers have suffered from lower foot traffic and weak sales growth for years now. What drove that? For context, nearly all retail apparel brands broadly followed the below pattern between 2006 and 2019:
- 2004-2007: Times are good, the consumer is doing great. Retail apparel is booming!
- 2007-2009: Recession hits. Consumer spending collapses, particularly among luxury/high-end fashion. The world is ending.
- 2010-2012: There is no snapback recovery. Consumers are now clearly cautious and are not apt to forget the pain of the Recession.
- 2012-2015: Consumers are now more bargain conscious. Let’s open outlets! Sales spike as consumers chase deals on high-end brands.
- 2016-2019: Consumers realize that more than 80% of outlet products are lower quality made direct for outlet. Sales growth freezes.
The last bullet is incredibly important. Retailers have gotten so much better at forecasting demand and managing inventory. They’ve had to, in order to survive. Any apparel retailer will willingly tell you comps have been much tougher to grow despite a long-running economic recovery. Instead, the biggest gains on margins have come from supply chain improvement and working capital management – not just predicting trends in fashion. Because of this, there just are not that many product overruns anymore, production yields are near perfect, and since those goods are now overwhelmingly made overseas, in most cases it makes sense to destroy the product there versus ship here for sale. That has profound implications for the outlet center model.
Not to throw stones at the bulls here, but in general, I think many retail investors are a little older and remember the heyday of outlet shopping. As a reader, ask yourself these two questions: What is an outlet center? What is its value proposition to consumers? Your answer is probably something along these lines:
Outlet centers are destination locations, generally thirty minutes or so away from major metropolitan areas. This is destination shopping because bargain-conscious shoppers often make a day trip to find great deals on brand name merchandise. In exchange for buying out of season or excess inventory, consumers can get awesome products at a low price point. The fun is in the hunt – finding those great pieces that would have cost three times as much in the main store.
Sound about right? I don’t think I’ve lost anyone yet. The value proposition for the consumer here is all about getting a great deal on a great product. It justifies the day trip or at least the afternoon. The problem is that value proposition just is not there anymore – or not to the degree it used to be. In most cases now, shoppers are buying a lower quality good for a lower quality price. That’s discount shopping – not outlet shopping. This means there is an identity crisis for the outlet model. When 80% of products sold at outlets are made for outlets with intentionally weaker craftsmanship, that allure is gone. As non-financial as it is, there are literally dozens of sites out there dedicated to how to spot made-for-outlet items (Example) because of the low quality.
To make matters worse, many brands have pulled back from the outlet side in the name of building brand allure. Let’s rewind the clock back to early 2015 when Coach, now Tapestry (TPR) after acquiring Kate Spade, was dealing with the fall-out from over-discounting in outlets. The same was also true for Ralph Lauren which, through its blue/black/purple labels, was aiming to increase its addressable market at different price points. These are early 2015 conference call quotes (Source: Ralph Lauren, Tapestry 2015 Conference Calls). Both are core tenants at Tanger Factory Outlet Center properties:
In outlet stores, the overall environment was definitely more promotional especially in our space with our competitive set becoming even more aggressive, traffic levels were weak and conversion was negative while ticket was up slightly. As planned, our store comp was down high-teens with our total comp pressured an additional five points by DOS as we pulled back from three flash sales events a week to only one event per week.
And the channel that continued to experience the most challenge was the U.S. factory outlet business, where traffic to the outlet channel in the U.S. continued to be down. I think longer term, what we believe is that with the expansion of the e-commerce business, we believe some of those e-commerce shoppers are choosing to shop online rather than drive to the outlet. And so we do believe there is a cannibalization impact that’s impacting the outlet channel.
While not the point of this research note, despite bull musings that Amazon (AMZN) and e-commerce fears are overstated, overall industry consensus is just as CEO Stefan Larsson says above: cannibalization is taking place at outlets as sales shift online. While the omnichannel model has merit (brick and mortar as a touchpoint for shipping and physical returns), the outlet center model by definition touches less raw population due to location.
The end result of all of this is that foot traffic is down and sales per square foot has been stagnant. Working back to my two examples, Tapestry, both within the Coach brand and now also through Kate Spade, has closed a hefty chunk of its outlet store footprint over the past several years. Ralph Lauren has undertaken similar initiatives. While sales data has improved at both of these retailers towards flat comps at their outlet stores since then, the broader issues remain.
Lack Of Levers
Just like malls, outlet centers are likely overbuilt. That doesn’t mean Tanger is significantly impacted; property locations matter. However, unlike some malls, there is much greater difficulty in repurposing these assets towards higher and better use. Most urban/suburban malls, even those that are not Class A, have better tenant diversity and are able to get on the train of redevelopment. That means targeting more “experiential” tenants like restaurants, movie theatres, and health/fitness providers to drive more consistent traffic. It also means shifting towards mixed use development (apartments, office space) that appeal to the average American today – particularly the younger set. A great location can always be repurposed.
While not true of all outlet centers, that just isn’t a viable alternative for most. The outlet center model was predicated upon large square footage, compartmentalized shopping with dozens of tenants. Remember, “destination shopping.” That often meant acquiring cheap land away from the city center. While many Tanger properties were developed closer to highway lines or, just due to urban sprawl, have seen their addressable markets grow, not all are. Mixed use development opportunities are limited in most cases as is shifting square footage to those experiential tenants. Yes, outlet centers have the occasional restaurant – there is no opportunity to shift a large portion of rent or square footage that way.
Disagree with me? The CEO and CFO are telling you that isn’t part of the game plan, instead stating that “we don’t have large boxes to fill, so we likely won’t be seeking alternative used tenants” and that their outlets are ”surrounded by multifamily housing, dining options, big box retailers, hotels and entertainment so that we do not have to put up our capital at risk to develop” (Source: Q4 2018 Conference Call). In other words, the plan is business as usual going forward and things will turn out fine. That is not what the market wants to hear and it is not what the market thinks will lead to success. Could it be as simple as staying the course? Perhaps. But that seems unlikely as 2017-2019 same-store net operating income (“NOI”) comps have (and will) stayed negative or that cash blended rental spreads remain woefully low. Steve Tanger seems stuck in his ways: compare the 2012 REITweek presentation versus the most current 2019 deck. They are basically the same once you get past the updated imagery despite the fact that seven years separate the two. If operating a REIT successfully was stagnant and formulaic, everyone would do it. The retail markets are undergoing real change – the company has to adapt with it.
Quick Note On Valuation, Takeaways
Bears quickly latched onto the fact that Tanger Factory Outlet sold four “non-core” outlet centers at a 12.6% blended cap rate. This transaction closed after quarter end in March, driving some meaningful dilution in funds from operations (“FFO”) and NOI numbers. I don’t see this as any more than padding numbers and trying to improve overall portfolio makeup. Factoring in some pro forma leverage, cash on cash returns on these properties were near 20%. That money will likely just be rolled into paying down debt.
While these properties were experiencing much worse sales performance and releasing spreads versus the rest of the book of business, the company (assuming $300mm in pre-sale 2019 NOI) is trading at about an 8.6% implied cap rate using proportionate share of its off-balance sheet obligations. There is still a massive amount of premium baked into the rest of the portfolio versus where those non-core assets traded. While outlet centers are an illiquid asset class and really do not see much trading volume, my slightly educated gut is that that range is about where it should trade on net asset value (“NAV”), perhaps a touch weaker. In my view, it is unlikely that Tanger sees any institutional interest from a takeover perspective despite the pretty broad appeal from a balance sheet perspective.
At the end of the day, you either buy into the “hunker down” mentality of Tanger or you don’t. For me, it’s tough to advocate stepping out on a ledge with these distressed retail players who – considering GDP growth and the overall health of the American consumer – ought to be doing very well. To sound like a broken record, shopping centers are the way to go here if you want to dabble in these kinds of assets. Investors still get investment grade credit and a great dividend yield with the shopping center players but they also get tenant diversity, positive same-store sales comps (2-4%), and better liquidity. The higher price is worth it.
In just two weeks’ time, I’ll be at REITWeek meeting with the management teams of a dozen REITs individually and watching many others present. This is a treasure trove of data I’ll be sharing privately with the Industrial Insights community.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.