Shares of Tanger Factory Outlets (NYSE: SKT) fell 9% to an eight-year low on May 2 after the outlet owner reported its first quarter earnings. Tanger beat estimates on the top and bottom lines, but also reported declines in its core business and cut its full-year guidance.
However, that plunge caused Tanger's forward yield to hit 6.4%, a level that hasn't been seen since 2004. Tanger has hiked its payout annually for 25 straight years, but now income investors might be wondering if its yield is worth the risk. Let's dig deeper into Tanger's first quarter report to decide.
Image source: Tanger Factory Outlets.
What went right for Tanger
Tanger's headline numbers were solid. Its revenue rose 2% annually to $123.5 million, beating estimates by $1.3 million. Its FFO (funds from operations) rose 3% to $59.3 million, or $0.60 per share, topping estimates by two cents.
As a landlord, Tanger relies heavily on the health of its retail tenants. Two of the tenants' growth metrics moved in the right direction over the past 12 months -- same-center tenant sales rose 1.7%, while average tenant sales per square foot climbed from $380 to $384.
Tanger should also remain a reliable income play for the foreseeable future. During the conference call, CFO Jim Williams stated that Tanger's dividend was "well covered," and that he expected its FFO to exceed the "dividend by more than $100 million in 2018" and keep the company's FFO payout ratio under 60%.
Tanger also plans to continue buying back shares. It spent $10 million on buybacks during the quarter, leaving $65.7 million in its $125 million buyback program, which will last through next May. Tanger's average repurchase price was $22.52 last quarter, so it's highly likely that it will ramp up buybacks, as its stock sits at an eight-year low.
Insiders also seem to be confident in Tanger's long-term prospects. Over the past three months, insiders bought about 343,000 shares on the open market, but sold only 142,000 shares.
What went wrong for Tanger
However, there are also three clear signs that Tanger's retail tenants are struggling. First, its occupancy rate dipped to 95.9%. That's high compared to other similar retail REITs like Simon Property Group (NYSE: SPG), which reported an occupancy rate of 94.6% last quarter, but still represents a decline from previous quarters.
Source: Tanger quarterly reports.
Tanger has kept its occupancy rate above 95% for 37 straight years, but reaching 38 could be a tough struggle if this trend continues. However, Tanger believes that modifying leases or offering short-term leases of 12 months or less could offset future declines.
Second, Tanger's same-center NOI (net operating income) slid 1.5% annually. The company attributes that decline to rough winter weather and store closures. Tanger's stores were closed for 900 hours during the quarter, compared to just 300 hours in the prior year quarter. However, the fact that same-center sales grew as NOI slipped also indicates that Tanger's tenants could be using markdowns to boost traffic.
Image source: Getty Images.
Lastly, Tanger cut its full year guidance. It now expects its same-center NOI to decline 1.5% to 2.5%, compared to its prior forecast for flat growth to a 1% decline. It also expects its full-year FFO to rise 13%-16%, down from its prior guidance for 15%-17% growth.
That reduction wasn't huge, but it was disappointing compared to Simon Property Group's decision to raise its full-year FFO guidance last quarter.
Did investors overreact?
Retail REITs are already out of favor due to the tough brick-and-mortar retail market and rising interest rates. That's why Tanger was punished harshly for the seemingly slight declines in its occupancy rate, same-center NOI, and full-year guidance.
But if investors take a breath and look at Tanger's valuations and yield, they should realize that its downside potential is fairly limited. The stock trades at just 8 times the midpoint of its FFO guidance for 2018, compared to a multiple of 13 for Simon Property Group. Its forward yield of 6.4% is also much higher than Simon's 4.9% yield.
I personally own shares of Tanger, and I'm sitting on a 16% loss as of this writing. However, I don't plan to sell my shares into this panic, since Tanger's outlook -- while rough -- doesn't indicate that the business is falling apart.
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