Why Tanger Factory Outlets Centers Is Our Top High-Yield Blue Chip

It combines a low valuation with future growth potential and a high dividend yield

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Jul 23, 2019
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When people use the term “blue chips” when discussing investments, they are often referring to companies that are the best in their sector. Blue-chip companies usually have long track records of dividend growth and tend to perform better during a recession than most others, as their business models and products are difficult to compete against.

One of our favorite high-yield blue-chip stocks is Tanger Factory Outlet Centers (SKT, Financial).

Company background and recent financial results

Tanger, which is a real estate investment trust, is one of the largest owners and operators of outlet centers in North America. The REIT has a market capitalization of $1.5 billion, with annual sales approaching $500 million.

The trust owns, or has a stake in, 40 upscale outlet shopping centers, which are spread across 20 states and Canada. Tanger’s portfolio of more than 2,900 stores leased by more than 500 different name brand companies covers 14.4 million square feet. Nearly 190 million people shop at Tanger each year. Outlets have become very popular with customers as they offer name brand clothing, shoes and other goods at discounted rates. This business model is appropriate in a recession, because consumers will still be able to save money buying the name brands that they like.

Tanger released first-quarter results on May 6. The company’s funds from operation, or FFO, were 57 cents per share in the quarter, which was in line with consensus estimates, but represented a 5% decline from the previous year. Revenue declined 0.3% to $123.2 million, though this was approximately $1 million more than expected.

Tanger’s occupancy rate declined 0.5% to 95.4% for the first quarter. Despite this decline, the trust’s remaining occupants performed well. The average sales per square foot increased $7, or 1.8%,  year-over-year to $391. This is evidence that customers are still flocking to outlet stores for the deals and discounted pricing on name-brand products.

Tanger renewed or re-leased 361 leases during the quarter, covering 1.8 million square feet. The REIT has now renewed or is in the process of renewing 63% of space in its portfolio that is on track to expire during the current year.

For a quarter century, Tanger’s occupancy rate has never fallen below 95%, showing that the trust’s business has been successful regardless of economic condition.

Net operation income was down 0.8%, but this includes the finalization of a sale of four non-core outlet centers. The four properties covered nearly 7% of Tanger’s square footage, but contributed just 5.1% of the trust’s forecasted NOI for 2019. Adjusting for this divestiture, same-center NOI decreased by less than 0.5%.

Tanger received $130.5 million for these properties, which was used to repay outstanding balances on a line of credit.

Since REITs are required by law to pass on to shareholders at least 90% of taxable income in the form of dividends, they usually have to access debt markets in order to fund expansion. Tanger is no different -- it currently has $1.7 billion of debt on its balance sheet.

Fortunately, Tanger’s weighted average term to maturity of outstanding debt is 6.2 years. The weighted average interest was 3.6% in the first quarter and the interest coverage ratio declined to 4.2 from 4.4. This should reassure investors that the trust’s debt situation is manageable.

From 2009 through 2018, Tanger compounded FFO by a rate of 6.1%. Over the last five years, that growth has slowed to 4.7%.

An average annual increase of 1.6% in shares outstanding is partially to blame for this decline in growth, but it is also likely that the growth in e-commerce shopping has contributed as well. While 190 million customers still shop Tanger’s properties every year, online and digital shopping are becoming more and more popular among consumers. For this reason, we have lowered our expected FFO growth rate to 4% annually through 2024.

Shares of Tanger are expected to produce FFO of $2.25 in 2019. Applying this 4% growth rate, shares can produce $2.74 of FFO by 2024.

Dividend analysis

Tanger has increased its dividend for 26 consecutive years. Tanger has increased its dividend:

  • By a CAGR of 3.3% over the past three years.
  • By a CAGR of 7.9% over the past five years.
  • By a CAGR of 6.1% over the past 10 years.

More recently, Tanger increased its dividend by 1.4% for the May 15 payment. Although the trust’s dividend growth has slowed in recent years, its yield is very generous.

Shares of Tanger have decreased 21% year to date. Though this is a steep price decline, it gives the stock a dividend yield of 8.7% as of the July 19 market close.

Even better, Tanger has a low dividend payout ratio. Funds available for distribution were 54 cents per share during the first quarter. This was more than enough to cover Tanger’s dividend of 35.5 cents per share. The trust’s payout ratio of 66% is very low for a REIT, but slightly higher than Tanger’s 10-year average payout ratio of 54%.

Many investors prefer to use free cash flow as a measure of dividend safety.

Tanger produced $33.2 million of cash flow from operating activities in the first quarter. The trust spent just $174,000 on capital expenditures, for a free cash flow of approximately $33 million. Tanger paid out $32.9 million in dividends, for a free cash flow payout ratio of almost 100%.

Over the longer term, this ratio is significantly lower. Over the last 12 months, Tanger has generated $241.5 million of cash flow from operations and spent just $1.2 million on capital expenditures for a free cash flow of $240.3 million. During this time, the trust paid out $131.8 million in dividends, for a free cash flow payout ratio of just 55%.

Because Tanger has a light, capital-intensive business, nearly all of its cash flow from operating activities translates to free cash flow. Over a longer period of time, Tanger’s dividend is well covered by free cash flow.

We find that Tanger not only offers an attractive yield, but the dividend is safe and unlikely to be cut in the future.

Valuation and total expected returns

Tanger’s stock closed the most recent trading session at $16. Using our expected FFO of $2.25 for the current year, the stock has a forward price-FFO ratio of just 7.1. Over the last decade, the stock’s average price-FFO is near 16. We have a more conservative 2024 target of 12x FFO.

If the stock reaches this level by 2024, then valuation could add 11.1% to annual returns over this period of time.

Total expected returns for Tanger could consist of the following:

  • 4% FFO growth.
  • 8.7% dividend yield.
  • 11.1% multiple expansion.

We estimate that Tanger can offer annual returns of 23.8% over the next five years. Using our 2024 estimate for FFO and valuation, we have a five-year price target of $33 for shares of Tanger.

Final thoughts

Tanger’s stock has suffered a severe downturn so far in 2019, but the trust’s business performed decently in the most recent quarter. Occupancy and NOI were down, but just slightly. Tanger’s business of offering high-end products for much less than other stores makes it likely that the business will hold up well in the next recession.

Tanger has also increased its dividend for more than a quarter of a century. The dividend is well covered both by FFO and free cash flow.

For investors looking for a stock with a high yield and the potential for significant multiple expansion, this decline in share price could be an opportunity to acquire shares of a blue-chip REIT. With the potential to return almost 24% annually through 2024, Tanger is our favorite high-yield blue-chip company.

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