Dividend Cut Risk For Tanger But SWAN With Simon (NYSE:SKT)

Buying stocks that pay out high yields can turbocharge your retirement timeline and even improve your quality of life during your golden years.

However, it is extremely important to simultaneously insist on the components that make that dividend secure instead of wildly chasing the highest yields. If you fail to exert proper caution and conduct sufficient due diligence before buying a high yield stock, you may very well destroy your retirement dreams thanks to steep dividend cuts and significant capital destruction.

Two clear and recent examples of these “yield traps” include Lumen Technologies (LUMN) and AT&T (T), both whom slashed their dividends (and actually entirely eliminated it in the case of LUMN).

As we warned investors ahead of time concerning T:

the dividend is not nearly as safe as the 65% payout ratio implies… if interest rates rise meaningfully for a sustained period of time, management will likely be forced to slash the dividend.

Since then, interest rates indeed soared, T slashed its dividend, and in their latest quarter management was forced to take another massive $29.4B pre-tax write down from rising interest rates and asset impairment charges during Q4.

We also warned investors ahead of time concerning LUMN, stating that investors should steer clear of the stock in part because:

LUMN appears to be keeping the option open – if not outright planning – to cut the dividend.

Within weeks, management announced that they had completely eliminated the dividend and the stock plummeted.

In this article, we help you avoid similar disasters by sharing one high yield at risk of cutting its dividend as well as one that is very likely to sustain theirs.

Dividend At Risk: Tanger Factory Outlets (NYSE:SKT)

Outlet Center REIT SKT on its surface looks like a pretty safe income investment. Its stock has been on a tear since late September 2022, crushing both the REIT sector (VNQ) as well as the broader S&P 500 (SPY) over that span:

Furthermore, its 4.6% dividend yield is about three times greater than SPY’s and also exceeds VNQ’s by over 100 basis points. Moreover, it grew its total dividend payout by 11.5% in 2022 from its 2021 total dividend payout and is expected to have covered it by roughly two times with adjusted funds from operations during the year. They also sport an investment grade credit rating, which indicates that their balance sheet is in solid shape.

However, we see several trends that pose a severe risk to the company’s dividend longer term.

First and foremost, the rise of e-commerce giants like Amazon (AMZN) as well as discount bricks and mortar retailers like T.J. Maxx (TJX) and Ross Stores (ROST) make outlet centers almost entirely obsolete beyond being simply tourist attractions. This is because AMZN, TJX, and ROST are offering similar products at similar prices. Meanwhile, AMZN will deliver the products to your door within a matter of days while TJX and ROST stores are located in very convenient locations in population centers.

In contrast, SKT’s outlets are mostly located outside of the major popular centers and therefore require much greater time and effort to shop in. While several outlet centers are located in regions near popular tourist spots – making them popular shopping locations for people wanting to spend some carefree money on vacation – they lack the economic appeal that they once did, leading to lost pricing power with tenants and the likelihood for lower rental income in the years to come.

This means that moving forward, SKT will need to be investing very aggressively to try to reinvent its properties and maintain their economic appeal. However, their land is simply not as valuable given their more remote locations, so their options to get creative and add value here are pretty limited.

Additionally, SKT has a whopping 16% of its leases expiring this year, another 22% expiring in 2024, and 17% expiring in 2025. This totals 55% of its total leases expiring within three years, a very risky place to be in given that a recession (and potentially severe one) is likely to hit sometime during that span. With most of SKT’s tenants being in the fashion industry, it is highly likely that they will experience a significant rise in vacancies in the coming years and will also have to make considerable rent concessions to retain some of these tenants with expiring leases.

Finally, with a BBB- credit rating, rising interest rates, its upcoming avalanche of lease expirations, and macroeconomic headwinds, SKT’s investment grade credit rating is at severe risk.

We think these factors could force SKT to slash its dividend at some point in the next few years in order to fortify its balance sheet and reinvent its properties to try to remain economically viable.

High Yield SWAN: Simon Property Group (NYSE:SPG)

In contrast, SPG – the world’s largest publicly traded retail real estate investment trust (“REIT”) – has a high dividend yield that lets investors sleep well at night. The reasons why we are much more confident in SPG’s dividend than SKT’s are the following:

First and foremost, its portfolio is much better positioned to thrive in the future. While it does own some outlet centers, it primarily owns class A malls that are located on very valuable real estate in or near population centers. As a result, it has virtually limitless opportunities to get creative by investing in its properties and transform them into fresh, economically competitive, and ultimately wildly profitable assets. In an age where e-commerce has taken market share from bricks and mortar retail, SPG’s malls continue to thrive.

In recent years, SPG’s redevelopment projects have delivered very attractive returns on investment and its malls have seen their key performance metrics continue to improve. This is illustrated by the fact that SPG’s NOI grew by 3.2% year-over-year in Q3 alongside strong occupancy gains and numbers (up 170 basis points year-over-year and 60 basis points sequentially to 94.5%). On top of occupancy improving, so is SPG’s pricing power with tenants, as its base minimum rent per square foot improved by 1.7% year-over-year and 0.4% sequentially.

CEO David Simon highlighted the strength of its business model on the Q3 earnings call, stating:

For nearly 30 years as a public company, like many companies and industries, we have dealt with significant shifts within our industry. In our case we embrace new challenges, and are better operators and more thoughtful and astute capital allocators. Many have tried to kill off physical retail real estate and in particular enclosed malls.

And I need not remind you, when physical retail was closed in COVID, all the naysayers saying that physical retail was gone forever. However, brick and mortar is strong – brick and mortar retail are strong and e-commerce is flat lining. And importantly, over this period of time, we have paid out $39 billion in dividends to shareholders, as we have become stronger and more profitable.

And why do I bring this up constantly? Well, because hopefully this will put an end to the so called negative mall narrative as you can’t pay those dividends without a strong underlying business.

Moving forward, we expect that the current trend will continue: the weaker bricks and mortar retail assets will go dark while the best assets – which make up the majority of SPG’s portfolio – will evolve and thrive.

A second reason why we feel good about SPG’s dividend is that its balance sheet has significant capacity. This is evidenced by the fact that it has an A- credit rating and still has access to capital at attractive rates despite the rising interest rate environment. It refinanced 16 of its property mortgages during the first nine months of 2022 at an impressive average interest rate of 4.78%. It also has $8.6 billion in total liquidity and fixed charge coverage that is greater than five. As a result, even if a major economic downturn hits and SPG is faced with a wave of lease defaults and vacancies, it has the financial capacity to make the necessary investments to restore the portfolio without having to slash its dividend.

When you combine the attractive business fundamentals and outlook with its strong balance sheet, its expected 1.7x dividend coverage ratio in 2022 looks very strong. Ultimately, it will take a very serious and prolonged economic downturn to make a big enough dent in its cash flow to force SPG to cut its dividend. Even then, its balance sheet capacity is such that it can probably bail out or even acquire some of its troubled tenants (as it has done very successfully and profitably in the recent past) in order to tide over the dividend until the economy rebounds.

Investor Takeaway

High yield investing is a powerful tool for investors seeking financial independence without needing to wait decades and decades for dividend growth investing to work its magic nor being beholden to the wild mood swings of Mr. Market when selling shares under the 4% Rule passive index investing model. However, it is far from risk-free.

As we showed in the past with LUMN and T, big dividend cuts can hit even companies that appear to have strong dividend coverage with their cash flows. The state of the business and its balance sheet are often just as important as the payout ratio when evaluating the safety of a dividend.

In the case of SKT, we see trouble ahead for its dividend whereas with SPG we believe its asset quality, balance sheet strength, and low payout ratio can enable investors to sleep well at night.