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2 Incredibly Cheap Retail Stocks

The so-called retail apocalypse is claiming victims left and right. Once-proud retailers have stumbled (Macy's) or, worse, gone bankrupt (Sears). But the apocalypse isn't what it seems.

Consumers have, indeed, been shifting to online shopping in large numbers, but physical retail stores are unlikely to disappear completely. In fact, many online-only retailers are starting to open brick-and-mortar stores. So what's going on is more of a transition, with older retailers learning new (digital) tricks or falling to the wayside, and being replaced by newer retailers that resonate more with today's customers.

How do you play this? By buying a financially strong and high-yield mall owner like Simon Property Group (NYSE: SPG) or Tanger Factory Outlet Centers (NYSE: SKT).

Image source: Getty Images.

1. Simon Property Group: The diversified mall giant

With a market cap of $45 billion, Simon is one of the largest real estate investment trusts (REITs) in the market. Its portfolio of roughly 200 enclosed malls and factory outlet centers easily places it among the largest mall owners in the world (of note: its portfolio, while largely domestic, actually spans the globe). Owning a mall is very different from running a store, but that's a good thing right now.

Simon's goal is to create a physical space that is attractive to both tenants and consumers. Location is a key piece of this puzzle, and the REIT's properties rank among some of the most desirable around. They are, generally speaking, in wealthy areas with sizable populations. But that's just half of the battle; they also need to be maintained and upgraded so they stay fresh and attractive. There is the practical side of that, which Simon is very good at operating. But there's also the tenant side, in which Simon has to curate the list of stores in each property so that consumers want to visit its malls.

Simon is pretty good at ensuring its malls stay relevant, but it isn't a one-time fix. It's an ongoing effort, and because malls tend toward long leases, change can be slow. Simon is spending heavily to update and upgrade its malls, bringing in more experiential tenants and more modern retailers. Getting the right mix takes time. It can be tough for investors to stick around through this effort, but with occupancy at roughly 95%, Simon is hardly in dire straits. And it has about $7 billion in liquidity to help fund its upgrades. On top of that, Simon has one of the strongest balance sheets in the mall REIT sector.

Data by YCharts.

It looks highly likely that Simon will be able to muddle through this retail shakeout without too much trouble. And, more important, it doesn't really matter which retailers "win," since the company is happy to rent to just about any business that will draw a steady stream of customers. So you can take advantage of the retail sector's troubles by acquiring Simon while many investors are throwing the baby out with the bathwater. You'll have to wait out the tough times, but in return, you get to collect a 5.6% dividend yield while the "retail apocalypse" runs its course. Note that Simon increased its dividend twice in 2019, too, which is a clear sign of strength despite what Wall Street thinks about retail-related names today.

2. Tanger Factory Outlet Centers: A more focused way to play

Another retail REIT that's currently in the investor dog house is Tanger, which owns a collection of 39 factory outlet centers. These outlets tend to be well located, with close to 90% of them situated in either key vacation destinations or near highly populated and wealthy areas. The big-picture story here is very similar to Simon's, but there are key differences.

For example, Tanger is highly focused on the factory outlet space. There are benefits to this: Since these properties tend to be more uniform in nature, it is easier and less expensive to bring in new tenants. They also lack anchor tenants, which saves Tanger the trouble of trying to fill giant holes when a tenant leaves. And, as they're largely outdoor structures, general upkeep is pretty cheap. All in all, Tanger's costs are relatively low compared to an enclosed mall, and that translates into cheaper rents for its tenants. That's the good news.

Data by YCharts.

The bad news is that outlet centers tend to be heavy on fashion stores and light on experiential tenants. The biggest pain among retailers right now is showing up in department stores (the anchor tenants that the outlet model avoids) and fashion stores. So while Tanger sidesteps the one, it is squarely in front of the other. Again, it's a matter of time, as the REIT is curating its portfolio of tenants to best fit consumer wants and desires. The process is going to be slow and harder for Tanger than it is for Simon because Tanger isn't pushing the experiential side as hard (it prefers to allow the areas around its centers to develop and add these types of draws).

That said, Tanger has a long history of being fiscally conservative. Like Simon, it has one of the strongest balance sheets in the mall REIT space. And despite the headwinds, occupancy remains strong at around 95%. Further, its funds from operations (FFO) payout ratio was a solid 60% or so in the third quarter of 2019 -- that leaves a lot of room for error. You'll need a stronger stomach to own Tanger, but its dividend, which yields over 9%, looks well supported and will pay you exceptionally well to stick out this rough patch.

Don't bet on a retailer, bet on a mall

Simon and Tanger are two of the strongest mall owners around. They don't care which retailers are killing it or being killed. They just want to fill their malls with tenants that draw a crowd. Owning one or both lets you avoid the risk of trying to pick which retailers will survive and which will fail. Instead, you can collect fat dividends from companies that focus all of their time and effort on getting the best stores into their well-maintained and located malls.

The "retail apocalypse" is real, but it's more a transition period with older retailers being replaced by newer ones. Simon and Tanger are simply riding that wave and should eventually get their list of tenants in line with current trends. When that happens, Wall Street will likely take a more positive view of these REITs. Dividend investors and those with a value focus should do a deep dive now, while the retail battle is still playing out.

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Reuben Gregg Brewer owns shares of Simon Property Group and Tanger Factory Outlet Centers. The Motley Fool recommends Tanger Factory Outlet Centers. The Motley Fool has a disclosure policy.


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