2023-12-11 20:10:41 ET
Summary
- EPR Properties has been a standout performer in the real estate sector, rising 10% as it recovers from COVID.
- The company's adjusted funds from operations (FFO) increased by 20% in the last year, beating consensus expectations, aided be deferred revenue recoveries.
- EPR's portfolio is poised for growth, with a focus on reducing exposure to movie theaters and expanding its experiential offerings.
In a year that has not been kind to most real estate stocks, EPR Properties ( EPR ) has been a standout performer, rising about 10% as the company continues to recover from COVID. While the company has significant exposure to the movie theater industry, a challenged sector, the rest of its portfolio is poised for growth. I view its 7% yield as safe and poised for modest growth. As such, I view it at a buy for income-oriented investors.
In the company’s third quarter, EPR generated $1.47 in adjusted funds from operations (FFO), up 20% from last year as revenue rose by 17% to $189 million. This beat consensus by $0.08, aided by strong deferral activity. During the quarter, the company recovered $19.3 million of deferred rent. The company has now recovered $150 million of rent lost during the COVID pandemic alongside related bankruptcies.
Because of this strong recovery activity, EPR raised guidance to $5.10-$5.18 from $5.05-5.15 with $225-275 of capital investment from $200-300 million previously. It also will be disposing $45-60 million of assets. For the full year, it expects $36 million in deferral receipts. These recoveries have helped to improve EPR’s financial standing, but they are now largely complete.
Because it has recovered essentially all of its recoverable losses, that revenue stream will drop to $0.8 million next year. When considering the company’s go-forward financials, these collections should really be viewed as a one-time item, rather than a source of recurring cash flow. Excluding these payments, guidance implies FFO of $4.67, up 5% from last year. Managements aims to grow this 4% in 2024 and 2025.
I view this target as a reasonable but ambitious one. EPR owns and leases entertainment properties. It owns everything from movie theatres to ski mountains and a casino. Over time, it aims to reduce its exposure to theatres and education, using proceeds from asset dispositions to grow the remainder of its experiential offerings. For now, though theatres are the primary driver of the business, accounting for 39% of EBITDA.
There has been a meaningful divergence in performance its customers. Theaters’ rent coverage is 1.5x from 1.7x pre-COVID. Other operators are at 2.6x from 2.0x, leaving the total portfolio at 2.1x from 1.9x. Its non-theatre portfolio is quite healthy as consumers have continued to spend on experiences. In particular, its eat & play unit is attractive, housing significant growth brands like Top Golf.
Unfortunately, the movie theatre business was hit hard by COVID as restrictions closed theatres. Studios shifted more to streaming, and it is unclear if the box office will ever be what it once was. According to Box Office Mojo , the box office is still down 20% from pre-COVID levels. It has risen significantly from the lows, though we are likely to see a quiet few months as the actors and writers strikes forced studios to postpone releases.
Now, theatres have been increasingly creative in finding ways to generate revenue, most notably AMC ( AMC ) releasing Taylor Swift and Beyonce concert films. Under their respective CEOs, Disney ( DIS ) and Warner Bros. Discovery ( WBD ) also appear committed to the theatrical model. While I do not expect theatres to ever be as culturally relevant or profitable as they once were, these trends should support their ongoing operations, even if the next few months are quiet.
The key thing for EPR is that theatres generate sufficient revenue to stay in business. Fortunately, it does own high quality theatres. While its 169 locations account for just 3% of the theatre count, they generate 8% of the revenue. I was also encouraged to see EPR reach a new lease with Regal in August. Regal accounts for $86 million in annualized revenue. In the new thirteen-year deal, EPR receives $68.5 million and additional payments if its revenue exceeds $220 million (which it did in 2022). It also took back 16 of its Regal properties, 11 of which will be sold.
There will be just a $7 million hit to adjusted EBITDA from Regal, but with the proceeds from other theatres, the effective hit should be even less. To see just a 5% EBITDA decline in a bankruptcy proceeding is quite a solid outcome. Even if the overall theatre business is challenged, that speaks to the relative attractiveness of these locations. I do not expect theatres to drive material growth for the company, but so long as they remain in operation, they should provide fairly steady cash flow.
Instead, we should see growth out of eat and play, which is now nearly a quarter of the business. It also owns 11 ski properties, and we have seen a post-COVID rise in skiers , which should help these locations. Critically, EPR also has an average lease term of 13 years, and its properties have 99% occupancy. That provides strong cash flow visibility. There are no meaningful lease expirations until 2027, and most leases have 1.5-2% price escalators implemented annually or every five-years, which supports ongoing revenue growth.
EPR has also brought its balance sheet onto a solid footing, with net leverage of 4.4x. It carries $173 million of cash and only has $137 million of 2024 maturities. Its $2.8 of debt is all fixed-rated or swapped to fix with a 4.5-year maturity. As you can see, these maturities are well staggered, and this minimizes the need for the company to borrow in this current interest rate environment.
Now, the new Regal contract will reduce run-rate earnings potential by about 1% vs the prior master lease. If it replicates the 5% growth this year, that leaves results poised to hit the 4% target. Importantly, these properties are tied to discretionary consumer spending. With inflation coming down and employment resilient, we are seeing disposable incomes rise again. That growth should support continued spending, which is favorable for the business. We may see growth slow a bit, but I view 3-4% as a reasonable central case. Over time, as it sells theatres to buy faster growing properties, this growth could improve somewhat.
Shares pay a $0.275 monthly dividend for a 7.3% yield. Based on its stated FFO, its dividend payout ran at just 56% last quarter. Now that was aided by deferral collections. Excluding this, it has 1.4x coverage on its $4.67 FFO run-rate. That is a solid level of dividend coverage, allowing it to retain about $100 million in cash. With that, it essentially can use 50% retained cash and 50% debt to fund its net capital investment program. I would expect EPR to sustain a similar coverage ratio, meaning dividend growth should track, but not exceed, FFO growth over time.
EP still pays out less than its $0.38 pre-COVID payment, which it suspended during the pandemic, as the theatre business is simply not as profitable as it was. I do not expect a return to this past dividend in the near future. At my expected 3-4% dividend growth, it will take ~6-8 years to get back to this level.
Still, investing is about the future and not the past. Pre-COVID, shares used to also trade north of $70 vs $45 today. Even if the theatre business is not as good as it was, it does not need to be for the company’s stock to be an attractive investment at today’s price. With its long-term leases and favorable bankruptcy settlements, its dividend is secure, providing a 7+% yield. Aided by capital investment and price escalators, EPR can grow FFO and dividends by low-to-mid single digits, which can provide a 10-12% long-term return potential (7.3% yield plus 3-5% dividend growth). This makes EPR an attractive income-oriented buy.
For further details see:
EPR Properties: Poised To Modestly Grow Its 7% Dividend