2023-12-19 12:30:00 ET
Summary
- EPR Properties is a triple net lease REIT with experiential properties that sells at a low price to FFO and also offers 3 preferred stocks.
- EPR Preferred “E” is a relatively very undervalued convertible preferred stock. It has a current yield of 8.21% versus only 7.16% for non-convertible EPR Preferred “G”.
- If EPR.PR.E sold at the same yield as EPR.PR.G, it would trade at $32.00 or $4.10 higher than its current price, and it once sold for much higher than that.
- Because both EPR “E” and “C” have embedded EPR options in them, you can write covered calls against them at no risk to juice your returns, especially with EPR-C.
- You can juice your EPR-E yield from 9.7% to 11% over the next 13 months and the EPR-C yield to a very nice 12.5% and without the risk of losing money from having sold calls.
At our Conservative Income Portfolio service, we try to think outside the box to provide members with high total returns with relatively low risk. I think readers will find this idea quite interesting.
EPR Properties
Anyone who follows EPR Properties ( EPR ) knows that COVID presented them with great challenges as their experiential properties were shut down during the lockdown. And even after the lockdown, it took some time before people felt comfortable being among other people.
Fast forward to today and all of the sectors that they are operating in, except their movie theatres, are performing as before COVID and even better. Box office attendance at the movies is still lagging from pre-COVID times. Currently, Regal Cinema, who EPR leases theatres to, is in bankruptcy. But we already know the outcome. Regal will continue to lease most of the theatres that it was leasing and it will exit bankruptcy a much stronger company as their debt is reduced in bankruptcy. The announcement of Regal exiting bankruptcy could provide a spark for the common stock.
EPR trades very cheaply relative to other triple-net lease REITs. It just announced an earnings beat with an adjusted FFO of $1.47 for the quarter although it did include some back payments they were owed. But an FFO of nearly $5.00 seems like a reasonable estimate for next year. With EPR selling at around $47.36 the price to FFO is less than 10 times. Compared to other triple net REITs that is quite cheap but EPR will always likely trade cheaper than some of the more beloved triple net REITs like O and NNN. This is likely due to PTSD from the COVID experience and their more unusual types of properties. It seems that it will take some more time before investors put the COVID experience in the rearview mirror. But currently, EPR is breaking out to new yearly highs.
But there is a way to play the common stock with less risk, and in one case with a higher yield, and that is with the 2 EPR convertible preferred stocks.
EPR Preferred "E" Looks Quite Undervalued
EPR Properties CONV PFD 9% SR E ( EPR.PR.E ) is a convertible preferred stock. Thus, it cannot be called and can move quite high in price, especially if EPR common shares perform well and/or interest rates continue to move lower. And even after COVID, in April of 2021, EPR-E traded above $40 per share. So EPR-E has come way down in price, much more than the common stock. This looks like an opportunity to me.
As you can see, from its high EPR-E has dropped over 28% compared to a common stock drop of only a bit more than 5%. But the important point here is how much upside there is to EPR-E. It has almost 50% upside to its old high from 2021 and the fact that it can't be called gives huge upside potential.
At its current price of $27.89, EPR-E's stripped yield is 8.21% and with a strong balance sheet. There are very few if any property REIT preferreds with good balance sheets that offer a yield this good. But what is also important is the relatively very large 8.21% yield that EPR-E provides versus the straight preferred stock EPR Properties 5.750% CUM PFD G ( EPR.PR.G ). EPR-G currently yields 7.16% and it doesn't have unlimited upside nor does it have an embedded call option or warrant which adds even more value to EPR-E relative to EPR-G. IF EPR-E sold at the same yield as EPR-G, it would sell near $32.00 per share versus its current price of $27.89. So the relative undervaluation of EPR-E versus EPR-G is enormous. Certainly, anyone owning EPR-G has got to swap to EPR-E .
The Value of EPR-E's Convertible Feature
Now, unfortunately, it is time to do a little math. However, you don't have to understand the math completely to get the point. EPR-E, being a convertible preferred, can be converted into common shares. Currently, EPR-E can be converted into .4826 common shares. This means that EPR-E has a forever call option on EPR common stock attached to it with a strike price of around $57.00. If EPR trades at $57, .482 shares of EPR will be worth very close to the current $27.39 stripped price of EPR-E (EPR-E goes ex-dividend 56 cents very shortly).
So what is a forever option with a strike price of $57 worth at EPR's current price? Well, the EPR $55 call with a strike price of 13 months away last traded at $1.50. I don't have an options model, but that would indicate to me that a forever option with a $57 strike price would likely be worth something like $3.60 (definitely a guess). Since one share of EPR-E only converts into about ½ share of EPR, you are getting an option worth about $1.75 along with the 8.21% yield making the disconnect even bigger between EPR-E and EPR-G which has no embedded option.
Selling Call Options Against EPR-E
We can monetize the embedded call option in EPR-E by selling $60 strike call options against it because the embedded $57 strike option within EPR-E makes it impossible to lose money by selling $60 strike calls against EPR. Since each EPR-E share only has an option for about ½ a share of EPR, you must sell only 1 option for every 200 shares of EPR-E you own. If you sell January 2025 $60 calls at $0.80 you will add another 40 cents per share to your EPR-E income since you can only sell 1 EPR call for each 200 shares of EPR-E while maintaining a large upside. That will juice your yield on EPR-E to around 9.7% over the next 13 months . And selling a $55 strike option at $1.50 has very low risk and this will juice your yield on EPR-E to 11% .
After the option expires, if EPR has moved up in price, you should be able to get an even better price on selling another call option. And it is quite likely that EPR-E will also be higher in price because the embedded call will now be worth more given that the price of EPR is now closer to the strike price of the embedded call. Of course if the common stock drops in price, you will get less the next time you sell calls. And if EPR closes above $60, the rise in the price of EPR-E will be greater than any loss you might take on the option as its forever call will always be worth a lot more than a call that is about to expire.
Let's look at a 10-year chart during a relatively normal period between the Great Financial Crisis and the COVID meltdown.
As you can see the 100% rise in EPR common dragged EPR-E up over 50%, in large part due to EPR-E's embedded call. So in the case that EPR moves up to $55.00 in 13 months, that is a 21% move. Thus, it is likely that EPR-E will move up at least 8% or about $2.23 adding another 8% to your return giving you a 19% total return if you sold the 55 calls.
EPR Preferred "C"
EPR Properties PFD C CV 5.75% ( EPR.PR.C ) provides a bit lower current yield than EPR-G but has a very valuable embedded option which gives EPR-C a lot of price upside if EPR common moves higher. The embedded option in EPR-C is definitely better than the one in EPR-E. So if you choose, you can juice the yield a lot by selling calls against EPR-C if you prefer to limit your price upside. Let's take a look at the numbers.
EPR-C can be converted into .424 shares of EPR common.
At a price of $21.13, EPR-C has an embedded EPR call at a strike price of $49.85.
With EPR common selling at $47.36, the embedded call in EPR-C is almost in the money. So what is this almost in the money forever call worth. The 13-month $50 strike call is around $2.60. So I would say that a forever call would likely be worth at least $5.50. Now we must multiply that $5.50 by .424 so each share of EPR-C has an embedded option worth around $2.33. That is a lot on a preferred stock selling at $21.13. And you can really monetize this embedded option in a big way because it is almost in the money. Let's look at the numbers.
Selling Calls On EPR-C
Let's say you decide to sell the January 2025 $50 strike call on EPR. That call last traded at $2.70 per share. So you can't lose money on the option unless EPR trades over $52.70, but since you have an embedded option attached to EPR-C with a strike of $49.85, there is no risk. In this case, you will sell 1 call option for each 235 shares of EPR-C that you own. So the $2.70 in option premium you collect for selling the $50 call will be divided over 235 shares of EPR-C. So you will improve your yield by $1.15 per EPR-C share that you own over the next 13 months. This will provide you with an oversized yield of 12.5% over the next 13 months . Pretty nice and certainly better than the current yield of 7.16% on EPR-G.
Interestingly The Number of Shares That EPR-C Converts To Is Growing Over Time
One other quite interesting thing about EPR-C is that the number of shares of common that it converts into grows each year making the embedded call better and better over time.
You can see here that EPR-C was issued 17 years ago and at that time it converted to .3504 shares of EPR common. Now it converts into .424 shares or 20% more shares than it did when issued. And it will continue to grow and will continue to increase the value of the embedded option into the future. This is because EPR-C's coupon at par is only 5.75% which is lower than EPR common stock's yield. So this annual increase in the conversion value of EPR-C is to compensate for the lower yield versus the common. It ensures that if EPR pays out a very high dividend to common stockholders, which will act to keep the NAV of EPR common from growing, that the holders of EPR-C won't be harmed by this; as EPR-C is a play on EPR common stock going higher as well as receiving dividends. This is a simplified explanation but it will suffice.
Let's look at the same chart for 2010 to 2020 and how EPR-C moved with EPR common.
As you can see, because the embedded option in EPR-C is almost in the money now, and the number of shares of EPR common that EPR-C will convert into will continue to grow, EPR-C should track EPR common very closely. And if EPR raises its common stock dividend, the number of common shares that EPR-C will convert into will grow at a faster rate so that EPR-C holders will also gain from any common stock dividend increases. Thus, why own EPR common when you can own EPR-C with the safety of a preferred stock and less downside price risk?
Just an added tax note, 20% of the dividends paid by EPR-C and EPR-E are tax-free as are the dividends from all profitable REITs. And if you plan to sell calls against your EPR convertible preferreds, you will need a margin account with privileges to sell naked calls as broker computer programs aren't smart enough to realize that these calls you are selling are actually covered by the convertible preferred stocks that you own.
Summary
EPR convertible preferred stocks offer valuable embedded options on EPR common stock that the market is overlooking. And these call options attached to EPR-E and EPR-C can be monetized by selling EPR calls against them at no risk except giving up some possible price upside, mainly on EPR-C.
EPR-E, even if it was not a convertible preferred, is still very undervalued versus EPR-G and would sell for $32.00 just to have an equivalent yield, up from its current price of $27.89. The 8.21% current yield is also quite good relative to other property REIT preferred stocks with good balance sheets and you can increase that yield by selling out of the money calls on EPR if you should so choose.
EPR-C, although the current yield is a bit less than EPR-G, has attached to it a forever call option on EPR common that is quite valuable as it is almost in the money. If you use that embedded call option to sell what are essentially covered calls against it, you can increase your current yield to 12.5% over the next 13 months. And then repeat the process when the current options expire.
EPR is breaking out to new highs now and sells at a low PFO multiple with a nice current yield. If it continues higher it will boost the prices of EPR-E and EPR-C due to the rising value of their embedded call options on EPR common.
For further details see:
EPR Properties: Undervalued Convertible Preferred Stocks - Write Covered Calls Against Them