2023-08-21 09:00:05 ET
Summary
- Essential Properties' total return over the last 5 years has almost doubled that of the S&P 500.
- EPRT's occupancy rating stood at 99.9% at the end of Q2 due to its differentiated investment platform of focusing on non investment-grade tenants.
- Due to the current macro environment many REITs including EPRT are trading at attractive prices offering investors potential double digit upside.
- EPRT's weighted average lease term stood at 14 years at the end of Q2, almost 4 years longer than the REIT average of 10+ years.
- EPRT shares similarities to STORE Capital, the only REIT Warren Buffet held a 9% stake in his Berkshire Hathaway portfolio.
Introduction
I'm sure many of my readers remember the REIT STORE Capital. It was very popular and many SA analysts wrote about it quite often. One reason for its popularity was probably because arguably the greatest investor of all time Warren Buffett's Berkshire Hathaway ( BRK.B ) owned a 9% stake. It was the only REIT he held in his portfolio. To be honest it was one of the reasons I looked into it and started a position. STOR was an internally managed net-leased REIT focused on acquiring single-tenant operational real estate, hence the name Store. Unfortunately, the company got bought out in an all cash deal in 2022, electing to go private. Many shareholders were disappointed with the deal including me. I enjoyed the dividends and liked the operations and structure of the company. I remember many people were disappointed because their former CEO, Christopher Volk, suddenly left the company without explanation. The man who started the company all of a sudden vanished! I remember saying, " man this guy must've been a great CEO if people are electing to not invest in the company because he suddenly left". Fast forward and few years later and I had the pleasure to speak with the former CEO. And one of the questions I asked him was what are some of his favorite REITs. One of the names he mentioned was Essential Properties ( EPRT ) I told him that I had done research on them a while back when I first started looking into REITs heavily. I stumbled upon them around the same time as STOR and became interested as their business structures seemed to share similarities. During our conversation, I told him I wanted to look into the company again as I haven't done so in a while. I am looking into a few REITs for my retirement account so I thought it was time to revisit what I liked about EPRT.
Who Is Essential Properties?
EPRT is a REIT who also acquires, owns, and manages single tenant properties leased to middle-market companies operating service-oriented and experience-based businesses through sale-leaseback transactions. They currently own 1,742 properties in 48 states and have 360 tenants. 99.9% of their properties are leased. Most of their properties are leased in Texas, Georgia, and Ohio. The company was founded in 2016 and went public in 2018.
EPRT investor presentation
Diversification
While many REITs focus on auto parts, auto service, and grocery stores, EPRT focuses their attention on tenants who are deemed E-commerce resistant. These include medical & dental services, car washes, quick service, and Early Childhood Education. One thing I like about this REIT is that they have very little exposure to movie theaters and home furnishing stores. Both industries are considered susceptible to E-commerce retailers such as Amazon ( AMZN ) and Walmart ( WMT ) Top tenants only account for 17.5% of total cash annualized base rent with their top tenant, Equipment Share, representing 3.6%. This is important because the REIT has less reliance on top ten tenancy.
EPRT investor presentation
Longer Leases vs Peers
Another thing I like about EPRT are their weighted average lease terms. They typically have 15-year lease terms with an average escalation rate of 1.7% every 1 and 5 years. This is currently longer than peers NNN REIT ( NNN ) at 10.4 years and Realty Income ( O ) at 10+ years. In the second quarter they acquired 78 additional properties; these had a weighted average lease term of 19.3 years! Due to these longer leases, this limits near-term cash flow erosion from their tenants. One reason why EPRT is able to obtain longer leases is their focus on non investment-grade tenants similar to NNN REIT. These tenants have less leverage compared to large retailers like Costco ( COST ) and Home Depot ( HD ). Because of this, it also allows for better pricing, superior risk-adjusted returns, rent growth over the lease term, and the opportunity for tenant credit improvement in the future. The rent growth was evident as the REIT experienced 1.5% same store rent growth during Q2. Unit level rent coverage also increased 4.1x.
essentialproperties.com
Conservative Balance Sheet
When looking into REITs, balance sheet strength is very important because of their business model. Due to the current macro environment, this is especially important as interest rates have risen drastically over the last year. EPRT ended the quarter with approximately $634 million in liquidity and the only debt maturity they have until 2026 is in April of next year. Most of their debt maturities are in 2026 and beyond. They also have an average weighted debt maturity of 5 years and a Net Debt and annualized adjusted EBITDA of 4.1x, lower than peer Realty Income's 5.7x. Additionally 100% of their debt is unsecured compared to 96% for O.
EPRT investor presentation
Total Return
Below is EPRT's total return vs the S&P's over the last 5 years. The REIT pretty much doubles that of the S&P. Having IPO'd just 5 short years ago, I believe the stock has a lot of room for growth and is a great long-term investment. As interest rates have risen over the last year, many REITs have seen their prices fall, especially over the last two weeks. EPRT is down 4.24% compared to popular and larger peers such as Realty Income at -22%, Simon Property Group ( SPG ) at 2.00%, and W.P. Carey ( WPC ) at -27%. I think this speaks to the growth prospects and resilience of the company's portfolio during the economic uncertainty we're experiencing right now, especially in the real estate sector.
Seeking Alpha
Future Growth
As I typically have a long-term outlook for my investments (5 years or more) some of the questions I ask myself are "Where do/can I see this stock in 5 years? What is my goal with this stock and how does it fit into my portfolio? Do I expect it to just provide me income or am I expecting this stock to grow 10 to 15% in the next 5 to 10 years?" So one thing I like to see is where do other analysts expect things such as revenue, cash from operations, earnings to be in a few years from now. Although some stocks don't experience tons of growth, I do like to see growth, even if it's slow. I don't expect every stock in my portfolio to be a fast grower like Starbucks ( SBUX ), especially from a REIT. But what I do expect is steady, reliable income with some growth over the next 2-3 years minimum.
SimplyWallSt
Management increased the top and bottom end of their full-year AFFO per share guidance due to their strong Q2 to $1.62 to $1.65. AFFO increased 8% year-over-year while core FFO increased 7% over the same period. As seen above revenue is expected to increase to $484 million from $355 million or 36% from end of 2023. Earnings and cash from operations are also expected to increase by 21% and 36% respectively.
Valuation & Risks
EPRT's dividend yield of 4.77% is slightly above its 5-year average of 4.46% and a forward P/AFFO ratio of 13.9, below its average of 16.3. I believe this REIT is poised for internal and external growth in the upcoming coming years. Having went public a little more than 5 years ago I believe EPRT is a great long-term investment due to its growth potential and differentiated investment platform. EPRT currently has a price target of $28 and a high of $36 offering investors double digit upside. REITs have experienced quite a bit of volatility over the last year and last month specifically, partly due to the FED battle with inflation and the recent downgrade of the U.S. credit rating by Fitch earlier this month. With the door open for more rate hikes the real estate sector could see further volatility in the near-term as higher interest rates are normally headwinds for REITs. I believe EPRT is at a good price right now making it a buy, and that investors should dollar cost average in and take advantage on any upcoming market volatility.
Seeking Alpha
Investor Takeaway
REITs have experienced a lot of price drops recently making a lot of them attractive investments, especially for investors looking for income. Being a fairly new REIT, I believe now is a great time to take advantage of EPRT as their growth prospects look promising over the next few years. Furthermore, EPRT had an occupancy rating of 99.9% at the end of Q2 due to their differentiated investment platform. With a low payout ratio of 63%, expected earnings and revenue growth, and diversified & growing portfolio, I believe this stock is a great long-term investment and I rate them a buy. While I don't currently own, I am seriously considering adding them to my retirement portfolio because of their underlying similarities to STORE Capital.
For further details see:
Essential Properties: STORE Capital 2.0? Promising Growth Prospects