2023-12-17 08:00:00 ET
Summary
- The Federal Reserve is expected to cut interest rates in 2024, signaling the end of rate increases.
- REITs, including EPR Properties, are expected to perform well with rate cuts. Six months after the rate hike cycle, some REITs usually see double-digit growth.
- EPR Properties has shown strong financial performance and offers a safe monthly dividend well-covered by growing FFO.
- I see EPR's price moving into the low-to-mid $50 range if rates are cut in 2024, offering investors some nice upside.
Introduction
During the latest FED meeting on December 13th, 2023 interest rates were left unchanged for the third straight meeting. Although they left the door open for more hikes, many believe they are done and cuts are coming in 2024. Actually, Federal Reserve officials foresee three rate cuts next year. The new projection implies more than originally anticipated; it signals the end is near for rate increases. I've mentioned this previously, but I think easing rates will not only help the market by boosting investor's confidence, but it will also likely boost the economy as more consumers gain confidence as well.
Throughout the year many high-quality businesses have felt the effects of the macro environment. The REIT ( VNQ ) sector felt it more. But I think the volatility is over and I expect several high-quality REITs to perform well next year. I've written a few articles on some of my favorites expected to soar, but another one I expect to do well is EPR Properties ( EPR ). In this article, I'll tell you why EPR is a buy going into 2024.
Why EPR?
I last wrote on EPR Properties back in September of this year where I delved into the REIT's financials and how they had been performing since reinstating the dividend. I also touched on how consumers viewed the movie theater segment and how it was changing/evolving. Well, fast-forward a few months and seems like the secular headwinds are behind us. At the time of writing the market is up more than 300 points. I'm assuming this is due to the FED's decision to hold rates here which I and many probably already anticipated.
With three rate cuts expected now instead of two, I think REITs will benefit greatly. Most experienced investors know REITs experience volatility during rate hikes and perform better after the fact. In the chart below, you can see the average returns for REITs before & after hiking period cycles. 3.3% before and nearly 16% six months after hikes. But as most know, past performance is no indicator of future (performance).
Despite the headwinds from the sector and consumer spending tighter this year, EPR actually performed well. During their Q3 earnings in October, they highlighted another strong quarter driven by revenue and FFO per share growth of 70% and 27% year-over-year, respectively. FFO of $1.47 beat analysts' estimates by $0.08 while revenue beat estimates by $25.7 million. This was off the strength of collecting $19.3 million of deferred rents during the quarter.
Additionally, they also made nearly $37 million worth of new investments in experiential build-to-suit development and redevelopment. This is important because movie-goers don't want to just go watch a movie and go home. Consumers are now seeking more experience. More bang for their buck. And one way to give them this is to spend capital expanding and redeveloping the business. Luxury seating, the latest technology, etc. As rates ease sometime next year, I see tight consumer spending following suit.
Safe Monthly Dividend
As a dividend collector, do you know what beats getting dividends every 3 months? Collecting them every month instead. Monthly dividends from high-quality stocks help investors not only sleep well but also compound at a much faster rate. In 2023, EPR has maintained a safe payout ratio well below the REIT average. Below we see the FFO EPR brought in in each quarter vs the dividend paid over the same time. Over the course of 2023, EPR's payout ratio averaged a very low 62%. So, investors get paid a monthly dividend that's well-covered. This also gives the REIT ample amounts of cash to reinvest back into business which will affect them positively in the long-term if allocated correctly. So, better movie theaters likely mean more revenue growth due to more customers.
Well-Laddered Debt
Another reason EPR has done well in 2023 in my opinion is the REIT did not have any debt to repay this year. And next year's amount is minimal at only $136.6 million. And with plenty of cash on hand at $173 million and $1 billion on their unsecured revolving facility, the REIT is well-prepared for an economic downturn. But with rates expected to drop next year and their investment grade rating, I think EPR is in a great position balance sheet-wise. They also managed to decrease their debt-to-adjusted EBITDA to 4.4x, down from 5.0x in Q2. For a REIT this is very solid considering they use a substantial amount of debt to grow. This is also significantly lower than peer Four Corners Property Trust's ( FCPT ) net debt-to-adjusted EBIDTA of 5.6x. Even throughout the next 8 years, EPR's debt maturities remain minimal with the largest amount not due until 2029.
Growth Outlook
Since the pandemic, EPR has seemingly been doing all the right things. One way they've been doing this restructuring and significantly enhancing their portfolio. During the quarter they entered into a restructuring agreement with Regal. This agreement was anchored by a new master lease. Furthermore, they managed to sell their fourth largest tenant's Southern Theaters assets to Santikos Entertainment, who paid the full deferred rent owed on the properties. The writer's strike was also settled a few months back in September.
For the first three quarters box office numbers were $7 billion, a 26% increase from 2022's amount in the first 3 quarters. And if we do see 3 rate cuts in 2024, I expect consumers to get back into the movie theaters at a much higher rate than anticipated. Especially with some of the highest-grossing movies of all time's sequels dropping next year. This includes Pixar's Despicable Me 4 and Inside Out 2.
And three very popular movies I'm excited to see next year are also coming out: Godzilla x Kong: The New Empire, Deadpool 3, and Kingdom Of The Planet Of The Apes. So, I expect EPR to see some nice increased revenue & FFO growth in 2024. EPR also saw revenue growth in their fitness locations, and this is expected to grow 2.7% annually over the next 3 years.
Valuation
Quant currently gives EPR a valuation grade of A. Although the REIT is trading closer to its 52-week high of $48.03, I think the stock is poised for growth next year. Furthermore, their FWD P/AFFO ratio of 8.8x trades below the sector median of 14.61x. It's also below their 5-year average of 11.8x according to Simply Safe Dividends. With the optimism after the FED meeting, the stock is trading near its price target at $47.84 at the time of writing. I expect EPR to post a minimum of 3% growth going forward. Using 3% growth, next year's dividend estimate of $3.34, and an expected 10% WACC since REITs typically post higher growth after rate hike cycles, this gives me a price target of $55 for EPR. And unless something major happens in the economy I see them touching the $50's sooner rather than later.
Risks
The broader economic environment poses the largest risk in my opinion to EPR as this could impact consumer discretionary spending going forward. Although I suspect consumer spending to rise with the anticipated rate cuts next year, this is not certain. Credit card debt remains an issue and the predicted recession that looms, both could impact EPR. The REIT's portfolios have been growing nicely and were well-occupied during Q3 with 100% and 99% occupancy in their educational & experiential portfolios. But a recession could cause these numbers to decline, which would likely reduce rental income.
Bottom Line
With rates predicted to be cut three times in 2024 according to FED officials, I see many high-quality REITs like EPR Properties that are poised for some good growth next year. Additionally, as rates decline, I see EPR benefiting greatly from this as consumer confidence grows and movie theaters see increased foot traffic. The REIT also has one of the safest payout ratios in the sector at 62%, well below the REIT average. As we get into 2024, I expect EPR to see an increase in FFO and revenue quarter-over-quarter as movie-goers seek experience as tight consumer spending wanes and they go see some of their favorite blockbuster movie sequels expected to drop next year. As this happens, I see EPR's price following suit and moving into the low- to mid-$50 range. For that reason, I rate the stock a buy.
For further details see:
Three Cuts Expected In 2024? Buy EPR Properties