EPR Properties: Hard Not To Watch This Growing Yield (NYSE:EPR)

EPR Properties (NYSE:EPR) is a real estate investment trust that saw some trouble in the aftermath of COVID.

After reviewing both FY 2023 and Q1 2024 results, I have doubts that the problems of COVID linger. Moreover, with an 8%, growing yield, this seems like a rare opportunity. I am going to review the post-COVID business and explain why, even if the growth isn’t very high, the current price makes this an easy buy.

Financial History

Over the past decade, EPR was enjoying a trend of growth until the onset of COVID in 2020.

The pandemic caused a massive decline in their rental income, taking two years to recover fully. Yet, REITs are measured by their Funds From Operations, not just revenues. The company had provided its history of FFO, along with Funds From Operations As Adjusted and Adjusted Funds From Operations (FFOAA and AFFO respectively).

These figures resolve non-cash items, as well as certain cash items, but with the exception of 2020, the numbers generally don’t deviate too much. All figures show significant declines in cash flows.

While the preferred shares were unaffected (FFOs are post-preferred dividend figures), we can see that the total cash dividends paid to the common took a hit. When looking at a REIT, the main thing we consider, whether we like the income or the total returns is the dividend.

On a per-share basis, 2020’s and 2021’s annual rates were not only cut, but distributions halted entirely from the spring of 2020 to the summer of 2021. As such, one of the leading questions is what kind of business we have now and whether or not it will be exposed to similar risks.

Business Model

EPR focuses on owning and renting what it terms “experiential real estate.” Movie theatres are its primary properties, but it owns a variety of assets for other forms of recreation, such as skiing, golf, dining, fitness, and others.

In addition to its experiential properties, the company also has properties used in the private education industry, but this is a legacy operation that they are gradually running off.

By the different property types, theatres are the biggest contributor to the experiential rental revenue, but the other classes still account for a majority from that portfolio.

Most of revenue is derived from rent, with certain portions from other sources, such as mortgages they issue to customers, which are often later renegotiated into leases. They typically issue attractive triple-net leases to their customers. They do, however, encourage and work with customers to develop the properties they use in order to maximize revenues.

About 40% of their revenue derives from three customers, which informs why they leverage the relationships to develop the properties and mitigate the risks of such concentration.

Following recovery from COVID, the rent coverage ratios for their customers are back to 2019 levels.

EPR’s own coverage for the debt on its balance has risen to attractive levels, with a payout ratio on AFFO that gives some flexibility. Additionally, their $2.8 billion in debt sits low at 4.3%.

Future Outlook

After the events of COVID, I believe it’s important to consider how safe the dividend is going forward. The 8% yield is attractive, but it’s priced that way for a reason. Even if COVID was a rare event, unlikely to occur again, we still want to see what management’s plans are to strengthen the portfolio.

Diversifying Out of Theatres

The main answer has been to shift away from their focus on theatres and to diversify more broadly into other forms of experiential real estate. In their 2023 Form 10K (pg. 3), management indicated:

We intend to significantly reduce our investments in theatres in the future and further diversify our other experiential property types. We expect this to occur as we limit new investments in theatres, grow other target experiential property types and pursue opportunistic dispositions of theatre properties.

This was accompanied by a major increase in non-theatre-related investments in 2023, and this is a trend I expect to continue over the years as they expand the portfolio into other sites.

Similarly, all acquisitions in Q1 were non-theatrical properties: a water park and two go-karting locations.

Debt

One of the biggest foils to a REIT in crisis is the debt on its balance sheet, and how repayment could compete with the dividends or even compromise the assets themselves.

Seen here, the real estate is valued at $4.6 billion, while the debt only stands at $2.8 billion, so that’s a good first sign. I also already mentioned how the debt is attractively low for right now, but what about due dates for the principal?

A majority of the outstanding debt is due within the next five years, mainly the latter half of it. With an AFFO payout ratio around 75% and sitting around $400M as of 2023, that gives about $100M in additional cash that can be used to pay down the debt. It is more likely that unpaid portions will need to be refinanced, potential at higher interest rates. Considering the lower rates at present, I do not think that should be difficult, but this does mean that this investment could be a bit of an interest rate game.

Cyclicality

The main risk that I see is the potential cyclicality that comes with these properties. Given that their customers provide services which are largely discretionary in nature, I believe rent and rent coverage could be challenged in the event of a recession. Consumers would have less available cash to spend on movies or similar outings, and even if the rent is covered, this compression could hinder EPR’s ability to achieve favorable financing down the road.

Valuation

I am going to value EPR with a Discounted Cash Flow Model. I will make the following assumptions:

• $412M as baseline FCF
• 2% growth rate across the decade
• A terminal multiple of 10

$412M is the company’s reported AFFO as of 2023. I am calculating 2% average growth to keep it modest, even though they are back to 2019 levels. A terminal multiple of 10 also prices in a high yield for the future.

At a 10% discount rate (typical return of a broad market index), that gets us to an intrinsic value for the business of about $4.7 billion, coming to around $62 per share, suggesting undervaluation, even if there are some bumps in the road along the way.

Conclusion

People often look at REITs as something like crowdfunding meets landlording. Yet, a REIT is a business, like any other, and management is capable of doing more than collecting rent. They can have strategy and vision. For my part, I believe the current management has taken a look at its portfolio and is making the necessary, strategic decisions to improve it. While EPR’s assets may not be as certain as those where top stores and chains operate, they also are not the most troubled, with COVID being a rarity and, perhaps, a wound that too many investors are still licking.

With an 8% yield, a manageable debt profile, and an improving mix of assets with good coverage ratios, I think the market offers an attractively low price for the long-term investor, making EPR a Buy.