Ignore The Headlines, Buy EPR Properties (NYSE:EPR)

Expensive readers/followers,

In the present day I wish to analyze EPR Properties (NYSE:EPR) which is a REIT targeted on experiential actual property. The corporate owns 363 properties price $6.7 Billion within the US and Canada and leases their properties to over 200 tenants. It is rather closely weighted in the direction of film theatres (41% of income), adopted by the eat & play idea (primarily Topgolf and Go karts) which accounts for additional 24% of income. Lastly the corporate additionally has publicity to amusement parks, ski resorts and different points of interest. Notably, the corporate has been attempting to cut back their publicity to theatres and schooling and focus extra on the remaining segments – this has been reaffirmed by latest acquisitions, however the transition has been very sluggish.

The inventory has been below strain ever since Covid shut-downs began in early 2020. As well as to excessive rates of interest, EPR at the moment faces two points which have traders apprehensive.

Situation #1: Secular decline in film theatres

Film theatres have been closed throughout Covid and though gross sales have picked up since, they’re nonetheless considerably under pre-pandemic ranges. Operators are doing every part they will to get individuals again in as they rework the shopper expertise by expanded meals and beverage ideas, luxurious seating and the newest know-how. EPR tries to make the case of their presentation that the emergence of streaming shouldn’t be actual menace as individuals are likely to stream reveals however choose to see main film releases in cinemas. Personally, I believe film theatres are right here to remain and so long as operators keep on prime of latest developments and curate the expertise accordingly, I imagine that individuals will proceed to go to films. With that stated I might welcome greater publicity to different experiential kinds of properties.

No matter the place the business heads sooner or later, poor efficiency over the previous two years has resulted in Regal (a serious tenant accounting for 12.6% of income) submitting for defense below Chapter 11 in September 2022. This precipitated the inventory worth to fall by virtually 20% as traders panicked. As unhealthy as it’s, Regal really continues to pay hire for now, however since there are not any ensures that it will proceed, EPR acknowledges the income on a money foundation. Regal’s dad or mum firm tried to promote the entire enterprise, however that hasn’t been profitable. The state of affairs will possible need to get resolved by some form of a restructuring scheme which is ready for a vote on Might 30. With this uncertainty in the best way, I do not anticipate the inventory to rally earlier than it will get resolved.

Situation #2: Weakening shopper spending

The truth that the complete portfolio is centered about individuals going out and spending cash on experiences makes the corporate fairly prone to an financial slowdown. If the financial system falls right into a recession and unemployment will increase, individuals will possible lower their spending on non-essential issues – together with going to films, consuming out and occurring trip. Whereas I’m not very bearish on the US financial system and assume {that a} potential recession could be fairly gentle, traders ought to remember the fact that EPR is prone to battle in that form of setting.

Financials

EPR has a strong portfolio with occupancy of 97% and regardless of the headlines, the corporate posted actually spectacular numbers for 2022. Particularly, whole income elevated by 24% YoY driving a rise in AFFO of fifty% YoY to $4.89 per share. Because of the uncertainty associated to Regal’s chapter proceedings, the Firm didn’t present 2023 earnings steering. Earnings steering is predicted to be offered subsequent to the decision of such proceedings. Analysts anticipate FFO to be principally flat for the subsequent two to 3 years.

The corporate has continued to spend money on its experiential portfolio to lower the relative publicity to film theatres. In 2022, with $402.5 Million spent on acquisitions and improvement. Additional $250 Million has been dedicated to rising the portfolio over the subsequent two years.

Close to its stability sheet, EPR has loads of liquidity with money readily available of $110 million and unsecured revolving credit score facility of $1.0 Billion (unused up to now). Their debt maturity profile can be excellent, with no maturities in 2023 and solely $136 Million due in 2024. This offers the corporate loads of time to kind out Regal’s chapter and climate the excessive rate of interest setting that we now have now. Your complete debt quantity has a hard and fast rate of interest that averages 4.32% – just a little on the upper facet, however on condition that the corporate has no debt to refinance over the subsequent two years, I’m comfortable with it.

The corporate pays a month-to-month dividend of $0.275 ($3.3 per 12 months) translating right into a dividend yield of 8.0%. With an AFFO of $4.89, this dividend is effectively coated with a payout ratio of 65%. Even when the negotiations with Regal fail and the corporate loses 12.6% of income, the dividend would nonetheless be coated!

The corporate additionally gives three sequence of most popular shares that yield between 7.4% and seven.9%. These might be of curiosity to traders that dwell off their portfolio because the dividend is probably going safer with the popular shares (for instance throughout Covid they stopped dividends on widespread inventory however continued to pay them on most popular shares). Personally I am going to persist with the widespread inventory as a result of a much bigger upside potential.

Valuation

The corporate is at the moment low-cost because it solely trades at a P/FFO of 8.7x in comparison with a historic common of 13.5x. Some low cost is justified given the uncertainties associated to Regal, however with very robust leads to 2022 and an ideal stability sheet/liquidity place, it’s onerous to not be bullish at this stage. Even with FFO anticipated to stay flat till 2025, if the inventory normalizes by then, investor will earn a 16% annual return from a number of growth alone as the worth reaches a PT of $63 per share. Add to this the 8% dividend, that is unlikely to get lower for my part, and you’ve got a inventory with a possible 24% annual return over the subsequent three years.

If we assume the worst case situation that Regal does not pay one other dime and EPR does not discover a new tenant for the properties, FFO will lower by 12% to $4.13 per share. Multiplying this by a a number of of 13.5x we get a worst case PT of $55 per share which continues to be 37% above the present share worth (11% annualized return). Any approach you take a look at it, the corporate is undervalued.

So with that stated, what can we moderately anticipate from EPR?

• 8% dividend yield
• 0% FFO development for the subsequent two to 3 years
• 11% annual return from a number of growth as the corporate normalizes (assuming worst case situation)
• -> whole return of 17% per 12 months (that is strong alpha)

Bear in mind how I look to generate alpha:

1. begin with a thesis why a given business/sector ought to outperform
2. keep chubby in these sectors for so long as the thesis is legitimate
3. search for corporations with sound fundamentals which might be both undervalued or pretty valued with distinctive development prospects
4. if an organization turns into overvalued, trim the place, and rotate into one other inventory/sector that’s nonetheless undervalued
5. if an organization turns into more and more undervalued and the thesis continues to be legitimate, add to the place
6. generate alpha and repeat

My whole return then comes from the dividend yield, EPS development and a number of growth because the valuation normalizes over time. I at all times goal a complete return in extra of market returns (>8%) to generate alpha.

What issues do I search for when choosing particular person shares to purchase?

1. robust and protected fundamentals
2. good administration groups with a track-record of caring about shareholders
3. wholesome EPS development
4. well-covered dividend
5. low cost relative to friends and/or historic honest multiples
6. different catalysts

Verdict

The funding comes down as to if or not you assume the Regal chapter will get resolved and the way you see the film theatre as an entire going ahead. Personally, I actually like EPR’s experiential portfolio and though I’m not thrilled concerning the film theatre publicity, I believe that the business will do fantastic going ahead so long as operators innovate. I’ll hold an in depth eye on Regal’s chapter proceedings.

EPR’s monetary place may be very robust. They delivered robust leads to 2022 and I actually like their stability sheet (with $1.2 in liquidity and no main debt maturities till 2025) which can allow them to cope with the Regal chapter in addition to a interval of excessive rates of interest. The corporate is buying and selling at a serious low cost and will earn as much as 16% a 12 months from a number of growth alone when the valuation normalizes. On prime of this traders will take pleasure in a effectively coated 8% yield, for a complete annual return of 24%. Even within the worst case situation assuming EPR by no means sees one other dime from area rented to Regal, whole annual return would attain 17%. Whereas I acknowledge that there are some dangers, primarily associated to an total film theatre decline and an financial slowdown, I imagine the corporate may be very undervalued and effectively positioned to generate alpha. Due to this fact I charge EPR inventory as a “BUY” right here at $41 per share with a PT of $55 per share (primarily based on the worst case situation).