EPR Properties: Lack Of Cash Puts A Hard Limit On Growth (NYSE:EPR)

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The Thesis

Surviving the COVID crisis has not allowed EPR Properties (NYSE:EPR) an opportunity to bloom in 2023; slowed growth and not enough cash for expansion leave EPR facing uncertainty ahead as rising inflation and unpredictable changes in interest rates become the main dangers for this year; it’s better to be cautious and Hold at the current prices.

What’s The Business Behind The Fun?

EPR is a diversified experiential REIT. Its holdings are service businesses that provide experience in the form of different experiential properties, ranging from golf complexes and amusement parks to yoga spas, skiing resorts, casinos, zoos, museums, and many more.

EPR classifies them by type and currently holds $6.8B+ in Investments, spread across 359 locations in 44 states and Canada. With such an extensive and well-diversified portfolio of investments, having them grouped by type becomes necessary.

Diversified Entertainment, A Portfolio Of Experiences

EPR holds $6.8B+ in 44 States and Canada, with over 200+ tenants; their central holdings are in cinema theaters as it is the original focus of the REIT, with Eat & Play centers being an interesting angle, as they offer a more varied experience, providing an exciting alternative to regular dining places and could potentially be on the path to become as customers new preferred night out.

The 7% in education is considered a legacy investment by the company. Nonetheless, they provide more diversification and nicely round up a portfolio mainly focused on fun and discretionary spending.

There is a generational divide between baby boomers and millennials (Who would have guessed!). The older generation had an ownership-of-things mentality, while millennials look for experiences instead of things. They also have increased brand loyalty if you can make the impression of the experience worthwhile; this shift could be a pretty good long-term driver of growth for EPR, mainly as the company focuses on high-quality experiences with a very diversified catalog and some unique offerings like Artmaint centers the brand has both a massive and solid base and some higher risk more innovative avenues.

On the negative side and from their 10-K page 3:

As of December 31, 2023, our owned theatre properties were leased to 17 different leading theater operators. A significant portion of our total revenue was from AMC and Regal. For the year ended December 31, 2023, approximately $94.7 million, or 13.4%, and $103.7 million, or 14.7%, of the Company’s total revenue was from AMC and Regal, respectively.

Though it’s never good to entirely depend on one primary customer, the 14.7% is not that high but presents their unique risks, as AMC and Regal’s primary industry is cinemas.

As ticket sales continue to decline year after year, as more people decide to stream their movies instead of a night out in the cinema, EPR could be left holding a losing bag of cinema theaters and a danger that could also be compounded with increased inflation, with cinema ticket prices average $10.78 vs. Netflix subscription of $8.99 a month cinemas seem poised to be struck by inflation, once again compounding the already risky position of the leading portfolio.

Significantly, 2024 is projected to be a year of 5% lower ticket sales for cinemas.

The 37% of theater holdings is still a vital part of the REIT, but management is taking steps toward lowering the percentage of income that depends on theaters, expanding on other areas.

Inflation And Water Parks, One Is Fun, The Other Not So Much

The company acknowledges that the two most significant factors outside its control are inflation and interest rates. They have the most significant impact on the top line (Inflation driving customers away) and the bottom line (rising interest rates making their CAPEX prohibitively expensive).

While much of the economy is directly affected by the FED, it sure can hit harder a company dependent on discretionary customer spending for their income and whose structure is capital intensive.

As service inflation has been the main motor behind inflation so far, EPR could use 2024 with lower inflation and lower interest rates, with the REALLY worst-case scenario being, of course, high inflation causing customers to shy away from discretionary spending, answered by the FED with an interest rate hike causing loan costs to skyrocket and bringing a bankruptcy cascade on the EPR’s holdings and taking the whole REIT down under.

Competition In The Business Of Entertainment

Their biggest rival is VICI (VICI), a massive experiential REIT with prized locations in the Vegas Strip and a market cap of nearly ten times more, VICI 30.842B vs. EPR 3.146B. Luckily for EPR, the main focus of VICI is in the casino industry. The locations of both REITs don’t have such a considerable overlap that the smaller EPR could be threatened or even pushed out of the market by outbidding or similar.

The more spread-out EPR locations also provide more geographical diversification and access to more local US markets, so it’s a net positive for the company.

Yet experiential REITs are relatively new, and history has shown again and again that the companies that are the trailblazers many times end up being swallowed by the competitors that can improve the new business model and exploit all the weaknesses of the older companies, so we can’t entirely discard that someone could cross the moat and assault the EPR castle.

Dividends From Fun Activities Are Doubly Fun

But you still need to ensure you can keep paying them without heading towards chapter 11 (which is decidedly not fun at all).

The payout ratio has been kept steady, while the dividend yield is in a clear secular trend; I consider this a good sign, as a stable payout ratio is both good for the needed financial planning the company has ahead and shows the actual effort in paying a higher dividend yield has not increased that much.

It’s essential to keep payout ratios in mind, as they are one of the best metrics to measure the sustainability of dividends.

The other great metric compares the FFO per share to the dividend per share, this is a test of the capacity of the stock to continue paying the dividend with the money generated by it.

As we can see from their last 10-K, the FFO per common share and the FFOAA per common share, both diluted, are 5.15 and 5.18, respectively. To be conservative, we can use the lowest of them: 5.15

With a DPS of 3.30 and an FFO per share of 5.15, the dividend is covered, even though the margin of only 1.85 per share for future investments could use a bump up.

Overall, EPR can keep the dividends going, but I’m curious if the needed investment in growth will not be left behind in 2024; I rate this as positive but not too good.

The Money To Keep The Amusement Park Music Going

Revenues were hit hard by the global pandemic, as expected from services where large numbers of people are gathered, with a secular trend of 5 years broken. Still, with a steady recovery, 2023 closed with revenues above pre-pandemic levels.

The interest rates right now are too high for the company to invest heavily and increase its capacity to earn the company.

As REITs are capital intensive, they are exceptionally sensible to changes in the cost of capital, the company says on their last 10-K

Subsequent to 2021, REITS have generally experienced heightened risks and volatility due to the impact of inflation, including rising interest rates. As a result, negative pressure in financial and capital markets has increased the cost of capital. Until capital costs improve, we expect that our levels of investment spending will be limited in the near-term and that these investments will be funded primarily from cash on hand, excess cash flow, disposition proceeds and borrowing availability under our unsecured revolving credit facility, subject to maintaining our leverage levels consistent with past practice. As a result, we intend to continue to be more selective in our investment spending until such time as economic conditions and our cost of capital improve.

But the company also has a dividend payout of 167.80%, meaning it pays way more dividends than its annual net income would allow. While REITs are required to pay more than 90% of their net income in dividends, they must also strike a balance of having enough Net Income left for investments. With interest rates not being cut yet, we could potentially enter a situation where EPR could not make new investments in the foreseeable future.

This is the biggest hurdle to investing in EPR right now. With the combination of slowed growth and the dangers of the current or rising interest rates, we could have 2024 without any investments, causing a lack of compounding for years to come. This is something other than what investors want.

Cold hard money is the KING of things a business needs; as Charlie Munger once said, “EBITDA are Bullshit earnings“

And once again, recovery has been slow; we are still below 2019 in Unlevered Free Cash Flow, in big part thanks to the large dividend payout of +166.70%, a number relatively high if we consider that the dividend yield is 7.90%, nearly twice the industry’s rate of 4.64% but causing EPR to keep burning precious money need to fund the expansion that could put the company on the track to a full recovery of the COVID pandemic.

But Can You Really Value Fun?

Yes, you can; as of right now, one of the biggest drivers of interest in EPR is the high dividend yield, with a 4-Year Average Dividend Yield a hefty 46.86% above the sector and the Dividend Yield (FWD) a staggering 73.12% above other REITs, EPR has become a big dividend option if they keep the dividends rolling.

I find the most logical way is to value this stock using the Dividend Discount Model for two main reasons: The first is, of course, the high dividend yield compared to its peers; the second is I believe growth might be impaired if interest rates and inflation do not go down. And although rising interest rates, might have a positive long-term impact for REITs either way, EPR has a long way ahead either way, with either having to wait for enough money to roll in and for their investment or waiting for the changes in interest rates that would help further grow.

The formula for the Dividend Discount Model I will be using is a simple DDM.

The cost of capital equity is a WACC from Valueinvesting.io.

And the dividend estimates I obtained from Seeking Alpha Premium.

The 1% growth in dividend is a figure I believe is the best conservative bet with the information we have right now and the previous problems for EPR to investing in its own growth. Thus, my principal assumption is that EPR is aiming to become established as a high dividend income stock and not as a growth stock, meaning just that, low growth in exchange for a high income for investors.

Conclusion

Here, we found the big question: is management trying to wait for lower interest rates and lower inflation to start working on the projects needed to grow YoY? Then, if the answer is a resounding yes, one should wait for that couple with a price drop caused primarily by market speculation.

The company has its merits; it has plenty of well-diversified holdings and an exciting and rather innovative value proposition, but at the current price and with stagnation caused by lack of resources, coupled with an uncertain future, the fun won’t begin until we can have a clear sight of investments that will bring growth and more cash.

Expanding into other areas becomes even more urgent, as the central holdings of EPR are in an industry with a secular decline, and no one wants to be left with a losing bag and no money to pivot into greener pastures.

With a $48 fair value vs the $41 it currently trades, there is not enough margin of safety to warrant an investment right now. Too many variables could negatively hit the price in 2024, like inflation, interest rates, and the continuing decline of cinemas, which still account for a large part of the revenues.

Personally, I will wait for a price drop, caused by an external FUD, while monitoring the intrinsic value and the margin of safety.

My final verdict is a cautious HOLD and keeping both eyes open.