EPR's Business Update Highlights Solid Liquidity Position But Dividend Remains Speculative
EPR Properties (EPR) provided a brief company update this evening.
Management said that since EPR's last update on March 24, "the impact of the pandemic has increased significantly with the temporary closing of substantially all of its customers' operations."
Tenants and borrowers have paid just 15% of April 2020 base rent and mortgage payments. EPR agreed to defer these payments on a month-to-month basis for substantially all of the customers that have not paid rent this month.
The big question is how many of EPR's tenants will survive this crisis. Movie theaters drive 45% of EPR's revenue, and Eat & Play businesses such as TopGolf and Pinstripes account for another 23% of sales. Education facilities represent 11% of revenue as well.
Source: EPR Investor Presentation
Theater operators AMC and Regal, which combine to account for nearly 30% of EPR's revenue, face an existential crisis due to their high debt loads and shuttered operations.
On April 17, AMC (18% of EPR's revenue) announced a $500 million debt offering which it believes will provide enough liquidity to withstand a suspension of its operations until about Thanksgiving.
While that's better than the alternative, the fragile state of AMC's finances resulted in EPR writing off its rent receivable of $12.5 million from AMC for the first quarter.
EPR will now recognize revenue for AMC (and two small tenants) on a cash basis, reflecting the lack of visibility the firm has into its ability to collect rent from these distressed operators.
Despite these severe headwinds, EPR's solid liquidity buys the company some time. EPR said it will have about $1 billion of cash remaining after completing its $150 million share repurchase program and capital expenditure commitments.
The liquidity analysis below indicates the number of months EPR expects that it could cover its Monthly Cash Burn Rate, which includes all operating expenses, interest expense, preferred dividends, and maintenance capex, without requiring additional sources of cash.
In theory, EPR's $1 billion cash pile could last the REIT as many as 19 months even if it did not collect any rent and maintained its current dividend.
Source: EPR Company Update
There's more to the story than EPR's monthly cash burn, though. Eventually, its nearly $4 billion of debt will need to be paid off or refinanced, and management's liquidity scenarios don't account for that:
The foregoing analysis assumes that none of the Company's available cash would be used for the repayment of principal on the Company's indebtedness, either at maturity or upon an acceleration event.
EPR's credit facility, which has an outstanding balance of around $750 million, expires in February 2022. The company also has $675 million of long-term debt that matures in 2023.
EPR has time to work on extending or refinancing these obligations, but it may not be able to do so on very favorable terms.
The REIT's BBB- credit rating from Standard & Poor's sits just one notch above junk, and a negative outlook was placed on the rating at the end of March.
Given the current state of EPR's business and the growing risk of a recession, its borrowing costs have likely increased substantially, and its covenant headroom could be pressured.
EPR's credit facility and senior unsecured notes contain various covenants or restrictions that limit the company's levels of debt and dividend distributions.
Few details about these covenants are disclosed in EPR's 10-K, but the REIT's plunge in rental income and need to burn through cash for the foreseeable future don't bode well.
EPR's dividend costs around $350 million annually and is the easiest lever management could pull to protect the REIT's balance sheet.
What's less clear is what business might look like once movie theaters, entertainment centers, resorts, and other non-essential companies are allowed to safely reopen.
Nobody knows the timing of when this might happen, but we expect demand to be slow to return to many of these activities. Continued social distancing precautions could play a role, but consumer confidence has also taken a hit.
It will take time for some people to regain the courage to return to public crowded areas like theaters due to lingering fears of contagion, and the unstable employment backdrop could reduce spending on discretionary entertainment.
Operators of these companies may also have to run their businesses at much lower capacity levels to restore confidence, or perhaps to comply with continued social distancing guidelines. Costs to keep facilities extra clean seem likely to rise, too.
The bottom line is that it's increasingly hard to imagine a world where EPR's tenants are able to return to paying their previous rent anytime soon, if ever. And that's assuming most of them even survive the next recession in their weakened states.
If EPR's rent returned to 75% of its previous level, we estimate that the stock's price-to-adjusted-funds-from-operations (P/AFFO) ratio would be around 6 today. A 50% rent reduction would put the stock's multiple closer to 10.
Source: Simply Safe Dividends
While that may sound cheap, it doesn't seem unreasonable given EPR's elevated leverage profile, weak tenant base, and diminished growth prospects due to the company's rising cost of capital.
EPR releases earnings on May 6, and we continue to expect the firm's dividend to eventually be significantly reduced. As conservative income investors, we prefer to own companies that have safer payouts, more in their control, and clearer paths to long-term growth.
