High-yield real estate investment trust (REIT) EPR Properties Trust (NYSE:EPR) has evolved from its early days when it focused on movie theaters and was known as Entertainment Properties Trust. Now a far more diversified landlord, it has increased its dividend for nine consecutive years. Add in a 6% yield, roughly three times what you'd get from an S&P 500 index fund, and there's a lot to like here. But is EPR a great dividend stock?
What it looks like today
When EPR was founded, it primarily owned movie theaters, with a sliver of exposure to entertainment assets (such as golf clubs). That meant EPR was almost wholly dependent on the ups and downs of the movie business. Such a focused approach comes with notable diversification issues, including that there is a limited number of large theater chains (the REIT's customers) in the country and only just so many locations worth owning. So it's a positive that EPR looked to broaden its portfolio.
Today it invests in entertainment (largely movie theaters), recreation, and education assets. Going from almost all movie theaters to a broader mix took a number of years. However, at this point, net operating income from the REIT's roughly 415 properties is spread roughly 50% in entertainment, 30% in recreation, and 18% in education (the "other" category rounds out the mix). Movie theaters are still the single largest property type in the portfolio (about 175 locations), but the list today also includes ski resorts, amusement parks, golf courses, schools, and early childhood education centers, among others. That offers a lot more levers for growth.
The REIT's balance sheet, meanwhile, is investment-grade-rated. Nearly all of its debt is unsecured, meaning its properties generally don't carry mortgages. And its financial debt-to-equity ratio is roughly 0.5, a very reasonable number for a REIT. It also has a $1 billion revolving credit facility that is largely undrawn, giving it plenty of liquidity to buy and build (it has a few entertainment assets in development) if there's an opportunity.
Rent coverage is fairly strong across the different sectors it serves, too. Recreation assets are at the high end with nearly 2.3 times coverage and education at the low end with a still solid 1.5 times. The average rent coverage across the entire portfolio is roughly 1.75 times. Occupancy sits at an impressive 99%.
EPR's top line has grown fairly steadily over the past decade, increasing roughly 260%. Dividends account for a reasonable 77% of adjusted funds from operations (AFFO), a metric that corresponds to earnings for an industrial company. And, as noted above, the dividend has been increased for nine years. The average annualized growth rate over that span was about 6%, roughly double the historical rate of inflation. The dividend is paid monthly (making it sort of like getting a paycheck) and the 6% yield is notable in today's low-yield world. So far there's a lot to like here.
Is that enough for greatness?
Although EPR is a landlord, a portion of its rents is tied to the performance of the assets it owns, so there will always be a little volatility on the top line. When times are good, this will be a net benefit, but if consumers pull back for any reason, like a recession, the REIT will feel some pain along with its tenants. Since the current economic upturn is among the longest on record and basically coincides with EPR's portfolio diversification efforts, it's hard to tell what this could mean for the portfolio. But it is likely to increase the hit from a downturn and, notably, negatively impact Wall Street's opinion of the REIT.
In addition, EPR actively manages its portfolio, buying, selling, and building assets. That can lead to timing issues that may make AFFO vary from time to time. In the third quarter of 2019, for example, AFFO fell 8% year over year due to a combination of factors, including asset sales. That's not the end of the world, but it is something to keep in mind as it has broader implications. For example, the payout ratio in the same quarter of 2018 was 68% -- notably better than the 77% seen in the third quarter of 2019. These vagaries aren't unique to EPR, but in light of the company's niche property focus, they increase the uncertainty a little bit.
Looking at EPR's value proposition, based on its current AFFO guidance for 2019, the shares trade at a price-to-AFFO ratio of roughly 13.5. That's fairly reasonable, noting that some of the leading REITs in the market have much lower yields and price-to-AFFO ratios over 20. EPR actually raised its AFFO guidance in the third quarter, which is a good sign. All in all, the negatives here aren't huge and are largely outweighed by the positives.
It's great, right?
EPR Properties Trust looks like a pretty good dividend stock, but it probably falls a little short of great.
Although it has diversified its business notably in recent years, it's still focused on unique property types -- two of which are highly reliant on consumer spending. It remains to be seen how this restructured portfolio will hold up in an economic downturn. That's not a small issue: During the last recession, the stock lost 75% of its value. While it was a very different REIT back then, the fact that the current business approach has yet to be stress-tested is a big issue. This is likely one of the key reasons the REIT's yield is 6% versus the average REIT's 3.1%, using Vanguard Real Estate Index ETF as a proxy.
Once EPR's approach has been put through that crucible, it would be worth re-examining the greatness factor. That doesn't mean investors should stay away, just that anyone who jumps aboard needs to go in with their eyes open to the risks this high-yield stock may present when times inevitably get rough.