EPR Properties (EPR -0.32%) used to be known as Entertainment Properties, and that's a pretty fair description of what the real estate investment trust (REIT) owns. This is an interesting focus in the REIT sector, but one that was not good during the early stages of the coronavirus pandemic. There are still lingering impacts from that period, but EPR increasingly looks like it can handle the situation while continuing to support its hefty dividend, which at the current share price yields 6.8%.
EPR is all about people
Like most REITs, EPR owns properties, but it has a unique focus on assets that bring people together into group settings for "experiences" -- think amusement parks, skiing, and movies, among other things. During the early stages of the pandemic, when people were socially distancing and many businesses deemed nonessential were temporarily shuttered by the government, EPR's tenants were facing a tough situation. To make sure that it could deal with the potential hit to rent collections, EPR suspended its dividend.
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That was a hard choice, but likely the correct one. Now that we are past the crisis stage of the COVID era, EPR's dividend is back. In fact, much of its business is stronger than it was before the pandemic. Rent coverage -- roughly how much cash a tenant is earning versus the rent it pays -- for the company's portfolio has increased from 1.9 times in 2019 to 2 times as of 2023's third quarter. But there's an important dichotomy to take note of here.
Roughly 40% of the REIT's portfolio is tied to movie theaters, which were hit extra hard by the pandemic, at least partly because consumers got used to streaming first-run movies at home. EPR's rent coverage for movie chains was 1.7 times in 2019, but fell to 1.4 times in Q3 2023. The other 60% of the business, which is much more diversified, saw rent coverage rise from 2.0 times in 2019 to 2.6 times in the third quarter. In other words, a big part of EPR's business is still struggling.
EPR is handling the problem
The REIT's management isn't sitting around hoping for the best. It is actively working with tenants to strengthen the portfolio by selling assets, restructuring leases, and releasing assets where appropriate, among other things. Although the end goal is to trim its exposure to movie theaters, it will take time to achieve this. For this reason, EPR stock is probably not an appropriate choice for conservative investors.
However, there's an important detail to understand about the REIT's dividend. In the third quarter, the company's adjusted funds from operations (FFO) came in at $1.47 per share. (For REITs, FFO is the key benchmark metric of earnings, reflecting the cash they take in from their business activities.) The dividend EPR paid during the quarter was $0.825 per share. That means its adjusted FFO payout ratio was a modest 56%. That leaves a lot of room to cope with adversity before the dividend would be at risk. Perhaps more to the point, it leaves the company a lot of room to shrink its exposure to movie theaters.
EPR has a big problem on its hands as the movie theater business more generally looks to regain its footing. But, at the same time, it appears as if the REIT is positioning itself to muddle through in relative stride. For investors who are willing to take on a bit more risk, EPR's lofty yield looks like it could be a worthwhile risk/reward trade-off. This isn't a set-it-and-forget-it kind of investment though. Shareholders will want to keep close track of its progress in shrinking its still-sizable movie theater portfolio. However, if the extra legwork doesn't bother you, then a deep dive is probably worth it.
EPR is exploring new ground
The key takeaway here is that EPR is not the same REIT it was before the pandemic. In fact, it's still trying to figure out exactly what kind of REIT it will be in a post-pandemic world. Because it's still in a state of transition, conservative investors will probably want to sit on the sidelines. But management appears to have positioned the REIT to continue paying a sizable dividend even as it works through a major portfolio transformation. More aggressive investors who are willing to bet that the transition will work out, and who are willing to monitor the restructuring closely, might want to step in here while the yield is still lofty.
