EPR Properties (EPR) Earnings Call Transcript & Summary

All right. Good morning, everyone, and welcome to the 9:15 a.m. session at Citi's 2023 Global Property CEO Conference. I am Eric Wolfe with Citi Research, and we are pleased to have with us EPR Properties and CEO Greg Silvers. As a reminder, the session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. And as a reminder, the questions I'll ask today do not reflect the views of Citigroup or myself are going to be asked for information purposes only. [Operator Instructions] Greg, I'll turn it over to you to introduce your team, give some opening remarks, and then we'll go into Q&A.

Thank you. As Eric said, I am Greg Silvers, President and CEO of EPR Properties. To my right is Mark Peterson, Chief Financial Officer. And to my left is Greg Zimmerman, Chief Investment Officer. For those who don't know, EPR is a REIT that focuses on what we call experiential properties. Again, properties where you really don't necessarily buy a good, but you go to experience that. We have a concentration in the exhibition theater business, but we also have 60% of our business in many names that you've seen and enjoyed whether that's TopGolf, [ Vail ], Six Flags. And we think it's a very exciting time to be in experiential properties. If you look pre-pandemic, in our non-theater portfolio, we had around a 2.0 cover. Last quarter, we reported that our coverage in our non-theater was 2.7. So the consumer is definitely supporting these properties. It's where people want to spend their money. We're very excited about the opportunity set that lays in front of us that there is a really high growth profile in experiential properties, and we welcome the opportunity to discuss those with you guys today.

Great. Thank you. So we've been starting each session with the same question, which is what are the top 3 reasons to buy your stock today?

I think it's pretty straightforward from our perspective, value. We're trading at a historically low equity multiple. We think also we have a very well-covered dividend. We're generating over $100 million of free cash flow beyond our dividend. And fundamentally, what I talked about earlier is the growth profile that's presented in the experiential space that we have a unique ability to identify underwriting close on deals. So we think we're in an exciting space. We think there's a real value play for us, and we think you're paid to wait.

Great. So you recently announced that John Case is going to be joining the Board. I was just curious, obviously, he has great experience. I'm sort of hoping to understand what you like to get out of having them on the board, whether it represents any type of shift in investment strategy from you or just try to leverage his expertise?

It's not a shift in our strategic objectives of experiential. It is really -- John's a well and a talented individual who has a vast knowledge of the net lease space. Again, somebody I've known and we've known for years, and we thought he could add a lot of experience and expertise in the space, and we think it will be very much a value-add to our overall Board composition.

I'm sure that you spent a lot of time this week talking about theaters and you'd probably rather talk about some other things in your business. But we'll start with theaters because I know it's always sort of topical. If I look at sort of other businesses that were impacted by COVID, a majority of them have sort of come back to where they were pre pandemic. So I guess my question is why do you think it's a little bit slower for the theaters. And if you look at sort of the major releases that are upcoming, do you think you can sort of get closer back to that level in 2024 and 2025?

I think the answer is definitely. When you look at what happened to the theater business, it really is a content issue. As much as people want to think, I think the issue of the great streaming debate is over. You now have all the studios and all the content providers saying, we don't make money releasing movies to streaming. And in fact, we're pulling movies that were made for streaming back and releasing them into theaters. So whether it's Azoff at MGM, who said we didn't make a dime on any movie we released to streaming. So clearly, it's a content. And if you look at just the numbers, we talk in terms of wide releases and to give you a reference point. And in 2019, we had about 135 wide releases. Last year, we had 75. Part of that is just pure production. It takes a while to make movies and it got shut down during COVID. Next year, we should have close to 95 million. So we're improving there. 2024, between 110 and 120 that are already scheduled for release. So we think comfortably box office is going to get back somewhere in the $9 billion to $10 billion range for '24. So we're now talking about a 15% to 20% kind of -- 10% to 20% kind of off the highs of the 11.3%. But then you look at what's going on in this space. And in this space, we've had the average per cap F&B spend move prepandemic from about $4.20 to about $7.40 now, and that's a much higher-margin business. So on a pure EBITDAR basis, even at those lower box office levels, we may have exhibitors who actually make as much money because they're making more money on their high-margin business. So I think what's a real interesting discussion that we're having now is if the theater business is returning and it's going to stabilize, what we really have is traditionally, we see all kinds of venues is we have 2 tenants who overlevered their balance sheets to complete M&A activity. They did major M&A activity prior to the pandemic with 80% to 90% debt financing. That's created stress on their balance sheet and they need to fix that. But the fundamentals of if you own good theaters and the industry is returning, we see that, that industry is going to stabilize and that we will once again be enjoying the kind of coverage levels that we did pre-pandemic.

Got it. And so on a per customer basis, your point is that per customer, the margins are actually a bit better today than they were before, given higher ticket prices. The real goal obviously is to get the volume back. If you look at the sort of releases that are upcoming next year, I mean, part of what's been missing, I think, is just some of the smaller releases, getting that customer back. I mean do you think -- from what you've heard that they'll be successful in that, getting not just people that are showing up for the superhero film, but those that show up for the kind of more small to midsized releases that the content that's going to be put out next year will be successful in bringing those types of customers back, getting that volume up, so that it can support the sort of the higher EBITDA that you're talking about?

Yes. I think it's really, again, back to content. You haven't had -- we're going to see some test runs. And it's really about if you talk to people in the industry, it's the 55 and above cohort, which are generally driven much more by drama from an offering. And we're starting to see more of that content being offered. Amazon is going to release Air, the Nike story. Originally, that was made for -- that was going to be a streaming release. They pulled that. They're going to release that into theaters prior to streaming. You also have Oppenheimer coming out. These are much more geared to that cohort of a demographic. So we'll see when we get content flowing for that specific demographic if they're going to come back in better numbers. But if you don't have anything to show them, there's no reason for them to show up. So we need to get the content flowing that is more directed at that demographic group.

Got you. And I guess assuming the fundamentals come back the way you think. I mean do you think that the sort of valuations for theaters will come back? I mean, obviously, we just had higher interest rates than we did 3 years ago. So that's a change. But otherwise, let's say, Cineworld emerges from bankruptcy in June as planned. Their capital structure looks better, higher amount of equity. Do you think there would be a market to be able to sell some of those assets? And where do you think they would trade?

I think clearly, if Cineworld emerges pursuant to their plan, and they're 3.5x levered and they have a backdrop of a strong content flowing into this. Again, there will be value and there will be a market for it. I think the major stress that we had is -- and we talk about this, for years, we had the stress of, okay, streaming is coming. It's going -- well, we faced that. And now we're -- the challenges we're moving past and once we have stabilization, fundamentally, theaters have been part of most net lease portfolios for a long time. It's just when we have these disruptions, something occurred, we've got through the stress period, it stabilizes, it will create a market for them.

Got it. And assuming there's a sort of liquid market there. I know just in general, there's liquidity in the market, is not great for transactions, but assuming there's liquid market, -- if I think about your business, I think you guys said this before we came in, but 60% of it is doing well, this 40% gets a ton of attention. Just from that perspective, would you sort of consider calling the theater portfolio, even though you like it or do you think would you rather just try to grow out of it, meaning that over time, you continue to acquire and that just becomes a smaller percentage of the overall asset base?

No, we publicly said -- the only way we're going to achieve our objectives is to sell theaters. It's not going to be grow out of it. So once we have a stabilized market, there is an opportunity to sell those assets, we'll look to lower that exposure. It's just not the right time now.

Got it. And are you already preparing for that? Or no, meaning like reaching out to that. I mean because you kind of know what the capital structure is going to be like, right? I mean, generally, for Cineworld post bankruptcy, you have an idea of what it's going to look like. You have an idea of what the fundamentals will look like in 6 months. So what I mean by prepared for it is sort of thinking through who the right buyers of those assets would be, whether you do maybe like a portfolio deal to try to get it done at once or maybe do it on a onesie, twosie basis?

I mean we know who the buyers are. I mean, again, it's prepandemic, we dealt in that world. So we know who those are. So I think it's more about the capital markets settling down. With any sort of thing being able to finance it is always first and foremost with someone. And I think as we see stabilization in the underlying tenant base and then we see capital market availability, then that will be an opportunity to deal with transactions.

Got it. And I guess on the flip side, sort of what are you seeing the best acquisition opportunities today? I know you're constrained by your cost of capital, but you're still looking at things. So where do you see sort of the best risk-adjusted returns in this environment?

Again, if you look at what we did last year, we have 8 categories in experiential that we are really focused on, we invested in all 8 of those. There's 10 categories that we list. We did a very minor cultural, and we didn't invest in gaming last year. The rest of the categories, we're seeing really strong opportunities. As we talked about, we had $1 billion-plus pipeline. We closed $600 million worth of transactions last year. So it's not -- these are organically growing businesses. As we said, the customer is heavily supporting them. So they -- these -- our tenants are wanting to grow their business, and we're seeing really good opportunities across the board. Greg, I don't know if you want to comment on any specific areas?

Yes. I think we spent a lot of time curating things. A couple of the deals that we got done last year, we worked on for 3 or 4 years, starting pre-COVID. We get a lot of opportunities from referrals and from the existing customers. And just to give you a couple of examples, in the fitness and wellness category, we have a really strong performing asset in Pagosa Springs, Colorado, a natural hot springs resort, did very, very well during COVID. So we decided to expand and renovate that with that same operator, we acquired a property in Murrieta, California, which is halfway between San Diego and Los Angeles, very strong demographics with natural hot springs that we're going to convert into a natural hot springs resort. We acquired Valcartier in Quebec City, Canada. It's been around for 60 years, family operated into our water park. We also did a deal in Frankenmuth, Michigan, which is one of the top 10 TERs destinations in Michigan with 2 million people a year. And then lastly, I would say we did a deal with Gravity House, which is a really unique new concept around Ski Hills. It's a combination of lodging, fitness and wellness, spa, fitness and also co-working space and good food. So if you want to come for a couple of extra days to Breckenridge, you can work from there. So a lot of great opportunities we saw last year.

Got you. Yes, that's not a tough sell out. That sounds pretty good a couple of days in Breckenridge?

It's listed by Conde Nast as one of the top 10 -- top 10 places to stay in the entire West.

And you mentioned a couple of industries in there. You talked of the ski slopes. You talked about some of the -- you're doing in the hospitality space. I mean, as you look across the different industries that you tend to invest in, can you maybe tell us about how sort of the acquisition team has set up, the expertise of some of the individuals within there? Do you have people that are singularly focused on, say, like water parks because that would be different than some of the things you're doing on the fitness side, which would be some of the things different on the hospitality side. Just how you set that up, how do you look at the specific industries and how your underwriting criteria might be different for each one of them?

So yes, great question. Our acquisitions team probably -- I never really thought about it in terms of years of experience, but probably something like 50 years' worth of experience between the 4 of them. We added a gentleman this year who has some experience in the lodging business, but candidly, he closed 2 deals, which were not lodging. We try to have the best athletes. And from the underwriting perspective, I think we know a lot about all of our businesses. So we're able to underwrite the businesses pretty well. In terms of the actual deals, it's more about relationships. And I would say there's not a lot of difference, generally speaking, between a water park deal and a lodging deal at that level. So -- again, we have a lot of experience in all these industries, and we do a very deep dive on them. As I said, a couple of these deals took 3 years.

Eric, I would say I will add to what Greg. Before we go into a space, we always do an internal white paper of what -- these are generally 60 to 100 -- it defines what success looks like and where points of fail you are. And so we have a kind of a grid of what we're looking for and what metrics are key driving metrics that guide our underwriting team and we compare back against those. So we're never usually -- again, when we're going into a space, we're not going into a blind and where we need -- like when we're looking at gaming, we have probably one of the leading consultants in the industry that helps develop that matrix that we're going to look at. So we're very thoughtful in how we approach any specific sector and where we think about what success and what points of failure look like relative to the underwriting under that. So I think Greg and his team do a great job of setting us up for understanding. And part of that, it feeds itself. As part of that research, we're actually meeting people in the industry. We're getting out. We're talking to people. Often that turns into transactions.

What's the sector that maybe you did a white paper on that just didn't meet sort of the criteria that you were looking for couldn't sort of define that success?

The greatest example that we can tell you, and it doesn't mean that it's not going to work for everybody. So again -- but we probably have 10 pickle ball ideas that come into our office all the time. And we cannot for the life of us figure -- I mean, in essence, relative to the square footage you're using, it becomes a very big restaurant and 80% to 90% of the money is truly just food and beverage. And so on a square footage basis and the productivity of it, we haven't been able to meet our requirements.

To give you an idea of one that actually works, we did a lot of research on the RV space for years, went to conferences, met a lot of operators, et cetera, et cetera. We did a deep white paper, did a first and second deals with operators. And then through that process, found another operator with whom we've been able to do 2 more deals and they just heard about us through the meetings we went to in the industry. So that's the way we develop our relationships.

And maybe on the RV, are those similar to sort of the transient sort of seasonal -- like that we would see at [indiscernible] -- are they sort of a different type of properties?

Generally, what we would see is they're anchored to some sort of experience, meaning they're in and around either where some -- there's something to go to other than park your RV. So whether it be mountains or water lakes, things of that nature that create a better sense of destination. And I think what you would see in most of what we've done is finding a property that needs to be amenitized. So if you saw what we did in Cajun Palms, which is in Louisiana in a very lake setting. We just relabeled it. Now it's a Camp Margaritaville. So we stepped it up, and we've seen a really, really strong response by taking a very -- a productive property and then amenitizing it to a level that greatly increases the productivity of it.

Yes. And to give you an example, so we have a Camp Margaritaville also in Pigeon Forge, Tennessee. So it's 10 minutes from great Smoky Mountains National Park. So it's amenitized, okay? It has a water park. It's got the Margaritaville brand, but it's also close to a national park. And then we have some Jellystone in the Midwest that also have water parks, water features. And to Greg's point, whenever we're investing, we're looking at ways to improve them with experiential amenities.

And then in terms of the competition you guys come up against and when you're doing deals, I'm sure it varies a lot by different space. But like, for instance, you did a $68 million mortgage loan to the Bavarian Inn Lodge. Is that something that they're just coming directly to you and you're just doing -- would they go to anybody else? Is there anybody else that [indiscernible]?

I don't even think they talk to anybody else. And here's a great example of how that occurred. They were looking to -- again, as Greg said, 75-year history, lots of things to do there. They wanted to add this element. They went out and talked to the actual product supplier of slides and things of that nature. And as part of that, that product supplier said, you know who you really need to talk to is EPR properties. I got the call of, just a random call from the family or people on the phone and said, "Hey, so and so said, we need to talk to you guys." And I said, "Well, that's wonderful." We spend time talking to them, I heard it over to Greg and his team, and it never -- I don't think it ever went anywhere in the market. And that's the kind of deal flow we make a living -- as opposed to some other people here who are much bigger, we make a living out of $50 million to $150 million deals. We find those deals that, candidly, for a lot of people, it isn't worth their time. We got our size turns into advantage. If we do that group of deals, $600 million for us is 10% net asset growth. That is very powerful given our size. And we really don't see -- I would tell you, for most of the big deals, we always get called on them. We always find out our interest, but most of the deals that we do, whether it's the biggest and best water park in Canada, never went to market other than a call to us. So that's very -- we've spent 25 years building our brand in that space, and we're generally a go-to call for anybody who is looking at exploring that -- this type of sale leaseback financing.

The one thing I would add, especially when it comes to something like the Bavarian is, we actually add value because it's not our first water park. So we have a lot of ideas that we're happy to share with the customer, whether it's about the location of the real estate or how big something should be or what kind of amenities there should be. And again, we're just -- we have a lot of knowledge that we're happy to share, and I think our customers appreciate that.

A reference point to that, Eric, is we have a long relationship with Topgolf and every -- there's a lot of other net lease groups that are now doing Topgolf, we still see every Topgolf deal before it goes to, I think anyone else. And so we picked this last year as a reference point, we did San Jose, Suburban L.A. and King of Prussia. So we're really pleased with building those long, deep relationships that allow us to access what we think are really quality product.

And so when you do the sort of $50 million to, call it, $150 million type mortgage financings, I mean like in a case like the Bavarian Inn Lodge, I mean, is it secured by the overall hotel? Hopefully, the water park, I guess, works, but in the case that it doesn't, like what's the security behind it? How do you structure it to make sure that you have enough potential?

By the overall hotel.

And a conservative loan-to-value ratio.

And it's also not only do you have the security of the physical plant and equipment in the hotel. You also have a family run business that they're very, very deeply committed. And in that nature, it ended up being 60% -- 60% loan to cost. So when you're able to do that with a very, very strong underlying commitment from the family, it feels like a very, very strong investment.

And it looks like you've sort of picked up some of your mortgage financings recently. Is there sort of a limit to the amount that you would do there just because I know that the public market doesn't always reward earnings that these are perhaps temporary to go away at some point? And then I guess the second question that you mentioned on the call that there were some conversion rights on some of these?

I was going to mention that. A lot of those, like you see with some of the deals that we're doing, whether it's Gravity House and some things -- that we have conversion rights. But when there is development going on, there's a couple of reasons that, that works. One, the security is actually better as a mortgage vis-a-vis, other lean right holders construction. And second of all, you actually get the earnings of the cap rate as opposed to capitalized interest. So I wouldn't interpret necessarily that it's going to be a mortgage for its entire life. It may be a mortgage buying through construction and then some period afterwards, we convert it more to a traditional kind of lease structure.

And is that solely your option, you pay some kind of extra amount?

No, that's at our option.

We also try to be flexible to meet our customers' needs. So when we're doing mortgage financing, our view is it is a long-term investment. I understand we don't own the real estate, but we don't view it as an in and out thing. We try to build relationships and provide additional financing as future needs arise.

And is there extra capital that you put in at the end to exercise the option?

No, no.

Got it. Could you help us understand sort of the earnings potential, the development and redevelopment program and probably not generating that much income today. I think in total, what do you have about $175 million, $200 million or so of assets. So help us understand how much that's generating today versus what it could look like in, say, 2 or 3 years?

Again, there is a lot of opportunity for development what we're constrained by, Eric, right now is our free cash flow. Again, as I said, we think we're trading at a very depressed equity multiple. So we're very mindful of really not issuing new equity. So we're limited, not by our opportunities. But as I said earlier, we're generating over $100 million of free cash flow. So when you look out there, as I said, we had a lot more opportunity, but we had to look at what we thought was the best risk/reward and some of those were development projects. As Greg talked about earlier, this opportunity in Murrieta, California, we had a very, very strong operator that we had done business with. We found this new opportunity. It's incredible real estate with a proven operator, and we felt like that was a better risk reward. And we think those opportunities continue to be there. I mean we're approached a lot about expanding things. So redevelopment, doing things at our existing properties. But we're -- candidly, we're limited by the capital constraints that we find ourselves under.

I mean, $250 million, we're capitalizing interest and then it flips to the cap rate, of course. So we laid that out in our supplemental as in terms of when the money is going out, but more importantly, when it goes in service, so you get the pop in sort of capitalizing interest moves to the cap rate. And of course, that will annualize even again in '24 because we'll get the full year from the '23s that go in service. So there is some ongoing earnings...

I'm sorry, spread is probably 200 basis points, something like 250, meaning...

Actually, our debt rate is like 4.5% -- long-term debt rate. That's what you capitalize that and then it moves to 8%, 8.5%. So it's pretty significant when it goes in service.

Got you. And I guess along that same line of thinking, we would have a question from the audience. Can you just talk about your balance sheet management, how you're sort of preparing for higher rates for longer?

Yes. I think the good news is we had pretty good timing in our bond issuance in October of '21. We hit a 3.6% bond, took out maturities. So our first maturity, we have nothing to do this year, $136 million due in '24 , so a pretty modest amount, $325 million. So our debt maturity laddering looks really good. As Greg mentioned, our ongoing cash flow is very strong. We took the opportunity coming out of the pandemic to reset our payout ratio to 70% or even less right now. It's in the high 60s. So we're generating a lot of free cash flow, and we're able to reinvest that cash flow very accretively. Obviously, if you're doing 8%, 8.5% cap rate and it's internally generated cash flow, combined with a little bit of leverage, it's pretty accretive. So -- and that's kind of what we're focused on not raising capital in this market with the displaced debt market, and our equity multiple being low, just using that internal cash. And we've got plenty of it. Even last year, we generated in excess of $175 million of free cash flow over the dividend. Some of that was due to some deferral payments that don't repeat in '23. But we still, as Greg said, expect in excess of $100 million of free cash flow in '23. So our leverage is in the 5s, low 5s. So we feel very good about that, and we're very mindful of that, especially in this environment. But we're really set up well to endure, I think, any coming storm, be it recession or soft landing and so forth in terms of low debt maturities, strong cash flow and not need to access in any meaningful way of the capital markets.

Got you. I wonder I ought to look at where they're trading, but is there any opportunity to buy back sort of in the market, sort of your debt or preferred just based on where they're trading or?

Yes, we've looked at that. It's always a -- we look at, is it better to buy or buy back stock or keep investing. And I will tell you on the preferred side, it's hard to get a meaningful amount, frankly. Debt, somewhat similar. It takes a lot of time to accumulate. But we do look at that. I think in our analysis, let me also look at buying back stock. But in our analysis of looking at all that, it appears doing the math, it's best to keep investing at the cap rates we're investing, continue the relationship with these tenants so they don't look elsewhere during the time if we decided to pull back. Because we do see the other side of this, and we want to be there for them to continue on with them as a customer. So -- and if you think about it, instead of shrinking as we continue to invest, we're continuing to diversify our portfolio, lower that theater concentration. So all things considered, we think using that free cash flow to buy assets at the cap rate we're buying is the best use of capital.

Great. And then before we do the rapid fire questions we've been asking in each session, what's your top ESG priority this year.

Again, I think we're still focused on improving our tenant reporting. We have a lot of really, really ESG aware tenants, whether that's [ Vail ], or Six Flags that are doing a lot of things. And we're continuing to improve that so we can tell that story as a net lease REIT. And I think we did a good job, a very good job with our initial corporate responsibility report. And hopefully, we'll continue that path as we go forward.

All right. So the rapid fire, what will same-store NOI be in 2024 for the net lease sector? And I guess you can sort of include any sort of estimate around bad debt or rent reserves, rent loss?

My guess is it still comes in somewhere 1.5% to 2%.

What's the best real estate decision today, buy, build, sell, hold or redevelop?

It's what Mark said, for us, given our cost of capital constraints, it still is buy. We think the buy opportunity is even greater if we can get back to a cost of capital. We think we can still locate incredible assets in this market -- we're talking about mid- to 8 cap rates. That's long term. That seems like a very good proposition.

And then last question is, will there be the same more or fewer public companies in the net lease space a year from now?

Again I'm horrible with this prediction. So I'm just going to say the same. There's no good -- or I guess we went back and looked at this, everybody is wrong, but I'll say the same.

Sounds good. Thank you. Appreciate it.

Thank you.

Thank you.