We turned optimistic too soon in our August article on EPR Properties (New York Stock Exchange: EPR) as Regal’s (OTCPK:CNNWQ) bankruptcy filing in September forced a further downgrade on EPR. We believe the downgrade is justified because the market needed to reflect significant risks related to Regal’s rental base, which could affect a substantial portion of its current rental and deferred payments.
However, management’s forward-looking guidance in its recent third-quarter earnings release suggests the situation remains under control (for now), even though negotiations with Regal are still in early stages.
However, with EPR’s valuation well below its 10-year average, we believe the market has already priced significant risks into Regal’s malaise. So investors adding to these levels, with an NTM dividend yield of 8.5%, could be well rewarded if they could tolerate short-term downside volatility.
Hold the buy with a medium-term target price (PT) of $45.
Management remains confident in its guidance range despite Regal’s woes
EPR Properties posted AFFO per share of $1.22 and FFO per share of $1.16 in the third quarter. In particular, management revised its FY22 FFO per share guidance from $4.50-$4.60 to $4.50-$4.68, improving the upper end of its guidance range. As such, the midpoint of its FFO guidance per share has improved to $4.59 from $4.55 previously.
Management’s confidence in its revised guidance came from Regal continuing to pay its rent and deferral payments in October and November, even though it stopped paying rent in September. A better-than-expected third quarter overall was also positive for its revised guidance, which took into account Regal’s rent arrears.
As such, management was confident that it could get some additional payments from Regal through the fourth quarter, leading it to increase the upper end of its guidance range. Chief Financial Officer Mark Peterson articulated:
So the benefit of our guidance now, since we’re dealing with deferred payments after the end of the quarter, really becomes the Regal deferment for 1 month, which is $1.5 million for December and $0.5 million for customers who don’t are Regal for the month. And as I mentioned, there’s the September rent payment which, at our guidance midpoint, we don’t anticipate receiving, but we might get a piece of that this year. So that contributes to the upside. (Call for results EPR Properties FQ3’22)
We believe there remains significant uncertainty about the entire Regal situation. However, Regal made rent payments and deferrals for October and November. So it seems reasonable for management to reflect increased confidence in the recovery of late payments since September, when Regal first filed for bankruptcy.
Coupled with its battered valuation, mean reversion potential looks attractive at current levels.
Are EPR shares buy, sell or hold?
Accordingly, we are confident that management’s guidance has addressed the near-term challenges for Regal. Nonetheless, ongoing deferred payments remain uncertain as Regal accounted for $92 million of EPR’s $123 million of deferred rent from the third quarter.
Therefore, we urge investors to continue to closely monitor Regal’s situation, although we believe these challenges have been reflected in its valuation.
Additionally, the company also lowered its investment guidance range to $400 million (midpoint) from its previous guidance of $600 million (midpoint). As such, the company’s revised outlook suggests fourth-quarter capex of about $79 million, down from $82 million in the second quarter. As such, it implies a capex of $161 million in the second half, well below the $239 million in the first half.
Management highlighted that it sees the need to be more prudent, given the increase in the cost of financing. Therefore, it could also affect the REIT’s ability to drive AFFO growth per share in the near term with elevated macroeconomic volatility and uncertainties.
However, EPR last traded at a NTM AFFO multiple per share of 7.8x, well below its 10-year average of 13.3x. Furthermore, it is well below its peer average of 14.1x. Therefore, we believe that significant damage has already been reflected in its valuation.
However, we must caution investors that the EPR remains in a long-term downtrend and has also lost its medium-term bullish bias. Therefore, it is clear that the market has lowered it, and investors should not expect a recovery from its August highs anytime soon.
Still, we view current levels as reasonable, with the opportunity for mean reversion already in place.
Hold Buy with a PT of $45.