Real estate investment trust (REIT) EPR Properties (NYSE: EPR) was focused on a great niche in the retail space until 2020 rolled around. The pandemic basically blew up the company's highly focused business model. As 2021 gets underway, the big question is whether or not EPR Properties can turn things around or is the trouble here going to linger?
An issue of focus
The EPR in this REIT name stands for "entertainment properties." This is important because, prior to 2020, retail-related landlords were dealing with the so-called retail apocalypse. Although there is more to the "apocalypse," a key piece of the story was, and still is, the ongoing growth in online shopping. EPR Properties was looking to sidestep that headwind by focusing on experiential properties, including such things as amusement parks, ski resorts, and schools. In fairness, children might not consider that last one very entertaining, but the key point is that a person had to show up in person to get the experience on offer.
The logic under which EPR Properties was working was pretty solid. The problem is that it focused all of the company's properties into one general category: in-person entertainment (putting the less-than- entertaining schools aside). This was viewed as a good thing until the coronavirus pandemic arrived. The novel illness spreads easily in group settings, so anything that required people to congregate was hit particularly hard. The list basically includes everything EPR Properties owns.
The pain was particularly swift, with the REIT's rent collection rate falling off a cliff. In April, 2020 EPR Properties collected just 15% of its rents. By the end of 2020, that number had improved, but only to 46% of pre-COVID levels. That's terrible by any measure, and it helps explain why the REIT eliminated its dividend in April last year.
A brighter future, right?
At this point, vaccines are rolling out and the U.S. economy is far more open than it was in the early days of the pandemic. Consumers are restless, too, so they are looking to get back to some semblance of "normal." That should spell improvement for EPR Properties' business. But there's one big headwind here that hasn't been addressed just yet: Roughly half of the REIT's pre-COVID rent roll came from movie theaters.
EPR Properties has already offered up major concessions to key movie theater operators, which will likely reduce the rents it collects for years. So even a full rebound in the theater business, which would likely be a slow and drawn out process, wouldn't result in a full rent recovery for EPR Properties. But the bigger issue is that the pandemic may have altered the dynamics of the theater industry for good.
Consumers have increasingly turned to streaming for entertainment, which allows them to stay in their homes (and likely save money over what it would cost to visit a theater). Movie studios, meanwhile, in an attempt to keep their businesses going, have gone where their customers are, pushing their content into the streaming space. At the same time, movie studios have stated that they will be more aggressive with movie theaters with regard to the amount of time theaters get exclusive showing privileges. That had long been a bone of contention, and the pandemic appears to have strengthened the studios' negotiating hands. In other words, going to the movies may not be quite as big a thing in the future as it was in the past ... And EPR Properties' business is heavily tied to the movie industry.
In fact, it is so bad that AMC Entertainment Holdings (NYSE: AMC), a major theater operator and lessee of EPR Properties, has already warned that it will be looking for even more rent concessions from its landlords. But it isn't just the landlords that will be asked for help, the company will also need assistance from debt holders. It bluntly stated that, "our current cash burn rates are not sustainable." While aggressive capital-raising efforts have provided near-term liquidity, if the movie business doesn't pick up, AMC Entertainment could be in big trouble. And that's just one of many theater chains that work with EPR Properties.
A glass-half-full look at this situation would say there's an incredible opportunity for improvement as the movie industry recovers along with the broader economy. Fair enough, but long-term investors should also consider the risk that a recovery doesn't improve things enough to return the movie theater space back to pre-COVID levels. If that happens, EPR Properties is indeed in very real trouble because some of its most important tenants will continue to face sizable headwinds.
Right now, conservative investors should probably be on the sidelines here. EPR Properties is a bet on a return to normal that may not happen quickly, if it happens at all in some of the REIT's key property niches. More aggressive types may like the turnaround appeal here, but the risk/reward profile is not one likely to please most investors.