Hollywood’s landlord just can’t seem to catch a break.

For those who don’t know, I’m referring to EPR Properties (NYSE: EPR). This is a real estate investment trust (REIT) that, among other properties, owns 175 cinemas leased to 18 different operators.

I checked in on EPR back in the summer to see how post-covid rent collections were going. And now, after working to restore rent collections back to 100% of normal levels (106% actually, including deferred payments), a key renter is headed for bankruptcy.

As you may have heard, Cineworld just filed for Chapter 11 protection. The U.K. movie exhibitor is the parent of Regal Cinemas, which was acquired back in 2018 at a cost of $3.6 billion. That ill-timed transaction has left Cineworld struggling under the weight of $5 billion in debt, not including another $3+ billion in lease obligations.

That burden might have been manageable before the pandemic. But the company has only generated $455 million in cash flows over the past year. Facing debt maturities on the horizon – and with a lull at the box office until at least November – Cineworld had no choice but to seek relief from the courts.

These proceedings won’t disrupt day-to-day operations. Cineworld will continue to pay its vendors and employees as it works to restructure debt. To this point, it has also made full rental payments on schedule. But the company will likely negotiate with its various landlords during the bankruptcy process to obtain more favorable lease terms.

That explains why EPR has sold off sharply the past couple of weeks, slipping from near a 52-week high in the mid-$50s to $41 recently. But as usual, the market has overreacted.

What’s Really Going On…

Let’s look at the facts. Regal accounted for $44 million of EPR’s $532 million in rental income last fiscal year. That’s about 8% of the total. Even if Cineworld can persuade EPR to cut leasing rates in half, we’d be looking at perhaps a 4% drop in rent. Compare that to the plunge in the stock that has erased $900 million in market capitalization.

Fans have returned to the big screen in droves this year. Even before Top-Gun: Maverick hit theatres around Memorial Day, box office revenues had already surpassed $2 billion — five times higher than last year’s pace. This year’s film slate has a projected 18 movies that could gross over $100 million, up from 11 in 2021.

That wasn’t enough to keep Cineworld out of bankruptcy, but it’s an encouraging turnaround nonetheless.

As I’ve explained before, there’s a lot more to EPR than just popcorn and auditoriums.

The vast $6.5 billion portfolio includes nearly 100 other leisure-oriented properties, including waterparks, bowling alleys, winter ski resorts, indoor sky diving facilities, and “eat-and-play” complexes such as Top Golf. With business returning to normal, the company hauled in $93 million in adjusted funds from operations (AFFO) last quarter, an impressive increase of 75%.

That works out to $1.23 per share, enough to comfortably meet the $0.82 in dividends – for a distribution coverage of 150%. Better still, management has just confidently raised its full-year outlook and is now expecting cash flows of at least $4.50 per share.

Ratings agencies like Fitch have taken notice, upgrading EPR’s credit to investment-grade tier. The company recently issued new notes at the lowest coupon rate in its history, a testament to its improved financial standing and dividend-paying capacity.

Action To Take

EPR’s focus on “experiences” over pure brick-and-mortar retail is what drew me to this unique REIT in the first place. This is a huge trend that isn’t going away any time soon.

And I think EPR is perfectly capable of absorbing this hit from Cineworld. But again, this is why you want tenant diversity when looking for a solid REIT. This development underscores the importance of management’s ongoing efforts to further broaden the revenue stream away from theatres and reduce customer concentration. This year, management intends to sink at least $500 million into the acquisition and development pipeline. It has recently branched out into destination resorts, such as Margaritaville Nashville, and is eying other unusual properties from zoos to aquariums to concert halls.

I expect a full recovery from EPR in time. But for now, I think it would be prudent to take a “wait and see” approach with the REIT until we get some clarity on Regal’s new lease structure.

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