Essential Properties Realty Trust is still a buy — here’s why (NYSE:EPRT)

Investment Thesis

Essential Properties Realty Trust (New York Stock Exchange:EPRT) is based on effective investment strategies that lead to elite-level business metrics.

• Excellent WALT
• Impressive rent escalator
• High operating rate
• Attractive cap rates
• Well-diversified portfolio across geographies, tenants and sectors

EPRT has outperformed many popular triple-net lease REITs in AFFO per share growth, is supported by a solid financial and credit posture, and has kept shareholders happy with decent dividend growth.

In this article, we’ve detailed why we believe EPRT is still worth including in your investment portfolio, based on multiple comparisons to its peers, due to its valuation appreciation potential, well-covered and growing dividend, and AFFO growth from further acquisitions and embedded rent growth.

I am bullish on EPRT.

introduction

EPRT is a service-oriented triple net lease REIT founded in 1937. Owned property (As of March 2024About 79.8% of the ABR was derived from service-oriented properties, while the remaining 13.4% and 3.4% came from experiential and retail properties, respectively.

Over the past 12 months, EPRT has delivered attractive share price appreciation, outperforming some of the most popular retail/service-oriented triple net lease REITs whose share prices have declined.

I am a member of Agree RealtyAdvanced) and NNN REIT (NNNN-san) will be covered later in this article to provide some benchmarks for EPRT’s metrics. The company is one of EPRT’s closest peers and operates in the retail/service-oriented real estate sector with triple net lease arrangements, owning 2,161 and 3,546 properties, respectively.

Information was obtained from:

1. Are the above price fluctuations justified from a business perspective?
2. How does EPRT compare to its closest peers?
3. Is there still potential for upside?

EPRT is a high-quality REIT operating in a sector that is doing well and is less vulnerable to recession and e-commerce, and I believe it remains worth having in your investment portfolio.

Let me explain why, read on!

#1 Good Business Metrics

When analyzing REITs, I take into account several business metrics, and I believe it is very important to compare them between different companies, so that investors can assess the performance of the company under analysis.

First, regarding occupancy rates, EPRT has a track record of maintaining a high occupancy rate of an average of 99.8% since its IPO in 2018. As of March 2024, the occupancy rate is 99.9%, higher than ADC’s 99.6% and NNN’s 99.4%.

Each of the companies above received high scores, especially when compared to the median S&P 500 REIT score for the period from December 31, 2000 to March 31, 2024. This corresponds to 94.8%. The ability to maintain high occupancy rates reflects the quality of a REIT’s overall portfolio.

In terms of weighted average lease term (WALT), EPRT boasts the highest WALT in the sector at 14.1 years. For comparison, ADC and NNN had WALTs of 8.2 and 10.0 years, respectively. Realty Income, the most popular REIT with a core of retail/service-oriented properties,oh), WALT is As of March 2024, it will be 9.8 years.

While a high single-digit WALT does provide cash flow predictability and reliability, EPRT is able to secure impressive lease terms within its transactions. Additionally, investment activity from Q2 2022 to Q1 2024 has further increased WALT by signing deals with longer original lease terms. Further highlighting EPRT’s strength in terms of lease terms, only 4.5% of ABR expires through 2028.

For readers who are unfamiliar with triple net lease agreements, these agreements are extremely advantageous from a landlord’s perspective because they relieve the tenant of the significant costs associated with maintaining and operating the property (repairs, taxes, insurance, etc.).

These agreements are particularly attractive because contractual rent increases have a significant impact on revenue. Rent increases are most often contractually fixed or CPI-linked (with certain upper and lower limits). Rent increases typically range from 1% to 2% per year, depending on the property sector, the mission-criticality of the asset, and the landlord’s negotiating position. EPRTs tend to remain at the high end of the stated range, with a weighted average annual increase of 1.7%, and 98.8% of ABRs being eligible for such increases.

These escalators may not seem like much, but they accumulate over time and tend to drive AFFO per share growth as a REIT’s internal growth engine.

#2 Diversification

EPRT has a well-diversified structure in terms of:

• Real Estate Subsector
• Geography
• tenant

The company’s properties span 48 states, with approximately 80% of its ABR coming from the top 21. Additionally, approximately 50% of EPRT’s ABR is generated in Sunbelt states, allowing its tenants to expand in the most promising markets for further growth.

Additionally, only 295 of the 1,936 properties are leased to EPRT’s top 10 tenants, accounting for about 19.1% of ABR. For reference, ADC’s top 10 tenants account for about 37% of ABR, nearly double that of EPRT.

Don’t get me wrong, I don’t doubt ADC’s ability to generate cash flow, address potential tenant issues and maintain high occupancy rates in the long term, but from a tenant perspective, this diversification is a good thing for EPRT, as potential tenant issues will have less impact on its financial position.

#3 Dividend and AFFO per share growth

EPRT has shown healthy dividend growth, registering a CAGR of 6.2% from 2020 to 2023 (2019 as the base year). EPRT is currently offering a future dividend yield. Approximately 4.2%While not particularly high compared to its peers, it is still attractive, and the company’s forward AFFO payout ratio is at a comfortable level. 66.1%.

EPRT outperformed ADC and NNN in AFFO per share growth over the 2020-2023 period (based on a 2019 base year), achieving a CAGR of 9.7% compared to 6.9% for ADC and 3.9% for NNN. Additionally, its interim guidance for 2024 assumes the highest year-over-year growth rate of 5.2%, the highest among the three companies mentioned above (ADC – 4.2%; NNN – 1.8%).

For more details, see the table below.

Table 1: AFFO per share for EPRT, ADC, and NNN

Click to enlarge

EPRT’s growth is driven by strong business metrics, strong rental growth and an effective investment strategy. Over the past eight quarters, EPRT has achieved approximately $1,961.1 million in investment volume with a focus on sale-leaseback transactions. EPRT focuses on mid-market and small-cap operators, and as such, an acquisition is typically the first time that a particular asset is the subject of a transaction. In a sale-leaseback structure, the acquired property is then leased back to the previous owner, ensuring continued occupancy and favorable terms. Towards the end of 202398.8% of EPRT’s investments have been through sale-leaseback transactions (based on weighted ABR), and a diversified tenant structure has ensured multiple relationships, giving EPRT a healthier project pipeline. The majority of recent acquisitions have been sourced through existing relationships.

It’s also worth noting that EPRT is still too small to make each acquisition significant and transformative for the company, especially given the high cap rates it commands.

#4 Solid balance sheet

Check out selected credit metrics in the table below.

Table 2: Selected credit metrics for EPRT, ADC, and NNN

	EPRT	Advanced	NNNN-san
Credit Rating	BBB	BBB	BB+ Plus
Fixed-rated debt as a percentage of total debt	100%	88.9%	97%
Fixed cost coverage rate	5.9 times	4.9 times	4.3 times
Weighted Average Debt Maturity	4.7	7	11.8

Click to enlarge

EPRT has a fixed-rate focused debt structure with 100% of its debt at fixed interest rates, with a weighted average of 3.6%. The company has a strong investment grade balance sheet with a BBB credit rating. The company’s fixed debt coverage ratio is the highest of any named company, at 5.9x.

EPRT’s weighted average debt maturity is relatively low compared to ADC’s approximately seven years (4.7 years). NNN has a much higher level of this metric, but it is among the longest across the REIT sector. However, EPRT has no maturing debt until February 2027, given that it has an unused revolving credit facility that extends through 2026. The above, combined with a 100% fixed-rated debt structure, should limit the impact of a high interest rate environment on EPRT’s financial position, at least for the next few years.

Considering the above factors, EPRT’s strong liquidity of $863.3 million (including cash, an undrawn revolving credit facility, and outstanding forward equity), and a low forward-looking AFFO payout ratio of 66.1%, the company is well positioned to capitalize on near-term investment opportunities and the dividend is well covered.

Rating outlook

As an M&A advisor, I typically: Main Tools To enable accessible, market-driven benchmarking in the trading process.

But this methodology doesn’t end with simply collecting metrics. The most important element of valuation is understanding the business-related rationale for a particular multiple. Without that, investors cannot properly evaluate market data.

That said, the forward-looking P/FFO multiple looks like this:

• 14.5 times For EPRT
• 15.1 times For ADC
• 12.9 times For NNN

I recently covered both NNN and ADC and gave them “Buy” ratings.

• Advanced – Ugly Realty Corporation: Elite business metrics with room for improvement
• NNNN-san – NNN: The best choice for investors looking for stability

I am long both ADC and NNN, and will also be initiating a position in EPRT, despite it having a higher multiple than NNN, as explained in my analysis of NNN.

EPRT has a unique investment approach that has proven effective and I believe is currently reflected in the following ways:

• Excellent WALT
• Impressive rent escalator
• High operating rate
• Attractive cap rates
• Diversification
• Outperformed on AFFO per share growth basis

Given the above and EPRT’s financial stance, we believe there is still room for the P/FFO multiple to rise to 15.5x-16x, barring a significant change in the economic environment.

Risk factor

If the high interest rate environment continues through to significant debt maturities in 2027, EPRT will be forced to refinance at a higher cost, adversely affecting its financial performance. Any potential tenant issues will naturally impact its financial stance; however, due to its well-diversified structure, the impact is limited. A significant deterioration in EPRT’s business metrics could lead to increased price volatility and adverse multiples as current and assumed levels would no longer be justified.

EPRT’s growth prospects depend on its ability to identify attractive investment opportunities. Reduced market trading activity may impair EPRT’s ability to continue to achieve superior performance in terms of AFFO per share growth.

Conclusion

EPRT has an effective investment strategy that has translated into strong business metrics and good diversification. It has outperformed many popular triple-net lease REITs in AFFO per share growth and has pleased shareholders with decent dividend growth backed by a solid financial and credit position.

That said, I still believe there is room for price multiples to increase, which will be further supported by interest rate cuts. EPRT still has a compelling value proposition, including room for price multiples to increase, a well-covered and growing dividend, and external and internal growth prospects that ensure continued growth in AFFO per share.