Essential Properties Realty Trust, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Essential Properties Realty Trust, Inc. is a real estate investment trust (REIT) that focuses on single-tenant, net-leased service-oriented and experience-based properties, aiming to generate consistent and predictable returns.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Essential Properties Realty Trust (EPRT) operates as a REIT, primarily owning and leasing single-tenant, net-leased properties to service-oriented and experience-based businesses. These businesses often include restaurants, car washes, convenience stores, and health and fitness centers. The company aims to generate consistent and predictable returns for shareholders through long-term leases with these tenants.

EPRT distinguishes itself from other REITs by focusing on service-oriented and experience-based properties, which are believed to be less susceptible to e-commerce disruption and economic downturns than traditional retail properties. This strategy is designed to provide both stability and growth potential.

Revenue Distribution: EPRT’s revenue primarily comes from rental income from its properties. The company seeks to enter long-term, triple-net leases, where the tenants are responsible for property taxes, insurance, and maintenance. This reduces financial burden on the company and ensures a predictable income stream.

EPRT has a diverse portfolio by geography and property type. As of December 31, 2023, it owned 1,719 properties across 48 states. However, some segments are more significant than others. The company’s top two categories are Car Washes and Experiential businesses representing more than half of the portfolio. The company’s portfolio is diversified by geography, although its concentration in the south eastern portion of the US seems significant.

Trends in the Industry: The REIT industry is heavily influenced by macroeconomic trends, and changes in interest rates and inflation have a significant impact on the company’s financials. Rising interest rates increase borrowing costs for the REIT, while higher inflation can affect the company’s operating expenses. Furthermore, demand for real estate is highly dependent on local market conditions. The industry is seeing a significant increase in the demand for e-commerce-resistant properties.

EPRT has focused on properties within what the company believes are e-commerce resistant industries which is a strategic competitive advantage. This focus on service-oriented and experience based properties has some downside in terms of the limited upside, given that these industries do not experience the explosive growth of some other sectors.

Margins: EPRT seeks to maintain its operating margins by entering into triple-net leases which reduces burden of operational expenses on the company. A significant portion of the company’s total costs are represented by depreciation and amortization. Historically, the company has had a respectable operating profit margin (EBITDA). The company also uses financial engineering to obtain a favorable cost of debt.

Competitive Landscape: The REIT sector is highly competitive. There are lots of other REITs with various strategies to seek competitive advantages. The company competes with other publicly traded REITs and also with private investors for property acquisitions. In some cases, it also competes with smaller local real estate operators.

What Makes the Company Different:

  • Focus on Net Leased Properties: EPRT is almost entirely focused on single-tenant, net-lease properties which greatly reduces the operating burden on the company. The leases are long-term, providing stable income to the company.
  • Industry Choice: EPRT chooses to invest in specific industries (e.g car wash, restaurants, medical facilities, and movie theaters) based on its analysis of the long-term fundamentals of the business.
  • Diversification: The company is diversified by geographies and tenant industry type.

Financials

Recent Performance: EPRT’s latest quarterly results, for the period ended September 30, 2024, show that the company had total revenue of $166.2 million and net income attributable to common stockholders was $47.6 million, which is an increase of about 16% YoY. They had 1,888 properties in 48 states as of September 30, 2024. The company acquired 26 properties for a total investment cost of $284.4 million.

The results were impacted by a gain of $13 million dollars on the sale of real estate, and also includes a charge of approximately $21.2 million for property impairments. This charge was primarily related to impairments on 11 properties and related to an adverse change in a tenant’s credit quality. The company reported that its portfolio had 99.7% occupancy which points towards strength and stability of the portfolio. This suggests that despite the difficulties, most of its tenants continue to pay their rent on time.

The company maintains high coverage ratios, the current fixed charge coverage ratio was 3.4X, and the company continues to maintain a strong balance sheet with low leverage. The senior unsecured debt outstanding is at $777.1 million.

Revenue Growth: EPRT has shown consistent year-over-year growth in rental revenue. The company’s annualized base rent was $660 million as of September 30, 2024, demonstrating stability. Additionally, the company’s portfolio occupancy is high, with average occupancy nearing 100%, indicating strong demand for its properties.

Profitability: EPRT’s net operating income (NOI) and adjusted EBITDA (EBITDA adjusted for non-recurring items) is also on the rise. The increase in NOI is primarily attributable to an increase in the portfolio’s operating revenue, and also a decrease in property operating expenses due to a decrease in impairments on the properties. However, the company had a significant impairment charge in the last quarter that affected the net income. This will not affect the economic value of the company in the long run.

Capital Structure: The company has a somewhat more leveraged balance sheet, with total debt at roughly 48% of total assets. However, it has maintained a good overall credit rating, and a reasonable interest rate exposure. The company’s debt structure is weighted average interest rate is 4.2%. They use a combination of fixed and variable rate debt. They have an interest rate swaps in place. The company’s debt has an average maturity of about 10 years which makes it more stable.

EPRT’s management states that they are targeting a leverage in the range of 0.4 to 0.5. They are more prone towards fixed rate long term debt.

Cash Flow: The company’s free cash flow is dependent on its operational performance and also on its investment activity. The company has a positive but fluctuating free cash flow.

Moat Analysis

Moat Rating: 2 / 5 EPRT has some limited competitive advantages, leading to a narrow moat rating.

  • Positive Aspects:
    • Strategic Industry Choice: The focus on service-oriented and experience-based businesses helps to insulate the company’s business from e-commerce disruptions.
    • Triple-Net Leases: The structure of triple-net leases provides a degree of stability and predictable cash flow, due to tenants being responsible for operating expenses.
    • Strong Customer Relationships: The nature of these businesses often result in stickier tenants that are less inclined to switch to a competitor.
  • Negative Aspects:
    • Lack of Differentiation: There is nothing inherently special about a service or experience-based business that provides strong barriers to competition.
    • Replication: The distribution networks of the properties are easily copied by competitors.
    • Management Dependent: A lot of value comes from effective acquisitions and expansions that are dependent on management effectiveness.

Legitimate Risks that Could Harm the Moat:

  • Economic Downturns: A recession or economic downturn could significantly reduce tenant sales and their ability to pay rent, leading to vacancies and reduced cash flow.
  • Interest Rate Increases: Higher interest rates could increase borrowing costs, making acquisitions more expensive and reducing profitability.
  • Technological Change: Though generally less susceptible, any drastic technological changes in tenant businesses can lead to reductions in traffic and store closures, putting leases at risk.
  • Regulatory Changes: Changes in regulations concerning real estate, leasing, or environmental restrictions may hurt the company’s operations.
  • Tenant Risk: The potential for tenant bankruptcies and the inability to release the properties remains a risk.
  • Competition Risk: Increased competition from larger players in the REIT market could squeeze yields.
  • Operational Risk: The company’s ability to identify, acquire, and manage new high-quality real estate assets successfully in new or existing markets is an ongoing challenge.

Business Resilience:

  • Good Occupancy Rates: EPRT boasts a strong occupancy level of its properties. The strong occupancy coupled with high demand makes its financials less volatile and increases stability.
  • Diversified Portfolio: The company’s portfolio has high diversification across industries and geographies that reduces reliance on individual tenants or sectors.
  • Long-Term Leases: Triple-net leases provide a long-term, stable revenue stream with limited expense obligation on the company.

Understandability

Understandability Rating: 2 / 5 EPRT’s business model is relatively easy to grasp at a conceptual level. The company’s purpose is straightforward—to acquire and manage real estate, lease it to tenants, and generate revenue via rent. However, the specific nuances of their lease agreements, the impact of various accounting metrics, the types of properties they invest in, makes it slightly more difficult to fully grasp. Analyzing financial statements also requires careful analysis of debt covenants. As a result, the understandability is not as high as for a simpler business.