ESSENTIAL PROPERTIES REALTY TRUST, INC. (EPRT) Annual Report: A 2023 Performance Review

Considering an investment in ESSENTIAL PROPERTIES REALTY TRUST, INC. (EPRT)? This summary cuts through the financial jargon to explain their performance in fiscal year 2023.

1. Business Overview EPRT operates as a Real Estate Investment Trust (REIT) specializing in single-tenant net lease properties. This means EPRT owns and leases properties to individual businesses, with the tenant typically responsible for most property expenses. Their portfolio spans diverse service-oriented and experience-based industries, including quick-service restaurants, car washes, medical facilities, and early childhood education centers. EPRT primarily acquires properties through sale-leaseback transactions, where they purchase a property from a business and then lease it back to that same business, usually under long-term, triple-net leases.

In fiscal year 2023, EPRT strategically expanded its holdings. Total property assets, encompassing land and buildings, grew by a healthy 7.9%, from $3.8 billion in 2022 to $4.1 billion. This expansion brought their portfolio to approximately 1,800 properties across 48 states. The company maintained an impressive 99.5% occupancy rate and an average remaining lease term of 14.5 years, signaling stable, long-term revenue.

2. Financial Performance EPRT delivered strong financial results in 2023. Total rental revenue climbed to $320 million, up from $290 million in 2022, driven by robust portfolio growth and contractual rent increases. Net income for the year reached $110 million, compared to $95 million in the previous year.

For REITs, key performance indicators include Funds From Operations (FFO) and Adjusted Funds From Operations (AFFO). EPRT reported FFO per share of $1.65 in 2023, an increase from $1.50 per share in 2022. AFFO per share, a metric many investors prefer as it accounts for recurring capital expenditures, grew to $1.58 in 2023 from $1.43 in 2022. This per-share growth, even with an increase in outstanding shares, demonstrates EPRT's ability to generate more cash flow from its expanding portfolio. The company also paid an annualized dividend of $1.10 per share, offering investors a competitive yield.

3. Risk Factors

• Interest Rate Fluctuations: While EPRT's current debt is stable, a significant portion matures between 2027 and 2035. Higher interest rates at refinancing could increase borrowing costs and reduce profitability.
• Tenant Health & Concentration: Although EPRT's tenant base is diversified, an economic downturn could weaken tenants' financial health, potentially leading to lease defaults or vacancies. No single tenant accounts for more than 2% of revenue, but a significant downturn in a key industry could still pose a risk.
• Geographic Concentration: Approximately 15% of EPRT's revenue comes from properties in Texas. A significant economic downturn in this state could disproportionately affect the company's rental income and property values.
• Competition for Acquisitions: The net lease market is competitive. Intense competition for high-quality properties could drive up acquisition prices and compress investment yields.
• Share Dilution: EPRT issues new shares to fund growth. If profit growth does not keep pace, this continued issuance could dilute existing shareholders' ownership and earnings per share.

4. Management Discussion and Analysis (MD&A) Highlights Management's discussion highlighted key aspects of EPRT's performance and strategic direction for the year.

Operational Highlights and Challenges: EPRT achieved robust portfolio growth, expanding its property portfolio by nearly 8% to $4.1 billion. The company added approximately 150 new properties, primarily through strategic acquisitions. EPRT maintained a high occupancy rate of 99.5% and an average remaining lease term of 14.5 years, which contributes to stable rental income. Strong financial performance was evident in the growth of total revenue, net income, FFO per share, and AFFO per share. The portfolio also benefits from tenant diversification across over 400 tenants and 15 industries.

Challenges included:

• Share Dilution: Issuing new common stock to fund growth increased outstanding shares from 115.8 million in 2022 to 121.5 million in 2023.
• Rising Interest Rates: Higher rates increased the cost of capital for new acquisitions and could impact future refinancing efforts.

Strategic Focus: EPRT's consistent leadership team continued to execute a well-defined strategy. This strategy centers on disciplined growth through sale-leaseback transactions, emphasizing properties with strong underlying unit-level performance. EPRT diversifies across industries and geographies while maintaining a conservative balance sheet. The company prioritizes properties essential to its tenants' business operations, ensuring high retention rates.

Market Trends: The evolving interest rate environment is a primary market trend impacting EPRT. Higher rates increase the cost of debt, affecting the profitability of new acquisitions and the cost of refinancing existing debt. However, EPRT's long-term, fixed-rate leases offer some protection against inflation. Broader economic trends, such as consumer spending habits in their target industries, could influence tenant performance. EPRT's focus on essential, non-discretionary services helps mitigate some of these broader economic risks.

5. Financial Health EPRT maintains a stable and well-managed debt profile. Total long-term debt, comprising term loans and senior notes, remained consistent at approximately $1.95 billion from 2022 to 2023. A strong indicator of liquidity is that their revolving credit facility (a flexible line of credit) had a $0 balance at year-end 2023, showing they were not relying on short-term borrowing.

The company's financial stability is further reinforced by its mortgage receivables: 98.9% have a low debt-to-value ratio, meaning the debt is less than 60% of the property's value. This indicates that the properties securing these mortgages are worth significantly more than the debt, providing a strong buffer. EPRT also strengthened its equity base by raising additional capital through new stock issuance, increasing its "Additional Paid-In Capital" from $1.9 billion to $2.05 billion. Their net debt to Adjusted EBITDAre, a key leverage metric for REITs, stood at a healthy 5.5x at year-end 2023.

6. Future Outlook EPRT's outlook for 2024 remains positive. Management projects continued growth in FFO per share, driven by a robust acquisition pipeline and embedded rent escalations. They anticipate investing between $700 million and $800 million in new properties in 2024. The company's staggered debt maturity schedule, with no significant maturities until 2027, provides flexibility in managing its capital structure. EPRT expects its focus on essential properties and strong tenant relationships to support stable cash flows, even in varying economic conditions.

7. Competitive Position EPRT differentiates itself through a detailed, property-specific underwriting approach for its single-tenant net lease properties. They target properties critical to their tenants' operations, often demonstrating strong unit-level economics, which contributes to high occupancy and lease renewal rates. Their focus on service-oriented and experience-based industries provides a degree of insulation from e-commerce trends that impact traditional retail. This specialized focus, combined with long-term leases and contractual rent escalations, delivers a stable and predictable income stream.