It's time for another quick update on the triple net lease REITs. This sector has produced a handful of great dividend growth stocks. The simplicity of their business model (big margins, low volatility on expenses) has made them a favorite with many income investors. The batch of triple net lease REITs we're going to use for updates is shown below:

Four Corners Property Trust Inc.

Before we get into our main topic for discussion, we've got a few more charts that have been popular with readers. We start by turning those values into a bar chart:

Then, we provide the payout ratios:

Many retail investors have a painfully hard time finding any information on the price to NAV (net asset value), so we've got a chart for that as well:

We need to remind investors that "Net Asset Value" for an equity REIT relies on analyst estimates for the value of the real estate. It does not use the book value under GAAP.

This is a unique aspect to equity REITs reporting under GAAP. Consequently, we often get comments from a reader who wants to tell us they divided equity by shares outstanding and came to a different number. While we love to see investors putting in the effort, that's not how NAV works on equity REITs.

It's time for a quick update on EPR Properties (EPR) and AMC Entertainment Holdings (AMC). For investors who aren't familiar with our record on EPR, we'll provide a quick refresher. Subscribers who want to relive the memory in detail can see the article on EPR.

In December 2019 (yes, months before the pandemic), we warned investors that EPR put themselves in a rough spot by taking on too much exposure to charter schools and theatres, with their exposure to AMC as our largest single concern. We had spent days researching AMC because we felt it was impossible to provide a fully competent analysis of EPR without an analysis of AMC. Following days of research, we decided EPR was not investable at that time (shares of EPR were $70) because the market was not respecting the bankruptcy risk at AMC.

In our opinion, AMC faced elevated bankruptcy risk because of the reckless decisions coming from management.

Specifically, the company was leveraged up and borrowing cash while paying out huge dividends and buying back shares. We highlighted commentary from AMC's management in the AMC Q3 2018 earnings call transcript:

We went on to say:

Want to write a textbook example on how to risk the solvency of a company worth billions of dollars? You can use this as your case study.

If you don't have internally-generated cash flows and can't sell assets, you're not in a good position to repurchase stock. Bad decision. We won't even go into that special dividend. Terrible choice.

To provide an analogy in personal finance. You might ask:

"Should I pay down my mortgage or add to my investment account?"

That special dividend is the equivalent of answering the question by saying:

"I'll go rent-to-own a huge TV."

That decision was so bad it shouldn't have been on the menu.

That bolding was in the original report we published also. So, our view on AMC was pretty clear.

We saw a remarkable rally in EPR while AMC was plunging:

AMC's current position is that they have cash and cash equivalents of $417.9 million. Based on their existing cash burn rate, they would expect to run out of cash by the end of 2020 or early 2021. The details in AMC's announcement were nasty:

This is why we avoided heavy exposure to AMC as a tenant. Our positions in triple net lease REITs generally have very little exposure to AMC.

We have some exposure through National Retail Properties (NNN), which has a total of 4.7% of rent coming from theatres, with 3.0% coming from AMC specifically. In evaluating NNN, we considered the possibility of NNN needing to release those spaces at a material discount to the rate paid by AMC. We decided at 3% of revenues (from AMC) and 4.7% (for all theatres), the risk is acceptable. Releasing those spaces at average rents that are 30% lower would mean about a 1% decline in revenue.

Simple math: 3% exposure to AMC * 30% theoretical rent reduction = 0.9% decrease.

At this point, we need to highlight that there isn't a viable way to nail down the rent reduction, so we went with a "bear case" scenario. It wouldn't be surprising if actual declines were less than 30%. However, if AMC goes bankrupt, leasing that space won't be as easy as leasing theatre space a year ago.

EPR's exposure to the sector and to AMC is substantially larger. It was running around 17% to 18% in late 2019 (the red bar):

To be fair, if we were to draw the same chart today, AMC might technically be a substantially smaller percentage of revenue (since they aren't actually paying rent).

AMC remains a major bankruptcy risk. In December 2019, we were warning investors.

In April, other investors began to recognize the risk:

Today, AMC's management openly admits the risk.

While EPR may recover, the impact of AMC's failure to pay rent, combined with the potential bankruptcy, remains a major concern. EPR remains one of the highest risk options in the sector.

We declined to put price targets on EPR when we evaluated them in December 2019, and we're still holding off. On one hand, the REIT has a dramatic potential upside if they can release those properties quickly to a tenant who pays rent. Even at a modest cut in rental rates, they simply need occupancy. On the other hand, we wouldn't be too quick to rush into a REIT when their largest tenant (by a substantial margin) is likely to enter bankruptcy within the next six months.

We aren't bashing on the REIT after it goes down. We issued our warning when shares traded at about $70. We're simply providing the update as many REIT investors may not have noticed AMC's filing regarding their need to issue equity in hopes of having enough cash to avoid bankruptcy.

Our method works. We know because we buy the same shares we recommend. We track our results on a real portfolio and we compare our returns with the major ETFs for our sector:

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This article was written by

Disclosure: I am/we are long NNN, WPC, STOR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.