NEW YORK--(BUSINESS WIRE)-- Fitch Ratings assigns a 'BB' credit rating to the $125 million 6.625% series F preferred stock issued by Entertainment Properties Trust (NYSE: EPR).
Net proceeds from the offering of approximately $121 million are expected to be used to redeem all of EPR's 7.38% series D preferred shares at an aggregate redemption price of approximately $115.8 million, which includes approximately $800,000 of accrued and unpaid distributions at the anticipated redemption date, and for general corporate purposes.
The company's ratings are driven by the consistent cash flows generated by the company's triple-net leased megaplex movie theatres and charter schools, together with the cash flows from the company's other recreational and entertainment-based investments, which are solidly in excess of the company's fixed charges. The ratings also take into account credit concerns including idiosyncratic risks involved with charter school investments and the company's investment in asset classes that are likely less liquid and financeable during periods of financial stress.
For the 12 months ended June 30, 2012, EPR's fixed-charge coverage ratio pro forma for the preferred stock offering was 2.6x compared with 2.5x and 2.3x for the years ended Dec. 31, 2011 and 2010, respectively. This coverage is solid for a 'BBB-' IDR. Fitch projects that EPR's fixed-charge coverage ratio will improve slightly over the next 12 to 24 months due primarily to the spread on new acquisitions over the cost of financing, and assuming future acquisitions are executed on a leverage-neutral basis. Fitch defines fixed-charge coverage as recurring operating EBITDA less recurring capital expenditures, non-cash interest income and straight-line rent adjustments, divided by interest incurred and preferred stock dividends.
EPR has a manageable lease expiration profile. Of the company's megaplex theatre revenue, which represents 62% of total revenue, the majority of leases expire beyond 2018. Of the company's charter school leases, which represent 11% of total revenue, all leases expire after 2030.
Historically, many tenants have chosen to exercise their renewal options, which has mitigated re-leasing risk and provided predictability to portfolio-level cash flows. That said, there is a risk that expiring leases might not be renewed or be renewed on less favorable terms to EPR given that a theatre's performance may have weakened during the term of the long-term lease.
The company's leverage, measured as net debt-to-trailing 12 months recurring operating EBITDA was 4.8x as of June 30, 2012, up from 4.4x and 4.6x as of Dec. 31, 2011 and 2010, respectively. The small uptick is a result of EPR funding acquisitions primarily with debt over the last year. Fitch projects that EPR's leverage will be in the mid- to high-4.0x range over the next 12 to 24 months, which would remain appropriate for the 'BBB-' IDR.
EPR has solid contingent liquidity from its unencumbered property pool. As of March 31, 2012, unencumbered asset coverage of net unsecured debt was 2.1x utilizing a stressed 12% capitalization rate on unencumbered net operating income (NOI) from the owned property portfolio, a ratio that is strong for a 'BBB-' IDR. The company also has over $350 million book value of unencumbered mortgage notes receivable that are currently performing. Including 75% of these unencumbered assets to reflect the cash-flowing nature of these investments would improve unencumbered asset coverage to approximately 2.6x, which would also be strong for a 'BBB-' IDR.
The company has a well-laddered debt maturity profile. Aside from maturities in 2017 ($240 million unsecured term loan), 2020 ($250 million unsecured senior notes) and 2022 ($350 million unsecured senior notes), annual debt maturities do not account for more than 12% of total debt in any given year, alleviating refinance risk. Over the next five years 29% of total debt will mature, the majority of which is made up of mortgages. EPR intends to further migrate toward an unsecured funding model, and will likely use unsecured debt to repay these mortgages, broadening the unencumbered asset pool, which Fitch views as a credit positive.
EPR's sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, expected retained cash flows from operating activities after dividend payments) cover uses of liquidity (pro rata debt maturities and expected capital expenditures) by 2.9x for the period from July 1, 2012 to Dec. 31, 2014. This strong liquidity surplus is driven in large part by no debt maturities until 2014 and further reflects the relatively low capital-intensive nature of EPR's business.
In addition, the covenants under EPR's credit agreements do not limit financial flexibility. As of June 30, 2012, the company was well within its covenants for the revolving credit facility, term loan and senior unsecured notes.
EPR currently faces increased risk from its largest charter school tenant. Imagine Schools, Inc. Imagine is the lessee of 69% of EPR's charter schools as of June 30, 2012, and recently closed or is in the process of closing several schools because of poor academic performance. With EPR's approval, Imagine can sell, sub-lease or substitute non-performing schools with performing schools on the nine assets. Although EPR is relatively well protected by a master lease structure, currently good cash flow coverage, and a letter of credit, these closings are indicative of the idiosyncratic risks of charter school investments.
The ratings also take into consideration a degree of tenant concentration. The company's two largest theatre operators collectively accounted for 43% of total revenues in the second quarter of 2012 (2Q'12), although the company has been steadily reducing its exposure to its largest tenants. Rental revenues from American Multi-Cinema, Inc. (AMC; Fitch IDR of 'B' with a Negative Outlook) accounted for 33% of total revenue and Rave Cinemas for 10% of total revenues. Imagine, EPR's largest public charter school operator, accounted for 9% of total revenue in 2Q'12. Given that most of EPR's top tenants are either unrated or have below investment-grade ratings, the potential for corporate default, bankruptcy and lease rejection could reduce EPR's rental revenues.
One mitigant to this risk is that on a portfolio basis, property-level EBITDAR covers rent payments by a healthy margin for nearly all of EPR's theatre and charter school assets, indicative of solid four-wall profitability. Box office revenues have been relatively resilient over the last decade, as total box office revenues have risen or stayed flat in eight of the last 10 years, indicative of stability in operator top-line cash flows. In addition, no theatre tenant has ever missed a lease payment since EPR's formation in 1997, and no tenants on a portfolio-wide basis have EBITDAR coverage of rent below 1.0x. Further, the company has increased the diversification of its tenant base over the last several years, which Fitch views positively.
The company's real estate investments are in or backed by mostly non-core property types (e.g. megaplex movie theatres, charter schools, wineries, ski areas and waterparks) and thus may be less liquid or financeable in periods of company or market stress. The demonstrated alternative use of certain of the company's assets may be limited, absent the company incurring costs to attract new non-theatre tenants, despite EPR's theatre properties typically being well-located and having high-quality amenities.
The Stable Outlook reflects Fitch's expectation that leverage will stay relatively unchanged and coverage will remain above 2.5x, over the next 12 to 24 months, metrics that are appropriate for a 'BBB-' IDR. The company's unencumbered asset coverage of unsecured debt will likely decline slightly as it repays mortgages with unsecured debt but will remain appropriate for the 'BBB-' IDR. In addition, EPR has strong liquidity and good demonstrated access to capital, mitigating potential refinance risk.
The two-notch differential between EPR's IDR and its preferred stock rating is consistent with Fitch's 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' Criteria Report dated Dec. 15, 2011, as EPR's preferred securities have cumulative coupon deferral options exercisable by EPR and thus have readily triggered loss absorption provisions in a going concern.
The following factors may have a positive impact on the ratings or Outlook:
--Fitch's expectation of leverage sustaining below 4.0x (leverage was 4.8x as of June 30, 2012);
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro forma coverage was 2.6x for the 12 months ended June 30, 2012);
--Growth in the unencumbered portfolio, particularly in the megaplex movie theatre portfolio.
The following factors may have a negative impact on the ratings or Outlook:
--Fitch's expectation of leverage sustaining above 5.5x;
--Fitch's expectation of fixed-charge coverage sustaining below 2.2x;
--A sustained liquidity coverage ratio of below 1.0x;
--A weakening in the credit quality of EPR's tenants;
--The company deviating materially from its core strategy of acquiring theatres, charter schools and other entertainment-based assets.
Fitch currently rates EPR as follows:
--Issuer Default Rating (IDR) 'BBB-';
--Unsecured revolving line of credit 'BBB-';
--Senior unsecured term loan 'BBB-';
--Senior unsecured notes 'BBB-';
--Preferred stock 'BB'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--Corporate Rating Methodology (Aug. 8, 2012);
--Criteria for Rating U.S. Equity REITs and REOCs (Feb. 27, 2012);
--Recovery Ratings and Notching Criteria for Equity REITs (May 3, 2012);
--Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis (Dec. 15, 2011).
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs
Criteria for Rating U.S. Equity REITs and REOCs
Corporate Rating Methodology
Steven Marks, +1-212-908-9161
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Michael Paladino, +1-212-908-9113
Sandro Scenga, +1-212-908-0278
Source: Fitch Ratings