GMRE - Global Medical REIT: Exited Position As Discount To NAV Closed

2023-08-08 03:45:18 ET

Summary

• Global Medical REIT only has 6.4% upside to its NAV estimate of $10.96 based on a 7% cap rate. There is not enough upside to warrant initiating a new position.
• GMRE is up 33% since my last article, and I exited my 15,000 shares GMRE position at a 24% profit over a four-month period. Evidence is within the article.
• FFO and AFFO have decreased since last year due to an increase in interest expense and operating expenses.
• Dividend payout ratio is now 100%, potentially leading to a dividend cut.
• Recent transactions surprisingly show that cap rates have been relatively unaffected over the last year, despite the rising rate environment.

Global Medical REIT now close to fully valued, achieving our previous NAV estimate of $10.96

My investment philosophy revolves around buying equities at substantial discounts to their net asset value ((NAV)) or theoretical liquidation value. Once the stock has reached its NAV, I no longer have any reason to own the stock as it is no longer undervalued.

On October 21, 2022, I published a bullish article on GMRE when the stock was trading at $7.74. The medical office building owner and operator's stock is now trading at $10.30, 33% above the price at publication. In my previous article, I estimated NAV of $10.96 based on a 7% market capitalization rate on GMRE's medical real estate assets' net operating income.

Based on an NAV of $10.96, GMRE was 29% undervalued at the time of my last article with 41% upside to NAV. The discount has now narrowed to just 6% at $10.30 a share, translating to just 6.4% upside to NAV. There is no longer enough upside to NAV to warrant initiating a position.

Entered Position at Average Price of $8.96 and Exited at average price of $11.10 for 24% Gain over 4 Months

Between October and November of 2022, I bought 15,000 shares at an average price of $8.96 and sold 14,999 shares at an average price of $11.10 in February 2023, for a gain of $32,000 or 23.9% in just 4 months. Evidence of the trade in my E*TRADE brokerage is below.

I kept 1 share in the portfolio unsold just to more easily track how GMRE is doing. I sold not because of any substantial fundamental change in the business, but because the only important thing that matters when making an investment decision is how undervalued the asset is. If there is no undervaluation, there is no longer any reason to be invested regardless of how strong fundamentals are.

FFO and AFFO Decreasing since Last Year, Driven by Increase in Interest Expense and Operating Expenses

While the changes in FFO (Funds from Operations) and AFFO (Adjusted Funds from Operations) since last year are not thesis changing on their own, it is clear that the interest rate environment is negatively affecting GMRE.

Since my last article , GMRE's quarterly FFO per share is down 8.7% from $0.23 to $0.21, and GMRE's quarterly AFFO per share is down 8% from $0.25 to $0.23. This is driven largely by a 57% increase in interest expense from $5.4M to $8.5M, and a 20% increase in operating expenses from $6M to $7.2M.

Dividend Payout Ratio now at 100% of FFO; Not Much Room Left for Dividend

Given the recent decline in FFO, the dividend payout ratio has moved from 92% of FFO to 100% of FFO. Any further decrease in FFO would likely result in a dividend cut, as GMRE would no longer be able to cover the dividend from funds from operations.

Portfolio Cap Rate appears to be relatively unaffected by rising rate environment; 7% cap likely still a decent assumption

In my previous article, I included a sensitivity analysis assessing the impact of cap rate movements on GMRE's NAV. As usual, NAV is fairly sensitive to movements in cap rates, and I would have expected that a drastic increase in interest rates would move cap rates upwards, bringing NAV down.

Judging from recent transactions in GMRE's portfolio, it appears that cap rates have not been negatively affected. GMRE reported an acquisition at a cap rate of 7.6% in April 2023, along with dispositions at cap rates of 6.5% in June 2023, and a disposition at a 5.3% cap rate in August 2023.

Final Assessment

GMRE no longer makes sense as an investment to a value investor looking to purchase significantly discounted equities. The dividend is at risk of a cut due to the high payout ratio of 100%, so dividend investors should be cautious and factor in the possibility of a cut in their investment decision-making. I continue to have GMRE on my radar, and if shares drop to $8.50-$9, I may try to recreate my initial trade with a target of exiting upon reversion to NAV. I do not think that there is enough upside to NAV to warrant initiating a new position in GMRE at this time.

For now, my money is invested in other more deeply discounted equities that I will write about in future articles.

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