GMRE - Global Medical REIT: From Buy To Hold After Q1 Results (Rating Downgrade)

2023-05-04 04:17:19 ET

Summary

• On March this year, I reiterated my buy rating for GMRE that was initially issued back at the beginning of 2019.
• The key drivers of my bull thesis were resilient cash flow generation, well-structured balance sheet, and extremely cheap valuations.
• Now, when Q1 figures are out, we can see how robust fundamentals bear fruit in times of economic uncertainty and market volatility.
• The quarter-on-quarter FFO has remained constant, despite surging interest costs and struggling capital (financing) markets.
• On a go-forward basis, GMRE trades at a P/FFO of 9.6x, providing ~9.5% dividend that is backed with truly resilient fundamentals (also as confirmed by Q1 figures).

On March 26 ^th , 2023, I reiterated a buy recommendation for the Global Medical REIT (GMRE) that marked an unchanged stance for eighth article in a row counting all the way back since February 2019.

In my previous article , the following building blocks of the bull thesis were outlined:

• Lion's share of leases based on a triple net-lease structure, which neutralizes a notable chunk of cost inflation factors.
• Large and well-diversified portfolio, which mitigates idiosyncratic risks (e.g., property specific risks) and limits their impact on GMRE's results.
• Distant lease maturities with a minor part of leases falling due this year, which allows GMRE to avoid negotiations over sizeable areas when the bargaining power is at least temporarily in favour of tenants.
• Portfolio-wide rent escalators, which helps offset the negative effects from surging interest costs.
• Ample liquidity constituting ~35% of total outstanding borrowings.
• Leverage profile with significant margin of safety relative to the stipulated debt (financing) covenant values.

On top of that, and perhaps most importantly, GMRE's P/FFO multiple of around 9.6x in combination with ~10% dividend yield made the bull thesis rather straight forward.

Since March 26 ^th , 2023, total returns by GMRE were at exactly the same level as for the broader REIT market. Yet, the key takeaway is that no material convergence to a more justified valuation multiple has taken place. The multiple still remains at extremely depressed level of 9.61x on a 2023 forward basis (P/FFO).

Q1, 2023 in a nutshell

Q1 earnings data are a testament of GMRE's resilient fundamentals. GMRE managed to hold FFO constant on a quarter to quarter basis. Against the backdrop of a divestiture of one medical office building in Q1, surging interest costs and overall challenges in the capital (financing) markets, a constant FFO can be deemed an acceptable result.

Looking at the details, there are no significant changes in the financials except an uptick of ~$4 million in interest costs, which was totally offset by slightly higher occupancy rate (from 96.5% to 97.0%) and minor increase in like-for-like NOI driven by the embedded rent escalators.

Although, the leverage has decrease a bit (by 0.2%) and will continue to drop as indicated by the Management, we should expect a further downward pressure on the underlying FFO from growing interest cost component. Currently, the weighted average cost of debt is at 4.28%, while the incremental financing for GMRE is available at ~ 6% . This might not seem a huge gap, but each additional basis point on financing costs bears a notable impact on the cash flows.

Going forward, the current FFO result will likely remain also constant or even slight increase as Q1 does not include the cash flows stemming from two relatively material acquisitions, which occurred in April. A positive in this case is that these transactions in the amount of $6.7 million were financed purely from the previous issuance of new units (shares) - at $11 per share. In other words, the leverage profile will still be kept in balance.

The bottom line

Q1 earnings indicate that GMRE has the ability to weather the economic and capital market's storm in a sound manner. The fact that the FFO figure has remained unchanged considering all of the systematic (e.g., rising interest rates) and idiosyncratic (e.g., reduced FFO of a property divestiture and lagged effects from newly acquired properties) headwinds, proves that GMRE's fundamentals are safe and embody a margin of safety.

At current P/FFO multiple of 9.6x and a dividend yield of ~9.5%, GMRE remains an attractive buy.

In my opinion, GMRE will continue to deliver stable results and with a combination of embedded rent escalators and cash flows from freshly made acquisitions, the Company will manage to offset the negative effects from higher cost of debt. However, at the same time, I do not expect GMRE to deliver stronger results than what is already backed into the cake for this year. This is because of GMRE's plans to further reduce the leverage and current hardships in the capital (financing) markets, which consequently hamper M&A activity that has historically enhanced GMRE's results. Hence, the probability of capturing superior returns via share price appreciation is limited.

Finally, I do believe that GMRE will continue to satisfy dividend investors and provide a stable stream of current income, while avoiding an impairment of capital via sudden equity issuances or unfavourable divestitures. My recommendation is to hold GMRE stock.

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