GMRE - Global Medical REIT: Revisiting Dividend Assumption After Q2 Results

2023-09-10 05:45:45 ET

Summary

• Before Q2 2023 results, I changed the rating to hold for GMRE due to an increased probability of dividend cut.
• The key drivers of such assumption were the increasing interest rate costs coupled with a gradual reduction in asset base due to Management's plans to optimize the balance sheet.
• Yet, during Q2, GMRE managed to divest several properties at extremely attractive cap rates, which has in turn lead to an accelerated debt reduction.
• Plus, GMRE has now managed to lock in majority of its financing at ~4% interest rate 4 years in the future. As a result of this, GMRE's dividend now seems much safer over the foreseeable future.
• Yet, the rating remains a hold due to limited growth prospects on a total return basis (i.e., lack of balance sheet capacity to fund growth opportunities and a continued focus on deleveraging).

On May 4 ^th , 2023, I issued my ninth article on the Global Medical REIT (GMRE) that marked an end to my unchanged stance for recommending a buy all the way back since February 2019.

The key reason driving my decision to assign a hold rating was limited growth prospects in conjunction with increasing interest cost component.

While the business operations metrics remain robust (e.g., 97% occupancy rate, growing like-for-like NOI, well-laddered lease profile), the financial capacity of GMRE to accommodate further growth via acquisitions is tiny. This is because GMRE's leverage profile is already exhausted in the context of internal financial policy that automatically forces the Management to focus on optimizing the balance sheet instead of financing external growth opportunities, which would imply even higher interest rate costs.

All in all, this is a prudent strategy considering the potential difficulties and volatility in lending markets, especially in tertiary geographies in which GMRE operates.

Yet, the optimization of balance sheet comes at the expense of further growth in FFO. If you add the fact that the current weighted average cost of debt is at 4.28%, while the incremental financing for GMRE is available at ~ 6% , the dividend story might not seem that attractive either (especially in the context of almost 100% AFFO payout).

So in May 12 ^th , I went a step further by issuing an article on the Global Medical REIT Inc. 7.50% CUM PFD A (GMRE.PR.A) stating that for yield-seeking investors a position in the preferred stock would be considered more optimal relative to the equity option (i.e., GMRE's stock) given the increased probability of GMRE's dividend cut and only 150 basis of yield spread between the two options.

Now, back in early August, GMRE circulated its Q2 results , which embody some interesting dynamics warranting a solid base of facts for me to revisit my thesis on GMRE's dividend.

With this being said, I want to underscore that I am not changing my view on GMRE's rating (i.e., maintaining hold) as there is still lack of fresh data, which could support a nice equity growth story going forward.

At the same time, there are now some solid elements, which indicate that the yield-seeking investors can actually be comfortable with the current dividend of 8.6%.

GMRE has managed to secure favorable financing until 2028 mainly through the interest rate swap agreements.

According to Robert Stevenson, CFO of GMRE in Q2, earning call :

We have swaps that go out through the maturity of both of those term loans. And in fact, we're going to start to see some of the benefit of forward starting swaps that we've put on in the past on the $350 million term loan. So as we extended that out in past years, we put additional swaps on as we add a term into that $350 million term loan. So I think the positive here is that the forward starting swaps are going to -- they'll start to kick in here in the third -- one we'll start to kick in here in the third quarter of this year and then next year similarly in the third quarter, we'll see actual step down in the rate on that $350 million term loan. But both loans are swapped out till their maturities.

As of Q2, 2023, GMRE had a weighted average cost of financing at 4.09% with a weighted average maturity of 3.4 years. Majority of the existing debt is stipulated at fixed interest rate terms, where only 12% is attributable to the floating revolver (SOFR + 1.5% spread).

If we adjust for the existing revolver, the weighted average maturity of the total borrowings exceeds 4 years, providing GMRE with a visibility and stability on the interest costs. The assumption of decreased outstanding borrowings stemming from the floating revolver facility is realistic given the recent divestitures and the Management's plans to deliver.

Moreover, due to the recent divestitures (see below), GMRE has managed to shrink its debt exposure and thus triggering an embedded clause in the revolver, which allows for a decreased spread in case the leverage ratio falls below 45%. From this, GMRE is now able to save 10 basis points in the cost of financing associated with the existing floating revolver.

All in all, GMRE's financing structure is safe and helps avoid suffering from higher interest rate environment until the first notable majorities, which kick in May 2026 and February 2028. This obviously supports GMRE's ability to deliver quarterly dividends, as the interest costs have only limited effect on the AFFO on a go forward basis (at least until mid-2026).

GMRE's recent divestitures have revealed how valuable its properties are. In other words, GMRE has succeeded with the balance sheet optimization process by monetizing several properties at highly attractive cap rates.

According to Jeffery Busch, CEO of GMRE in Q2, earning call:

During the quarter, we sold a 4-property MOB portfolio in Oklahoma City, Oklahoma for gross proceeds of $66 million at a 6.5% cap rate, resulting in a gain of $12.8 million. And earlier this week, we closed on the sale of a medical office building in North Charleston at 5.3% cap rate that generated an additional $10.1 million of gross proceeds. These dispositions have enabled us to achieve our goal of reducing our leverage to our target range of between 40% and 45% as of June 30.

As a result of these transactions, GMRE was able to recognize profit since properties were sold at a significant premium to their book values recognized in the balance sheet.

Most of the captured proceeds went directly towards reducing the outstanding borrowings, specifically targeting the floating rate debt to maximize interest cost savings.

A small part of the inflows was deployed for acquisitions of 2 medical office buildings in Redding, California for $6.7 million with a 7.6% cap rate (albeit, the primary funding source here was the previously issued OP units at $11 per unit).

The bottom line

After seeing Q2, 2023 results, there is a sufficient base of new data from which yield-seeking investors can revisit their assumptions pertaining to the sustainability of GMRE's dividend.

The successful financing transactions (i.e., swap agreements) with several divestitures at very attractive cap rates have allowed GMRE to reduce its leverage, exposure to floating rate debt and lock in ~4% cost of debt 4 years in the future. At the same time, the like-for-like NOI performance remains strong with resilient occupancy ratio and well-laddered lease maturity profile.

As a result of this, GMRE is now in a position to safely accommodate the existing quarterly dividend from its internal cash generation.

Going forward, I expect GMRE to continue divestitures yet in a more balance manner as currently the asset rotation target of $90 million is almost achieved. There is some probability of GMRE doing more in the property sales, but that will depend on the cap rate environment, which is currently finally showing some initial signs of convergence towards a more realistic pricing (i.e., higher pricing).

So I do not expect a significant growth or additional returns on top of the dividend considering the Management's goal to continue with deleveraging and being very conservative on the acquisitions front.

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