UHT - Universal Health Realty: 7.4% Dividend Yield Medical Office Buildings High Leverage

2023-10-17 10:58:28 ET

Summary

• Universal Health Realty has seen a significant price drop in its common shares due to interest rate headwinds.
• The REIT has a total debt-to-equity ratio that's ahead of its peers. The variable debt burden is driving up its quarterly interest payments.
• FFO per share is trending down and the 93.5% dividend payout ratio could worsen on the back of continued FFO pressure.

Like its REIT peers, Universal Health Realty ( UHT ) has seen its common shares get smashed against interest rate headwinds to pull back materially from its highs. The REIT was initially trading for $130 per share prior to the pandemic and has since shed 70% of its value with the common shares currently trading for just over $39 per share. Price returns over the last decade are negative despite the REIT having maintained and increased its quarterly paid dividend over the same time frame. At the core of UHT's headwinds is a total debt-to-equity ratio of 1.62x, above the upper threshold of comfort at around 1.50x and ahead of most of its healthcare REIT peers.

UHT had $311.4 million of outstanding borrowings and $3.1 million of letters of credit outstanding under its credit agreement. There is a further $39.7 million of non-recourse mortgages on its facilities. These collectively drove a quarterly interest expense of $4.2 million during UHT's fiscal 2023 second quarter, up 76% year-over-year from $2.4 million. The credit agreement is pegged to adjusted term SOFR plus a 1.20% margin. Hence, the REIT has faced marked headwinds with the Fed fund's rate currently sitting at a more than two-decade high of 5.25% to 5.50%. There might be some respite with the market currently pricing in a roughly 92.7% chance that the November 1, 2023 Federal Open Market Committee meeting sees a consecutive rate pause.

Liquidity, Debt, And Revenue

The REIT held a cash and equivalents balance of $9.5 million at the end of the second quarter with $60.5 million of available borrowing capacity left on its credit agreement. This was set against $6.2 million in debt coming due in 2023, a $12.43 million mortgage maturing in 2024, and a credit agreement scheduled to mature on July 2, 2025. Near-term maturities can be addressed by existing cash and the borrowing capacity hence, there are no known liquidity risks and UHT does not need to chase asset divestitures to meet its maturities. Floating rate debt forms the core headwind facing the REIT which realized second-quarter revenue of $23.81 million, up 7.4% over its year-ago comp.

UHT owned seventy-six investments spread across 21 states at the end of the second quarter. This includes medical office buildings, acute care hospitals, rehabilitation hospitals, sub-acute care facilities, freestanding emergency departments, and childcare centers. MOBs formed the largest component of its property portfolio at roughly 68% with acute care hospitals coming in at around 17%. Net income at $3.48 million fell from $5.2 million in the year-ago period with the decline being led by an additional $1.8 million in interest expenses during the second quarter.

FFO, Dividend Coverage, And A Possible Fed Pause

UHT last declared a quarterly cash dividend of $0.72 per share , flat from its prior quarterly distribution and for a 7.4% annualized forward dividend yield. The REIT reported a second-quarter FFO of $10.62 million, around $0.77 per share. This was down around 11 cents from $0.88 per share in the year-ago period with FFO for the last six months solidly trending below its year-ago comparative. UHT has historically been a strong dividend payer with its quarterly distributions growing at a steady clip over the last decade.

The REIT's dividend trendline shows an uninterrupted move up with a yield that's also jumped to its highest level in more than a decade. However, I don't think the commons are a clear buy here as FFO per share meant the dividend was 107% covered. This 93.5% payout ratio is not bad but could look precarious with FFO set to come under continued pressure. There was a further 25 basis points hike at the July FOMC meeting which will pull up interest expenses even further.

This comes as the REIT's previously significant premium to tangible book value gets weathered away with the tangible book value at $208.3 million as of the end of the second quarter. This was around $15.07 per share and down sequentially from $15.45 per share in the first quarter and from $16.24 per share in the year-ago period. UHT forms a decent hold from here with pressure on FFO keeping me away from recommending the commons as a buy. Whilst we could see the dividend coverage continue to decline, a possible near-term cut to the distribution is likely to be avoided with rates likely at their peak. UHT also likely will want to avoid regressing on its long illustrious history of dividend growth and stability.

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