UHT - Universal Health Realty: Fairly Valued And Low Dividend Coverage

2024-01-02 22:44:02 ET

Summary

• Universal Health Realty is a healthcare REIT that invests in and leases healthcare and human service related facilities.
• The dividend may not be very safe due to a high payout ratio and slow FFO growth, making UHT less attractive for income investors.
• Additionally, the shares are fairly valued right now, so value investors are better off adding UHT to a watchlist and looking elsewhere in the meantime.

Universal Health Realty Income Trust ( UHT ), founded in 1986 and headquartered in King of Prussia, PA, is a healthcare REIT that invests in and leases healthcare and human service related facilities, such as medical/office buildings, acute care hospitals, behavioral healthcare hospitals, specialty facilities, free-standing emergency departments, and childcare centers.

Its portfolio may be widely diversified, its growth decent, and its solvency profile healthy, but the dividend doesn't appear very safe and there is no margin of safety present.

Portfolio

As of November 1, 2023, the REIT's portfolio consisted of 77 investments or commitments spread across 21 states. The breakdown is as follows:

• 60 medical/office buildings, with 4 owned by unconsolidated LLCs/LPs.
• 6 hospital facilities, consisting of 3 acute care hospitals and 3 behavioral health care hospitals.
• 4 preschool and childcare centers.
• 4 free-standing emergency departments ("FEDs").
• 2 specialty facilities, currently vacant.
• 1 vacant parcel of land in Chicago, Illinois.

Below is the geographical diversification of the company's properties which can help you better understand how well-diversified the portfolio is:

For those who are looking for exposure to healthcare facilities, this is really attractive. However, you should know that the portfolio is less diversified based on property type as it overwhelmingly consists of medical office buildings and clinics:

However, I would personally want that kind of MOB exposure if I were to invest in a healthcare REIT. In fact, I see the exposure to the other property types as a more than adequate diversifier.

Performance

When it comes to its operating performance, the last decade was the period where the REIT experienced the most growth in revenue. While operating income has been growing more erratically, FFO has been increasing as well in the last 10 years after a long period of shrinking.

More recent results tell a slightly different story, though. Based on the latest quarterly report, revenue and FFO annualized are 10.86% higher and 7.97% lower, respectively, than their corresponding average annual figures from the last 3 fiscal years.

Now, it seems that the stock price trend has been less erratic:

What surprised me the most though was that the stock price reached triple-digit territory in 2019 only to fall to work its way down to the low $40s, a level it hadn't fallen to since 2014. Another surprise was delivered by the fact that while many REITs made new highs after reaching 2020 lows up until the Fed started raising the rate, UHT did not behave in the same manner. For this stock, it was a faster fall from grace, which made me suspect there could also be some fundamental issues behind this behavior.

Leverage

But it can't be the leverage, as far as I can see. The assets are 59.36% funded by mortgages and a line of credit, a ratio I don't find particularly attractive, but not alarming either. In any case, a debt-to-EBITDA ratio of 5.4x and interest coverage at 1.9x reflect more than adequate liquidity and a very healthy solvency profile. My only issue is the trend of increasing leverage over the long term that is present:

Another thing I didn't love is that the REIT's fixed-rate debt has an average interest rate of 4.4% and its variable-rate debt has one of 6.62%, together weight-averaging 6.38% because its variable-rate debt is much greater.

Regardless, what I think that the market has probably taken into consideration is the upcoming maturity in 2025 which consists of all of the variable-rate debt ($321.5 million). Aside from that there are no major maturities.

Now, as I said, the interest rate for this portion is 6.62%; this is high enough to make me think that a higher cost of debt is very unlikely to be realized at refinancing. Actually, considering where the Fed is expected to move rates in 2024, it's more likely that the REIT is going to be able to refinance at a lower rate by 2025.

Dividend & Valuation

The company currently pays a quarterly dividend of $0.73 per share which results in a 6.75% forward yield. First, the payment record has established a very long trend of consecutive years of growth (20 years in a row). If you go even further into the past, the growth story is overwhelming:

Now, there are two opposing factors present. The first is the payout ratio based on FFO which is 90.15% and doesn't leave a good margin for dividend growth and business expansion. The second is the relatively slow FFO growth. So the picture is actually mixed when it comes to the safety of the dividend.

Moreover, the shares are trading at a 5.9% implied cap rate, which is more or less what I would use to value the REIT's assets as MOB cap rates seem to have been trending around 6% in the past [ source ]. Therefore, I believe that the stock price has reached fair value.

Risks

Which brings me to the first risk I want to mention. Fairly valued businesses certainly pose less of a risk than overvalued ones, but an important one nevertheless. Buying real estate assets for less than they're worth provides a margin of safety that is useful for an investor's confidence in the investment decision. A lack of that and volatility can shake one's conviction enough to motivate them to realize a loss at some point.

The other risk is related to a potential dividend cut. Though the payment history makes this seem unlikely, the high payout ratio and slow FFO growth beg to differ. For this reason, I wouldn't recommend UHT as a dividend portfolio pick either.

Verdict

Because the REIT doesn't seem attractive from neither an income nor a value investment perspective, I must assign a hold rating on the stock. If the market continues driving the price down and UHT reaches anywhere close to $33 per share, I would have to reconsider my thesis as the dividend yield would increase to 8.85% and the discount to NAV would be 21.59% based on a 6% cap rate. As this isn't unlikely to happen, I recommend you add this to a watchlist for now.

What do you think? Was this post useful? Did I miss something you wanted to know? Let me know below! Thank you for reading.

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