2023-06-08 07:35:00 ET
Summary
- You're unable to control everything that happens in your life.
- When it comes to the management team - you cannot evaluate them based on what happens to them, but on how they handle what happens.
- Every dividend is a reward that cannot be taken away.
Co-authored with Treading Softly.
Do you ever feel as though you are waiting in line at a store for an eternity? It can be frustrating to be stuck in a line.
Einstein once explained his theory of relativity like this:
"Sit with a pretty girl for an hour and it feels like a minute; sit on a hot stove for a minute and it feels like many hours."
Our perception of time can shift based on the activity that we're doing. Our willingness to participate in an activity for a certain length of time can also shift based on whether we enjoy it or not.
When it comes to the market, it is much easier for an income investor to hold a position that has dropped in price because that position is still consistently rewarding them. A regular steady dividend paid by a company can provide great psychological comfort - it also makes it more difficult for those who bet against the company via acts of shorting because those people are then forced to pay for that dividend in the meantime.
Investing in dividend-paying stocks can be an exceptionally defensive investment style, simply because every dividend received cannot be later taken back by the company. It is a realized gain, going into the pocket of the investor. I hold many companies that have paid me more than 100% of my original capital and are still paying out a regular dividend. Each directly adding to my total return.
Companies that focus on share buybacks try to reward shareholders by concentrating one's ownership. Yet, those companies can just as quickly flip the switch and issue a ton of shares. Undoing years of share buybacks in a single SEC filing. A company that pays dividends can cut the dividends to nothing, but it can never take back all the dividends they've paid you.
Collecting cold hard cash today is much better than the hope that, in the future, someone will offer you a higher price.
Let's look at two great opportunities that pay you to wait!
Pick #1: MPW - Yield 12.9%
Medical Properties Trust, Inc. ( MPW ) has become a "battleground" stock. At one point, short interest in the stock was over 20%. The price is at lows not seen since the Great Financial Crisis. "Scary" news stories have become the norm for MPW as numerous "short reports" have been published, with one particular short report writer crossing the line far enough that MPW decided to file a lawsuit.
Even well-known financial news sources like the Wall Street Journal recently published an ominous article: "Hospital Tenants of Medical Properties Trust Hire Advisers for Refinancings," from which any reader would have concluded that the two tenants discussed were going to file for bankruptcy.
As it turns out, the Wall Street Journal could have saved their time talking to unnamed "people familiar with the matter" and simply listened to the publicly available earnings call where the people most familiar with the matter - the owners of the property - frankly disclosed what was going to happen.
Here is what CEO Aldag said during the prepared remarks in the earnings call on April 27th:
"Subsequent to quarter end, Prospect received a binding commitment from several third-party lenders for financing, which should provide Prospect with significant liquidity. Importantly, A portion of the proceeds of this anticipated financing will be used to pay off Prospect's existing receivables-backed loan arrangement, the result of which will be that Prospect will face no near-term debt maturities."
Three weeks later, the Wall Street Journal reports that Prospect hired advisers... a month after a deal was already reached. Then on May 23rd, the deal closed and is completely in line with what management discussed in the earnings call.
With this deal, MPW now owns:
- $513 million in California hospitals, which were performing well all along and will resume partial rent payments in September 2023 and full rent payments in March 2024. At an 8.44% cash cap rate, that is approximately $43 million/year in rent. Note that $0 rent was reflected in Q1 earnings.
- $355 million in cash from the sale of the Connecticut properties, expected to close in Q3.
- A $150 million mortgage on the Pennsylvania real estate. Converting their rent collection to an interest collection on these properties. These were the weakest in Prospect's portfolio.
- A $573 million equity interest in Prospect's Managed Care business stemming from the conversion of loans, deferred rent, and deferred interest payments into equity. Note that this is the Managed Care business, a separate entity from the hospital operating business. We've seen a lot of commentary fail to make this distinction.
If you read the Q&A in the earnings call, this is what management was expecting. If you go back to the Q4 earnings call, you will see this is a similar result to what management guided for upfront as their strategy to recover the maximum from Prospect.
"Prospect owns a valuable managed care business that we believe, based on third-party offers and negotiations and independent valuations is currently worth about $1 billion."
Monetizing that business is what management saw as the best route to extract the value of the Pennsylvania hospitals. Prospect itself was in the process of trying to sell the managed care business, but did not enjoy the luxury of having time on their side. Prospect needed cash now. MPW has the advantage of taking time, and was guided back in February that the whole process would take 12-18 months.
When managing a business, challenges happen. That's the reality of the world. When you are a landlord, tenants will run into difficulties paying rent. It doesn't matter whether you are a "good" or "bad" management. These events are outside of the control of management. Their ability to solve problems as they arise separates good from bad management.
Prospect ran into trouble and struggled to pay rent. MPW management reacted swiftly, working out a deal that will allow for rent payments to start resuming in September, a lump sum of cash will be received within a quarter, and they have obtained equity in the profitable managed care business that Prospect owned. A position that MPW management believes will result in a full recovery of all back rent and their original capital investment.
All the news indicates that everything is going according to the plan management laid out in February, and the timeline appears to be about the pace they predicted. It turns out the management that built this real estate investment trust, or REIT, for the past 19 years, navigating the Great Financial Crisis and COVID, actually understands the business they devoted their lives to!
This is what good management does. When a problem occurs, they deal with it while communicating to shareholders as clearly as possible what they are doing.
MPW is trading at a bargain price, allowing for long-term investors to buy at a steal and get an extremely high yield while we wait for management to walk the path they have laid out.
Pick #2: CSWC - Yield 11.6%
Capital Southwest Corp. ( CSWC ) is a BDC that focuses on the "lower middle market." CSWC lends to companies with EBITDA of $3-$20 million/year. CSWC provides debt to companies that are large but not large enough to be able to tap the public markets.
At its fiscal Q4 earnings (CSWC fiscal year ends in March), CSWC reported a company record NII of $0.65/share for the quarter and $2.30/share for the year, over 20% growth from the $1.90 the prior year.
Like most business development companies, or BDCs, CSWC has benefitted from rising interest rates. BDCs borrow at fixed interest rates and lend at floating rates. So, as interest rates rise, their income increases while their liabilities are fixed. However, in addition to that natural tailwind, CSWC has improved its operating efficiency. Since 2016, CSWC has seen its operating expenses - excluding interest expense - decline from 4.9% of assets to 1.9% of assets. Source .
The increased earnings from rising interest rates are great. We love the extra dividends. Yet, they won't last forever. Interest rates will decline again, or if they stay high, CSWC will eventually have to refinance its fixed-rate debt at current rates. The improvement in operating leverage is permanent and will benefit earnings regardless of what happens with interest rates. If the macroeconomics all returned to 2019 levels overnight, CSWC would be a better company with higher earnings than in 2019. CSWC has taken advantage of a favorable environment to make permanent improvements, in addition to thriving on the more temporary tailwinds.
The best part is that CSWC has seen growing earnings and a growing portfolio while reducing leverage. CSWC's leverage currently sits at 0.88x, well below the 1.1x it was at last year.
On the earnings call , management addressed this decline, with leverage now slightly below the bottom end of their targeted range:
"As we have said many times, we manage our BDC with a full economic cycle mentality. This starts with our underwriting of new opportunities, but it also applies to how we manage the BDC's capitalization. Managing leverage to the lower end of our target range positions us to invest throughout a potential recession, when risk-adjusted returns can be particularly attractive. It also allows us to support our portfolio companies, while also opportunistically repurchasing our stock if it were to trade meaningfully below NAV."
The smaller companies that CSWC lends to are at higher risk than the very large upper middle market that peers like Ares Capital ( ARCC ) lend to. So with the risks of recession rising, it is prudent for CSWC to be more conservative than other BDCs we hold. The good news is that CSWC has managed to be more conservative without sacrificing earnings growth.
This prudent management gives us a lot of confidence that CSWC will be able to navigate a recessionary environment while maintaining its regular dividend. In the meantime, CSWC has announced it is maintaining its $0.05 supplement dividend for the June dividend and intends on paying supplements for the "foreseeable future" as interest rates remain high.
We continue to be impressed with CSWC's management, and this is a BDC that we are willing to hold for the long term.
Conclusion
With MPW and CSWC, we can enjoy high dividend income while waiting to see what goes on in the market. Both management teams are proactively managing their respective companies and trying to stop any issues before they arise within their realm of control.
As those management teams continue to run their companies, I'm able to go about my daily life. I can enjoy going outside with my friends. As the dividends continue pouring into my account, I can enjoy that income without worrying about daily share price maintenance. I'm not a victim tied to the mast of my portfolio as the market whips it around. Instead, I'm a captain who knows what the other side of the storm looks like and is willing to sail through rough seas to enjoy the benefits.
That's the beauty of my Income Method. That's the beauty of income investing.
For further details see:
Buy The Dip: 2 Bargain Dividends For +11% Yield