2023-08-04 16:35:08 ET
Summary
- Q2-2023 showed a small decline in FFO even though revenues went up.
- Payout ratio is right near 100% and growth should be hard to come by.
- We tell you why we are lowering our price target further and go through why the preferred shares might be an interesting bet down the line.
On our last update of Global Medical REIT Inc. ( GMRE ), we took the price target down as headwinds were everywhere.
We are lowering our 2-year target to $11.50 from $12.50. It still makes sense to hold from an income perspective but the volatility could get higher during a recession. On our existing positions, we took the opportunity on the ride up to sell the July $12.50 covered calls for 50 cents on February 2.
This gave us another 9.3% of annualized yield over the yield of the stock. Since it fit with our price target objectives, there was really nothing to lose by getting called on the stock over $12.50.
Source: Why We Are Lowering Our Price Target
That was a good call as the stock did not do a runaway move and we also pocketed the entire 50 cents of option premium.
We look at Q2-2023 results and update our thesis.
Q2-2023
For Q2-2023, GMRE reported flattish revenues in relation to the previous quarter. What little increase we did see, was offset by rising interest expenses which went from $8.27 million to $8.46 million. The company kept a tight leash on most expenses but we saw a small decline in funds from operations (FFO) from $0.22 to $0.21.
Adjusted FFO (AFFO) has declined marginally as well but held to the same 23 cents per share as Q1-2023.
GMRE has correctly pulled back from capital market activity as issuing either new shares or new debt has become expensive at current prices. You can see that to some extent in the picture above where the weighted average units outstanding has been flat since Q2-2022. What it did do was small tinkering with its portfolio with five medical office building sales and two purchases over the last few months.
Outlook
The results had no unusual items, but the stock rallied anyway. This was the reverse of what happened with some REITs we follow like WP Carey ( WPC ), where the results were excellent but the stock tanked. The core investment thesis here is that medical office buildings represent a low-risk play on real estate. That is supported by a very high rent coverage from tenants.
If that is not impressive to you, then you should see as to what passes for "strong" rent coverage. Here is Omega Healthcare Investors Inc. ( OHI ), which is in the senior housing and nursing care arena boasting about 1.04X EBITDAR coverage.
GMRE's further differentiating factor was a focus on the secondary markets, versus the larger markets that REITs like Physicians Realty Trust ( DOC ) focus on. The difference comes down to cap rates and DOC has bought very expensive properties at very low cap rates for all of its existence. GMRE buys cheaper properties and hence it has been able to grow its FFO over the last few years relative to DOC. But even that growth requires being able to issue units above NAV and funding new debt at sub 6% rates. GMRE's analyst consensus NAV peaked around June 2022 at $15.00 per share and is now down to $11.50. The drop comes as expanding net operating income (NOI) has been more than offset by higher cap rates. That in turn has been influenced by risk-free rates expanding from 0% to well over 5%. The NAV today is still higher than the stock price and in general this has been the case for the last 15 months. So GMRE has to issue stock in a way that is dilutive, if it wants to buy more properties. The company has stayed out of this for now, and it is hard to forecast when the conditions will allow a return to the capital markets.
In the absence of accretive growth via stock issuance, some REITs can use their excess FFO. This is also not possible for GMRE as its payout ratio is right near 100%. So what we have here is a high-yielder that likely has zero growth prospects for the next two years at least.
In the interim, the lease expiration is not too daunting and most doctors tend not to move their practice locations for a slightly lower rent.
The bigger challenge might be the debt load which actually has a pretty good interest rate currently, but has a short maturity profile.
The swaps and hedges shown below will protect the interest rate for now, but the weighted maturity is just 3.4 years and the "higher for longer" scenario will blow through the dividend coverage.
Verdict
The last time around we had lowered the fair value to $11.50 and we are moving even lower today to $11.00. This is about in line with some of the lower NAV estimates. The properties are well buffered against economic stress, but there is a huge glut of regular office space in secondary markets. The difference between medical office and regular office space is not so large that it cannot be bridged with the right capex. Coupled with the lack of growth and the short debt maturity, we have enough to want to hit the exits. We sold the $10.00 calls recently and along with the current dividend, this provides enough of a buffer. GMRE gets a 5 on our potential pain scale rating.
Global Medical REIT Inc. 7.50% CUM PFD A ( GMRE.PA )
For investors most interested in the yield of the security, the preferred shares present an interesting option. The common shares yield 8% at the current price while the preferred shares yield a smidge above 7.6%. The common shares offer zero growth prospects for the foreseeable future. So you are pretty much buying both just for their yield. But the preferred shares have a huge common equity buffer in front of them.
The preferred dividends currently are about 10% of FFO. So there might be scenarios where the common dividends takes a cut, but none where the preferred shares remotely get impacted. We have not bought the preferred shares as we currently think the combination of the common share dividends plus high option premiums offer a better deal. But this might be an issue we might buy down the line.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
Global Medical REIT: Higher For Longer Scenarios Will Stress The REIT