2024-01-09 13:29:27 ET
Summary
- Shares of Medical Properties Trust skidded heavily after the REIT disclosed new problems with tenant Steward, raising concerns about a potential dividend cut.
- Steward's liquidity crunch poses a binary problem for MPW, as the REIT relies on Steward for a significant portion of its revenues.
- MPW has hired experts and provided emergency liquidity to Steward, but uncertainty remains regarding the recovery of rent and the impact on MPW's financials.
- Medical Properties' shares are priced as a restructuring play, but the risk matrix clearly deteriorated last week.
Shares of Medical Properties Trust ( MPW ) traded sharply lower last Friday after the hospital REIT disclosed new payment obstacles with one of its tenants, Steward, which itself has become a restructuring play. The weak cash flow profile of Steward has caused trickle-down effects for Medical Properties which may be put into a position in which it will have to review its dividend policy again. Considering the most recent developments, I believe the risk matrix has unfortunately deteriorated and shares are in a high-risk situation as a result. Therefore, I expect more downside pressure to build on Medical Properties’ shares which suggests that a re-test of Friday's lows may follow. Given the changed revenue/cash flow outlook, investors may not see a valuation recovery in the near term and I am changing my rating from strong buy previously to hold!
Previous rating
I only recently started a speculative buy position in Medical Properties -- Strong Buy After The Dividend Cut -- because I felt that the dividend cut in the second half of FY 2023 took pressure off of the REIT’s cash flow and ultimately helped create a safer dividend play for income investors. Since my first buy, which occurred at ~$7 (my average cost is now $4.50), shares of Medical Properties have declined 50%. As much as I like Medical Properties as a restructuring investment, I believe that the latest development is a negative catalyst that could result in yet another dividend cut. Given that Medical Properties has failed to defend its $0.29 per-share dividend in FY 2023, I believe the risk profile, unfortunately, has deteriorated.
A binary problem: will Steward pay or not?
The problem at Medical Properties is binary in nature and chiefly relates to whether or not Steward will make good on its outstanding rental debt. The REIT's market cap collapsed and skidded by about one-third on Friday after the hospital REIT effectively issued a solvency warning with regard to Steward to which Medical Properties leases a large number of properties. According to Medical Properties’ supplemental Q3’23 disclosure ( Source ), Steward was responsible for approximately 19.9% of the REIT’s revenues (including the Massachusetts partnership). The second-largest tenant was Circle Health with a revenue share of 13.8%.
According to a Medical Properties’ disclosure from last Thursday, Steward informed the REIT that an unfavorable change in vendor terms has caused a liquidity problem for the company which creates down-stream problems for Medical Properties as well.
As you can see below, Medical Properties billed $52.1M in rents to Steward in the third-quarter, not including straight-line rent receivables and interest. In total, Steward generated $70.7M in revenues for Medical Properties so a considerable amount of revenue is now at risk that may impact the REIT’s ability to pay its dividend. The $70.6M broken down below calculate to an approximately 23% revenue share in Q3'23.
What is the most likely outcome for MPW and its investors?
Medical Properties Trust has hired expert counsel as well as a legal firm to help recover its uncollected rents. The REIT apparently also helped tie Steward over by agreeing to provide emergency liquidity in the amount of $60M (secured by collateral) to its struggling tenant.
Medical Properties had $340M in cash on its balance sheet at the end of the September quarter, so the REIT can certainly afford to make a short term cash infusion into Steward’s business. But ultimately, Steward will have to make other, more significant efforts to restructure its operations which could lead to divestitures of managed care facilities and a broader down-sizing of operations.
This may also result in a situation in which Steward facilities are transitioned to other tenants. At the end of the day, I believe it is likely that Medical Properties will be able to recover a large portion of its rent, but this rent may be paid in installments, or partially delayed.
Unfortunately, the situation does create a lot of uncertainty for Medical Properties’ financials in the coming two or three quarters. The REIT warned that it would write off its straight-line rent receivables in the amount of $225M which essentially functions as a profit warning. Additionally, a cash-strapped tenant occupying key properties of Medical Properties raises the write-down risk in the coming quarters if Steward’s cash flow profile is not quickly restored. Personally, I expect Steward to be forced into more asset divestitures with proceeds going straight to Medical Properties in the next several quarters.
Priced as a restructuring play
The Steward news put Medical Properties into a tricky situation, from a financial point of view, but also from a sentiment one. Having a leading tenant standing at the brink of a financial cliff is not great news, for obvious reasons. The fact that Medical Properties could lose a tenant responsible for such a large revenue share obviously is concerning and it does raise questions about the dividend. Medical Properties has said that, excluding its Steward contributions, it expects to see a payout ratio in “in the high-70% range.” While the dividend may still be covered by cash flow in the short term, it did become a lot more shaky last week.
In terms of valuation, Medical Properties is now a restructuring play all the way through. The REIT was slated to benefit, I figured, from the Federal Reserve ending its tightening policy which is set to take pressure off of Medical Properties’ interest expenses and balance sheet which includes ~15% variable rate debt. With the Steward news causing an urgent problem for Medical Properties and investors, the question may now be how to value MPW.
If we were to cut Medical Properties’ adjusted FFO by ~25% (to account for a similar-sized share of Steward-related investments), then the REIT has a more realistic AFFO potential of $1.00-1.05 per-share going forward (as opposed to $1.35 per-share on a TTM basis). Shares are trading at $3.45 (pre-market), therefore implying a risk-adjusted annualized adjusted FFO multiplier factor of 3.4X (at the midpoint). The multiplier is this low because of the considerable risk that Medical Properties will not be able to collect all its rents from Steward and, consequently, face additional write-down risks in the quarters ahead.
Risks with Medical Properties Trust
The news from last week clearly had a negative effect on the REIT’s overall risk profile and the risk matrix as such has greatly deteriorated. There are a number of issues with regard to Medical Properties Trust including a potential hit to cash flow/AFFO in the near term, additional impairment charges, which would be non-cash and which would depress the REIT’s earnings and, potentially, another dividend cut may loom as well if Medical Properties fails to contain the situation.
Final thoughts
The risk matrix unfortunately greatly suffered last week when Medical Properties disclosed that Steward suffered from deteriorating vendor terms and a strained liquidity profile. The additional disclosure that Medical Properties has hired restructuring experts to help ensure that its outstanding debt receivables can be collected, is obviously a major warning sign. The ultimate question for investors here is whether Steward will be able to claw its way back and whether Medical Properties Trust will stick to its dividend. If this is not the case, then investors must brace for impact and they will likely suffer a hit to the dividend again. I believe this is not the time yet for complete pessimism and I won't rush into issuing a sell recommendation here. The best way to resolve this is to acknowledge the growing dividend risk and monitor the progress of the MPW-Steward relationship closely going forward!
For further details see:
Medical Properties: Time To Worry About The Dividend (Rating Downgrade)