2023-07-20 14:00:05 ET
Summary
- Medical Properties Trust has faced allegations of unethical business conduct and weaker-than-expected Q1 earnings, leading to a significant REIT stock selloff.
- MPW, a self-advised REIT, has seen strong long-term financial performance with over 20% revenue CAGR. However, the company's latest earnings release missed consensus estimates, and it lowered its top-end FY2023 guidance.
- My valuation analysis shows a massive upside potential, and the forward dividend yield of 11% is very attractive. That said, the stock is solid high-risk high-reward opportunity.
Investment thesis
In recent months, there has been a lot of controversy around the Medical Properties Trust ( MPW )related to allegations related to the management's unethical business conduct. The weaker-than-expected Q1 earnings also fueled a massive year-to-date REIT stock selloff. Risks are substantial, especially if allegations regarding potential fraud turn out to be true. But the stock offers a high forward dividend yield above 11%, and the upside potential is close to 60% in my base-case valuation analysis scenario. I suggest potential investors seeking a decent high-risk and high-reward play Buy this REIT stock.
Company information
Medical Properties Trust is a self-advised REIT founded in 2003. The company aims to acquire and develop net-leased healthcare facilities. According to the latest 10-K report, as of the latest fiscal year-end, MPW had investments in 444 facilities and approximately 44,000 licensed beds in 31 U.S. states, seven countries in Europe, across Australia, and Colombia in South America.
The company's fiscal year ends on December 31. Rent billed revenue represented about 63% of the total in FY 2022.
Financials
The company's financial performance over the long term was strong, with above 20% revenue CAGR. The operating margin within the 60-70% range has been stable over the decade. The free cash flow [FCF] margin has been volatile due to the nature of the business of unstable cash acquisitions and sales of properties. The FCF margin, in general, was positive at double digits. In FY2022, the FCF margin outnumbered the top line due to extraordinary items related to real estate sales.
MPW has consistently paid dividends to investors, and the current payout ratio is close to 75%. The past five year's dividend growth rate was decent at a 3.4% CAGR. The current yield looks attractive at 11.8%, substantially higher than the 4-year average dividend yield.
The latest earnings release was on April 27, with the company missing consensus estimates. Both the top line and the FFO delivered negative surprises. Due to the harsh environment, revenue demonstrated a 13% YoY decline. The quarterly operating margin was at 63%, notably softer than a 67% last year.
During the earnings call , several bullish trends were mentioned by the management. For instance, admissions and surgical volumes steadily increased YoY over the last few months. The next positive moment is the improvement of demand in international markets. Spanish market demonstrated particular strength in terms of admissions and surgical volumes. The management also announced new projects like acquiring behavioral hospitals and rehabilitation hospitals in Germany and the partnership with Intermountain Health. The partnership will provide both of the company's Idaho Falls Community Hospital and Mountain View Hospital with additional access to highly trained specialists and vast resources as a result of collaborating with one of the region's largest and most successful health systems. I am optimistic about the management's initiatives to improve the reach and coverage of its business.
The company lowered its top-end FY2023 guidance. As a prior outlook, the normalized FO per share range was $1.50-$1.65, and after the downgrade, it became $1.50-$1.61.
The balance sheet is highly financially leveraged. The company has a substantial net debt position, with an above 100% debt-to-equity ratio. The covered ratio looks not-so-high at 2.72. On the other hand, the company historically has been in a substantial net debt position, and it was never a big problem to sustain long-term margins expansion and increase dividend payouts.
Valuation
MPW demonstrated a 13.7% decline in price year-to-date, significantly weaker than the broad market's performance. Seeking Alpha Quant assigned MPW the highest possible "A+" valuation grade due to valuation multiples which are mostly significantly lower than the sector median levels.
I will use discounted dividend model [DDM] to proceed with my valuation analysis. Valueinvesting.io suggests that MPW's WACC is close to 11%, which I consider fair. Consensus dividend estimates expect the FY2024 dividend at $1.16. MPW's ten-year dividend growth rate was 3.79%. I will use this growth rate for my base-case scenario.
Author's calculations
The REIT looks undervalued with a 62% upside potential under the base case scenario. Due to the current headwinds in the macro environment, dividend growth might decelerate from long-term historical averages, so I would like to simulate a more conservative scenario with a 2% dividend growth.
Author's calculations
As you can see, there is still about 30% upside potential, even under the very conservative dividend growth assumptions. The upside potential looks very attractive.
On June 6, MPW released June Investor Update , which emphasized the huge disconnect between the valuation and underlying fundamentals. I will cover the REIT's valuation in the section below, but I would like to emphasize that the management reiterated its commitment to long-term strategic priorities in the presentation. A separate special slide in the presentation was devoted to the negative narrative surrounding the stock:
MPT REMAINS FOCUSED ON EXECUTING ITS PROVEN STRATEGY DESPITE REPEATED FALSE AND MISLEADING CLAIMS PERPETUATED PRIMARILY BY SHORT-SELLERS
When there is a "noise" in the environment, I prefer to check the track record of the company's success. Since its inception, the REIT consistently increased dividends YoY. The years of the Global Financial Crisis [GFC] were the only two years when there were dividend cuts. Also, in the aftermath of the GFC, the company struggled to increase dividends. But, since then, even during the COVID recession, there have been increases in dividend payouts.
Risks to consider
The massive upside potential and an 11% dividend yield are impossible without risks, which are also very high.
The most significant risk is the investigation claims conducted on behalf of shareholders regarding the possible misconduct by the company's management. Allegations include potential fraud, negligence, or other unlawful business practices by Medical Properties Trust. These legal actions might have massively adverse consequences for investors. Potential legal liabilities are highly likely to impact MPW's reputation severely.
The real estate industry is facing significant headwinds in the current harsh environment, which is why the company demonstrated a YoY decline in revenue in the last three consecutive quarters. Profitability metrics are also under pressure. Given such a challenging environment, there is always a risk that the company might fail to deliver above-the-consensus financial performance in the upcoming quarter. This might lead to a new wave of sell-offs. On the other hand, since I consider the dividend safe, the decline in the REIT stock's price will lead to growth in the dividend yield, and investors might have an excellent opportunity to increase the exposure. Therefore, I would suggest to dollar-average and look at how the two mentioned above risks will unfold. This approach would help to be on the safe side.
Bottom line
To conclude, MPW is a "Buy". Risks related to unethical business conduct allegations are very high, but so is the potential reward. Not many instruments offer an 11% fixed income and a 62% upside potential. Headwinds are also apparent in the harsh environment but are temporary and not secular. I think that MPW is a good choice for investors seeking high-yielding investment opportunities among REIT stocks.
For further details see:
Medical Properties Trust: A Decent High-Risk High-Reward Play