2023-08-10 08:00:00 ET
Summary
- MPW reported pretty decent Q2 results and some financial progress at its main troubled tenant.
- However, the stock price still tumbled following the earnings call.
- I examine why the dividend is all but certain to be slashed by management in the near future.
Medical Properties Trust ( MPW ) recently reported Q2 results. The results themselves were not bad, yet the stock plummeted after the earnings call:
In this article, we will share why we think it is a near certainty that the dividend will be slashed in the near future, which explains the dramatic decline in the stock price since MPW's earnings call.
MPW Stock Q2 Results Recap
First, a recap of the headline results. In Q2, MPW generated a normalized FFO of $0.48 per share, surpassing the consensus estimate of $0.37 and up from both the previous quarter's $0.37 and the same quarter last year's $0.46 numbers. That said, the current quarter's figure included $0.11 per share in non-cash FFO, which came from received equity instead of cash for previously unrecorded owed rent and interest revenue from Prospect Medical Holdings. Given the shaky nature of the entity, the long-term value of this equity is highly speculative and may end up being far less than indicated. In that sense, the true cash FFO per share for that quarter was actually in-line with both the consensus estimate and last quarter's numbers and was down sharply on a year-over-year basis.
The company also narrowed the range of its full-year FFO per share guidance, while the midpoint remained relatively unchanged and was in line with consensus estimates.
On top of the decent FFO per share numbers, management also touted the ongoing strength of their U.K. and broader European hospital portfolio and also highlighted some financial improvement at some of their largest - yet struggling - tenants in the U.S.
One major example of this is that Steward refinanced its asset-backed credit facility earlier than planned with a fairly lengthy four-year term and delivers a substantial amount of badly needed liquidity to Steward to help keep its business afloat as it continues to strive to navigate the challenging environment. MPW also stressed the fact that Steward is maintaining solid operational performance, with an EBITDARM coverage of 2.9 times and volume growth that is expected to continue to improve through 2024.
The company also had some positive things to say about another one of its major troubled tenants - Prospect Health - though it is currently grappling with a ransomware attack.
However, that is where the good news ended for MPW stock, as much of the rest of the earnings call pointed to a masked, yet unmistakably inevitable impending dividend cut.
Here Comes The Dividend Cut
MPW management has defiantly stuck by their dividend despite numerous warning signs flashing.
In late 2022, when shorts were already signaling major trouble ahead for the company, MPW doubled down on the company's strength by initiating a large stock buyback authorization.
However, the first hint of trouble for the dividend appeared on the Q4 2022 earnings call, where an analyst asked :
I think a lot of us are trying to back into dividend coverage. And I'm guessing that if we took a step from 2022 to 2023, the difference in AFFO is less than the difference in FFO.
Management replied with:
Yes. So, if you take that worst-case scenario again at $1.50, and you make necessary adjustments for AFFO, we're at about $1.29.
Then on the Q1 earnings call , the questions began to be more direct. That said, management insisted that its dividend was on stable footing, stating in its prepared remarks:
our Board has declared a quarterly dividend unchanged at $0.29 per share and will be paid on July 13 to stockholders of record on June 15. After a virtually unchanged business model since we started the company almost 20 years ago, I thought I would make a few comments that are relevant to analysis of that model sustainability.
And even leaving the prospect of a stock buyback on the table in the Q&A session. Moreover, when asked directly about the dividend by an analyst:
You've made it clear [the dividend is] covered, but nonetheless, the market seems to be giving very little credit to it today, yielding north of 14%. So has the cut also been considered by the Board? And wouldn't that perhaps be another good capital allocation decision and use those potential retained funds to shore up the balance sheet even faster and pay down debt?
Management responded with:
Yes. Well, we're very satisfied. As you can tell, we made an announcement that we declared the dividend this morning. We're satisfied with where we are on the foreseeable future. But all of those are levers that any company has to pull, whether it's dividend or property sales or share repurchases or debt tenders. Thankfully, we're in a very, very strong position, liquidity wise, the value of our assets, the growth in the NOI of our assets... we will have all of the maturities coming due through '24, taken care of in short order. And then we feel very comfortable about where the remaining maturities are and where they're laddered. And we're obviously not going to make any knee-jerk reactions. We've got good cash flow that well covers the dividend on a growing basis. And so again, just not going to make knee-jerk reactions.
However, on the Q2 earnings call, management seemed to be finally waving the white flag on the dividend.
First and foremost, they communicated a much greater sense of urgency toward deleveraging the balance sheet, stating:
Our primary focus continues to be on use of capital for debt reduction.
While management tried to point to major asset sales as a primary means of handling those maturities, they also had to admit that they may not get quite the cap rates on those properties as they have in the recent past, which could mean that these asset sales may end up meaningfully reducing previously held notions about the NAV of the company and certainly its FFO per share numbers. This alone could be enough to force them to reduce their dividend.
Moreover, later on in the Q&A session, an analyst asked:
sticking with the updated guidance from this morning and the midpoint of kind of the third quarter and fourth quarter FFO implied by the updated guidance is about $0.35 and then if you take out the non-cash income, you'd get to just call it, $0.28 or so of FFO, which would be below the quarterly dividend , but I know that's expected to improve in the next year. And I asked about sustainability of that dividend last quarter and you said you were comfortable with it, but the market today is still giving you little credit with the stock yielding 13% and leverage is up from last quarter to nearly 7 times. So I just have to ask again, has the Board seriously considered a cut to retain more funds to more quickly improve the balance sheet and pay down debt?
This time, management's tone took a markedly different tone from Q1 and suddenly seemed to be backtracking their previous assertions of confidence in the dividend, stating:
So, look, I would just reiterate what both, Ed and I have already said, and that is we're not satisfied with our cost of capital as implied by the share price. We're not getting the credit that we think we should.
And so going all the way back to, I think, our fourth quarter call back in February, I think, we actually said everything is on the table and that's at the Board level. And then, again, just a few minutes ago, I said the Board is constantly evaluating, considering that. And we've talked already on this call about liquidity opportunities and I'll just repeat it, if everything is on the table.
What does this mean? It means that management has finally woken up to the realization that:
- Its debt is a huge problem.
- Its dividend is oversized relative to the cash flow being generated by the business during this challenging period.
- Asset sales will likely have to be made at a price point that will also require a dividend cut to properly navigate the debt maturities.
Investor Takeaway
MPW's operational performance was not bad at all during Q2, and its main problem tenants seem to be limping along. There does appear to be a light at the end of the tunnel for MPW's tenant issues, however, the path to get there remains quite long.
Moreover, MPW is running out of runway as they rapidly approach their wall of upcoming debt maturities while interest rates remain incredibly high. This means that they are going to have to start making some hard choices concerning asset sales and cutting the dividend. As we stated in an article earlier this year:
MPW is highly leveraged and its financial standing is far from secure given its junk (BB from S&P) credit rating. According to TIKR.com , its net debt to EBITDA ratio is 7.25x and its FFO interest coverage ratio is only 2.06x. While we are far from predicting bankruptcy for MPW, our point is simply that any further meaningful tenant issues (which we think has a high probability of occurring, especially in a recession) will have a substantial impact on its FFO per share given how much debt is on the balance sheet. This means that the dividend is far from safe and a cut is actually quite likely in our view.
What specifics will MPW follow? It is hard to know for sure and likely largely depends on where interest rates go in the near future as well as cap rates in the hospital industry. MPW maintains that there is still plenty of investor interest in its assets, including in joint ventures. However, to get decent cap rates, MPW will likely have to sell off at least stakes if not entire properties from its very best assets. This could leave the intrinsic value of the company permanently impaired and regardless will meaningfully hurt FFO per share that is already struggling to cover the dividend.
As a result, we are convinced that MPW will have to cut the dividend at least a little bit, regardless of which course it chooses to take with asset sales. Moreover, we think management will likely choose to rip off the band-aid and slash the dividend pretty aggressively in order to take off the pressure of having to sell a lot of assets at fairly generous cap rates. Moreover, such a move would also remove pressure and maximize financial flexibility should some of its main operators also prove to have worse struggles than management is letting on at the moment.
One of the biggest warning signs of this was the fact that management - despite its stated focus on paying down debt and willingness to consider cutting the dividend and sell of prized assets to do so - still chose to invest up to $140 million in Stewart's new asset-backed loan. Yes, management raved about the terms of the deal, but if it were truly focused on serving its shareholders and cared at all about preserving its dividend - and if Steward was on as firm of footing as management claims - it would not have needed to invest in the ABL and instead would have allocated all of its available capital to deleveraging and supporting the dividend.
Given these factors, I remain on the sidelines of MPW and will wait to see how bad the dividend cut is and how the stock price responds before considering opening a position in the stock.
For further details see:
Medical Properties Trust: Here Comes The Dividend Cut (Rating Downgrade)