2023-07-24 15:34:26 ET
Summary
- Companies like Medical Properties Trust, Inc. want to get properties back during times of inflation so they can rewrite the leases with better terms.
- Management already had an inflation component in the leasing contracts.
- Management is paid to adequately deal with unforeseen future challenges before they occur.
- Portfolio turnover is yet another way to deal with inflation.
- Management has long replaced operators successfully the few times that needed to happen.
There has been a lot of talk about the effects of inflation on the model used by the management of Medical Properties Trust, Inc. ( MPW ). But as management recently demonstrated, they already took into account some inflation in the current contracts signed. If the inflation outlook changes, then management is likely to "roll with the punches" and adjust the strategy accordingly.
Shareholders pay managements to think ahead and deal with unforeseen situations ahead of time. This management appears to be doing just that and is likely to do that in the future. Managements rarely "sit there and take it" because that is often the death of the company. Therefore, a far more likely scenario is that management has some flexibility to deal with future industry scenarios as they arrive.
Inflation
Many comments indicate that the MPW company model would not survive inflation. But that would be highly unlikely. It is true that management cannot do the same deals it did in times of low inflation. But if the "price is right," then the deals get done. Otherwise, management will wait for sufficient requirements to be met before executing any more leases.
It should also be noted that most managements, including this one, can sell (or begin to put into the contract to sell) the leases or otherwise rearrange things to give themselves flexibility. What no management ever wants to do is not "leave themselves an out" for things that are likely to happen.
Inflation has been a bugaboo that occurs time and time again. Therefore, it is probably wise to plan on some in any long-term outlook.
Medical Properties Trust Example Of Inflation Strategy When Executing A Lease Transaction (Medical Properties Trust June 2023, Investor Update)
Management has mentioned the above strategy several times in the past. The market has also worried about this at least as many times. Now investors have an example from management as to how it can work. Investors can also depend upon management to have several ways to do this (and, therefore, not be locked into the example above as the only way to handle inflation).
But the financing world often begins to think about refinancing as long as 2 years in advance of refinancing. This gives management time to consider an exit strategy if that is what is required, rather than refinancing at a loss. Therefore, if the contracted strategy does not work, there is often a "Plan B" and more "just in case."
But the other consideration is that there is a natural portfolio turnover going on all the time for various reasons. A rise in inflation may dampen that activity. But markets almost never shut down. Instead, costs vary with the current economic environment. Most managements monitor their business and act in the event of any threatening future event. But sometimes markets act as though that is never the case.
This presents a contrarian investment opportunity because the stock will be priced for the worst possible outcome, while a lot of better outcomes are far more likely.
Portfolio Turnover
Management has long demonstrated that they can get the money invested back. The overpayment argument that makes the rounds really loses credibility very fast from current events.
But there is another duration argument that keeps getting "swept under the rug" in the process.
Medical Properties Trust History Of Recovering Investment Amounts At A Profit (Medical Properties Trust June 2023, Investor Update)
Fiscal year 2020 was likely a one-time event that many industries are recovering from. This management has found creative ways to aid that recovery while making money in the process. As shown above, historically, management has done well for shareholders.
What needs to be emphasized is that those transactions are a significant part of the portfolio. Many potential investors get caught up in the length of the leasing terms and run the other way screaming about inflation risk and other imagined disasters.
But the fact is that the portfolio regularly turns over just from ongoing business transactions. Even though fiscal year 2020 was challenging, investors should note that hospital-type properties like the ones shown above are still being bought and sold. So, the average duration of the holding period is nothing close to the contract terms.
Medical Properties Trust Schedule Of Debt Due (Medical Properties Trust First Quarter 2023, Supplemental Presentation)
Notice that the transactions listed above (which did occur over a few years) managed to equal about 40% of the very roughly debt due shown above. That is a significant amount that is large enough to allow management to reposition itself should the need arise.
Not only do those transactions not imply that management is "locked in." They instead imply quite a bit of financial flexibility because management can lock in higher return transactions as properties are sold should that be necessary.
Even if the market should slow down due to rising interest rates or any other disruption (like another round of covid type challenges), it is clear that buying and selling will continue. This is another way for management to exit unfavorable leasing agreements, should that be the case.
Prices will adjust to rising interest rates. No buyer will be in business long if properties are regularly purchased with negative cash flow. Therefore, any serious seller knows to come into an inflationary market with a price that will sell. Not all sellers can wait for inflation to end and low interest rates to return.
If Disaster Strikes
The other thing to remember about rising interest rates and other industry disruptions is that management can get the properties back should a client fall behind in payments or file for bankruptcy.
Medical Properties Trust History Of Replacing Operators (Medical Properties Trust August 2022, Corporate Presentation)
Management has a darn good history of replacing operators when that needed to happen. Every company I ever followed had a bad debt expense. This one is certainly no exception because "things happen" and you get stuck from time to time. But the above experience should demonstrate that management has shareholders in a good position should "disaster strike" and they have to replace a management.
Fiscal year 2020 was probably the worst for the hospital industry in some time. But the key thought is that such a year is unlikely to repeat. If that is the case (and therefore the industry recovery is likely to continue), then management has investments in the operating companies that should grow in value over time. Contrarian investing works for managements as well.
Summary
The whole thing can be summarized that the market put this stock in the doghouse at a time when the perceived threats passed back in 2020 and 2021. Management probably has more issues to navigate than would normally be the case. But management appears to be navigating those issues just fine.
(Note that the stock price is not that different from when management made this slide. Any adjustments that could be made do not really change the message.)
Medical Properties Trust Comparison Of Key Valuation Measures With History (Medical Properties Trust June 2023, Investor Update Presentation)
The time to worry about a dividend cut is frankly when Mr. Market is pretty sure one will not happen. Because what can happen next is shown above on the graphs. So, the risk of a dividend cut in the future needs to be weighed against all possible outcomes given that the unforeseeable (in this case) can come about. It is a major reason for diversification.
The time to not worry about a dividend cut is probably in the current situation, where the price of the stock is so low as to give an absurd dividend return. Even with the stock price up roughly 15% since this slide was made, the dividend yield is still generous. Any dividend cut is more than likely priced in.
Furthermore, one troubled client, Prospect, closed new f inancing. There is now an agreement for this particular set of properties to either be sold or return to current payment status. As the recovery of the industry proceeds, the unlikely prospect of another pandemic makes this agreement look pretty solid.
As long as the financial rating of Medical Properties Trust stays away from the higher risk debt categories (which are the "C's and the D's"), then there is a good chance that the company will recover from whatever is worrying the market at the current time whether or not there is a dividend cut.
Principal is far more important than the dividend. In this case, the market outlook opinion is so poor, that it is hard to imagine the stock going any lower. This is especially true given that management announced a solution to Prospect, which was changed to a cash basis until a solution was found.
Should Prospect run into trouble a second time, which is unlikely, but there is an elevated risk, then the current inflationary environment should aid in replacing the operating party if that needs to happen. Management has done well replacing operators in the past. There is no reason to expect that to change in the future.
Valuation
Companies like this one that "produce" tend to return to historical valuations over the long run. Given a five-year time span, the chances of that appear pretty good.
Nonetheless, the current price obviously screams elevated risk. Therefore, diversification is probably essential. This stock as part of a well-chosen basket of stocks should outperform the market by a wide margin if it even comes close to its historical valuation. In fact, it could miss that projection by quite a bit and still be a good investment.
The current dividend alone is about twice the percentage return that investors report long-term. So, risk averse investors may want to pass on this stock. On the other hand, those that do not mind a contrarian idea and all the negativity surrounding this stock could easily triple their investment at a lower risk than the market perceives.
Contrary to market perceptions, low price stocks where a lot of negative outcomes are priced in, are less risky than stocks with optimistic projections as far as one can imagine into the future. But some darn good due diligence is needed here first.
For further details see:
Medical Properties Trust: Management Likely To Continue Forward-Thinking