2023-10-27 15:00:00 ET
Summary
- Medical Properties Trust stock soared over 15% following the release of its Q3 results.
- We take a look at the good and the bad from its Q3 results.
- We also look at the valuation to see if MPW is really as cheap as it seems and if further downside is ahead.
Medical Properties Trust, Inc. ( MPW ) - a REIT that specializes in investing in hospital properties across North America and Europe - recently released its Q3 results. The stock had been tanking in the three months prior to the earnings release, losing over half of its value during that period:
However, results clearly exceeded market expectations, as the stock soared by over 15% following the release of the quarterly report and accompanying conference call with management:
In this article, we will look at the good and the bad from the quarter and see if we think the bottom is finally in for the stock or if it remains too risky for us to dip a toe in.
MPW Stock Q3 Earnings Review
MPW's Q3 update was a mixed bag, with some good and some bad takeaways for the company:
The Good
FFO Guidance Boost: MPW's FFO per share guidance hike to $1.57 at the midpoint, beat analyst consensus estimates and the previous guidance midpoint by $0.02 thanks to Q3 FFO per share beating consensus estimates by $0.02.
Balance Sheet Improvements: MPW continued to make progress towards reducing debt, particularly through its sale of its Australian hospitals in October that brought in over $300 million. These proceeds can be used to reduce debt at an accelerated pace because MPW's bonds are trading at substantial discounts to par value at present.
In fact, after completing its Australian hospital sale at a cap rate of ~5.7%, MPW pointed out that it had also repurchased about £50M ($62M) of its 2.550% unsecured notes due in December 2023 at a repurchase yield averaging almost 13%. Selling assets for proceeds that it can then use to repurchase debt at yields that are more than double the cap rate of the assets they just sold to raise the proceeds at is an extremely positive action for management to take because it reduces risk while also improving MPW's profitability. If management can keep doing this moving forward, they could potentially unlock a lot of value for shareholders while also making significant progress towards deleveraging their balance sheet.
Moreover, management stated that they are focused on improving their liquidity moving forward while also effectively addressing their upcoming debt maturities in an effort to position the business and shareholders for long-term prosperity. Specifically, this will likely involve raising ~$2 billion in liquidity over the next year through a combination of asset and joint venture sales as well as asset-level debt issuance.
Tenant Performance Progress: Another big positive from the earnings release and conference call is that some of the company's tenants are showing promising signs of continued post-pandemic recovery. For example:
- Hospital utilization and cost trends for 2023 show signs of normalization.
- Revenues for MPW's Circle facilities are up by 11% YoY.
- Priory, the largest independent mental health care provider in the UK, leased by MPW, is showing strong financial performance. Moreover, its management, Median, also a tenant of MPW, is performing exceptionally in the German market.
- The Swiss Medical Network is delivering improved year-over-year performance.
- CommonSpirit's new platform, Prime’s excellent financial management, and Ernest Health's new facilities indicate promising growth potential and stability for MPW's portfolio in the U.S.
- LifePoint Health is seeing positive growth trends and putting considerable effort into generating improved cost efficiencies.
- Concerning Prospect and Steward, MPW's two major operators, Prospect has resumed timely rent payments to MPW and management had this to say about Steward:
Their hospital operations continue to perform well as evidenced by strong trailing 12-month EBITDARM coverage of 2.7x. In addition to cutting run rate expenses by nearly $600 million in the last 16 months, more than $150 million in the last quarter alone, in part due to a 90% reduction in contract labor utilization, Steward believes it's making progress on its revenue cycle management and accounts payable backlog...Steward is reporting improved efficiency of collections. Steward expects these improvements will result in an incremental $50 million of cash annually based on current volumes. In the third quarter, Steward was also able to successfully upsize their new ABL by $30 million. Further, it is resuming a noncore asset sale program that Mackenzie recommended prior to the global pandemic, which is expected to provide significant liquidity to Steward's balance sheet.
Between better-than-expected FFO per share, steady progress on the balance sheet with management outlining a plan for significant further improvements moving forward, and some green shoots sprouting among its tenants, there was definitely more than a glimmer of hope in MPW's Q3 report and commentary.
The Bad
That said, it was not all positive, hence why MPW's stock price remains deeply suppressed.
Not Much Progress On Leverage: While its Australian hospital sale, highly accretive note repurchases, and plan outline for the next year were all positive signs, MPW still has a lot of work to do on this front as debt has hardly improved so far year-to-date and has a flurry of debt coming due in the coming years that was originally issued at rates that are far lower than where MPW's debt is trading today.
Specific amounts maturing include $446 million in 2024 at 3.6%, $1.4 billion in 2025 at 2.7%, $2.9 billion in 2026 at 4.2%, and $1.6 billion in 2027 at 5.2%. If current interest rates persist, MPW may need to refinance its debt at significantly higher yields. For example, the bonds maturing in 2029 with a 4.625% coupon were recently trading at a yield of 11.6%.
Moreover, as Julian Lin recently pointed out , MPW faces potential debt covenant risks as they are getting closer to their upper limit on their debt to adjusted total assets ratio, which could prevent them from issuing additional debt if needed to raise the needed liquidity. What this may force them to do is sell assets at less than market value and/or issue shares at deeply depressed levels in order to navigate their upcoming financial obligations. Overall, MPW is going to be facing massive headwinds from rising interest rates and potentially dilutive equity raises unless it can pull off a lot more asset sales like it did with the Australian portfolio. However, the sheer magnitude of the amount of liquidity that MPW will need to raise in the coming quarters means that it is unlikely that they are going to find enough eager buyers who will pay them such attractive cap rates on their properties.
Tenant Challenges Still Linger: Similar to the debt situation, while some positives are taking place, the bottom line is that they still have enormous exposure to tenants that are struggling, even if they are showing some signs of progress. As a result, they have little margin for error on this front, and any meaningful additional tenant distress could significantly jeopardize their balance sheet.
Is MPW A Buy Yet?
With all of that said, is the bottom finally in? Does today's strong rally in the stock mean that the worst is fully priced in and that the risk-reward is asymmetric to the upside?
On the one hand, MPW looks deeply undervalued, trading at just 3.96x NTM AFFO, a 19.7% dividend yield, and just 40% of its consensus NAV. By any metric, MPW clearly is a deep-value opportunity. Additionally, its operators seem to have left the worst behind them - at least to the best we can tell - so MPW is unlikely to suffer any major new hits from the revenue side.
However, its massive leverage in the fact that its EV/EBITDA is not particularly cheap at 11.00x. While this is clearly discounted, it is not that far below its historical average of 12.95x. This hefty leverage means that even small assumptions in the fair value of the company's properties will have an outsized impact on its NAV. As a result, if there is additional distress in the sector and/or if MPW and some of its fellow hospital landlords begin to sell properties en masse to deal with rising interest rates, cap rates may very well increase, pushing MPW's NAV per share down quite significantly.
Moreover, its very lucrative AFFO and dividend yields could wind up being largely a mirage if MPW is unable to effectively tackle its significant upcoming debt maturities because its AFFO will likely rapidly get eaten up by rising interest expense, forcing it to slash its dividend as well.
Investor Takeaway
MPW ultimately comes down to two big risks:
- Will interest rates remain elevated for a prolonged period of time or even continue to rise?
- Will MPW struggle to sell enough assets at attractive enough prices to pay down maturing debt?
There is also the third risk of potential fresh defaults from tenants - especially major tenants like Steward or Prospect - but we think this risk now counts as more of a minor risk rather than a major one.
MPW showed signs of progress towards being able to tap its portfolio for relatively attractively priced liquidity to deal with its nearest-term debt maturities. However, it still has a long way to go. For investors who have confidence that there is enough demand for MPW's properties that it can get a reasonable valuation for billions of dollars worth of them in the coming years and/or who are looking for a way to make a leveraged bet on a rapid decline in interest rates, MPW could be a big winner. The valuation is certainly very cheap here, leaving shares like a coiled spring ready to launch higher.
However, the risks are also huge. If interest rates do not cooperate and/or there is a lack of sufficient demand for MPW's properties such that it has to resort to dilutive equity issuances, shareholders could see significant further downside and - in a worst-case scenario - get left with nothing in a bankruptcy. As a result, we remain neutral on the stock price and will be staying on the sidelines, especially given that there is a plethora of other much lower-risk REITs trading at compelling valuations right now anyway.
For further details see:
Medical Properties Trust Stock: Is This Finally The Bottom?