2023-08-09 15:27:14 ET
Summary
- Medical Properties Trust reported a Q2 net loss of -$0.07 per diluted share, down from a net income of $0.32 in the prior year.
- Adjusted funds from operations increased from $0.35 to $0.41 per diluted share, indicating that dividends are likely to be covered in the near term.
- Tenant concentration and debt refinancing at higher rates remain significant risks, but the stock is undervalued according to price multiples.
- We maintain our "buy" rating on MPW stock.
Medical Properties Trust, Inc. (MPW) is a self-advised real estate investment trust, or REIT, formed in 2003 to acquire and develop net-leased hospital facilities.
We initiated coverage on the firm in November 2022 with a "Buy" rating. In March 2023, we published a second article on the firm, reiterating our bullish view.
In this period, however, the firm has not been performing particularly well. Since November, the share price has declined by as much as 26%, while the broader market has gained about 14% in the same period. The performance has been somewhat better since our March writing, but due to the latest steep decline, the stock again underperformed the broader market in this period.
In both of these articles, our bullish thesis has been revolving around the firm's perceived undervaluation based on a scenario analysis and various dividend discount models. Our range of fair value estimates has been $6.7 to $9.9 per share, based on different dividend assumptions.
In today's article, we will be concentrating on the firm's latest quarterly earnings and the main developments concerning the risks related to tenants that have been consistently driving the share price down in the recent quarters.
Medical Properties Trust Q2 earnings results
The first thing that may have gotten the attention of current and prospective MPW investors after the earnings release is that the net income attributable to common shareholders has turned negative. On a diluted share basis it was -$0.07, compared to a net income of $0.32 in the prior year.
While we definitely cannot claim that these results or changes are attractive, we have to understand, what factors have been driving this decline, and how it may impact the firm's ability to keep paying dividends in the coming quarters. After all, dividend payments are what we have based our valuation on.
1.) When looking at the table above, we can see that the depreciation and amortization line item has almost quadrupled compared to the prior year. This development is related to Steward's early termination of five Utah hospital leases:
"Included in 2023 second quarter net loss is the previously disclosed roughly $286 million in accelerated lease intangible amortization related to the early termination of Steward’s leases of five Utah hospitals now leased to CommonSpirit and a related $95 million straight-line rent write-off, [...]"
2.) On the other hand, a more favorable tax outlook, which is related to establishing a REIT in the United Kingdom has partially offset the above mentioned items.
"[...] partially offset by a roughly $160 million tax benefit related to the Company’s establishment of a U.K. REIT, [...]"
What we have to acknowledge here is that both of these items are one-off items, which are not likely to be recurring or negatively impacting the financial performance in the coming quarters. Further, these charges are all non-cash charges, which need to be added back to the net income to get the AFFO figure. And for us, as dividend investors, the AFFO plays a more crucial role now. Adjusted funds from operations in normally calculated by the following formula: AFFO = FFO + rent increases - capital expenditures - routine maintenance amounts, and it is generally the preferred metrics to assess a firm's dividend paying abilities.
If we compare the firm's financial performance to the prior year in terms of AFFO, we can see that there has actually been an increase from $0.35 to $0.41, which is quite substantial. Currently, MPW is paying a quarterly dividend of $0.29, which is well covered by the current AFFO. For this reason, we believe that looking forward MPW is not likely to completely cut its dividends in the coming quarters, which makes us still bullish on the firm from a dividend investment standpoint.
Before moving on to our next topic, it is important to look at the revenue also by operator. In our previous article, we have highlighted tenant concentration as one of the primary risks. This risks still remains relevant. While MPW is trying to diversify its tenants, Steward, Circle, Priory and Prospect still make up about 53% of the total revenue. This can get especially concerning when two of the largest tenants have been just seeking debt refinancing. Still, the concentration is much higher than we ideally would like to see and we are looking forward to MPW addressing this risk more actively.
Debt
Another important element when analyzing MPW's business is debt. Debt makes up a significant portion of the company's capital structure and, therefore, can have substantial impact on the financial performance of the firm. The following table shows MPW's debt maturities in the coming years.
So, why is it important? Well, as debts mature, MPW can decide if they want to refinance it or not. If they decide to refinance it, it is very important at what interest rate they can do so. Most of their current debts are fixed rate and have been issued during a relatively low interest rate period. Now, however, interest rates have skyrocketed, due to the Fed's actions of combating elevated inflation rates.
In 2023 and 2024, about 9% of the total outstanding debt matures. In 2025 and 2026 this figure is significantly higher, as much as 32%. As of now, the interest coverage metrics of the firm look healthy, but looking forward, we believe that the debts expiring in 2023 and 2024 are likely to be refinanced at higher rates as we do not expect the interest rates do be lowered in the near term. This in turn may have negative impacts on the financial performance of the firm in the coming quarters. The refinancing costs of the debts expiring in 2025 and 2026 are somewhat more uncertain. Interest rates may be lowered by then, which would be definitely a positive development for MPW, but the rates are still not likely to come close to zero again, which means financing costs are likely to be higher than they are now. Investors need to keep this in mind, when making an investment decision about buying or selling MPW's stock.
MPW stock valuation
In our previous writings , we have valued MPW based on its dividends. Today, we have decided to take a different approach and look at a set of traditional price multiples.
The following table shows the valuations of firm in the healthcare REIT industry. According to many metrics, including price to free cash flow, price to book and EV to EBITDA, MPW appears to be one of the cheapest REITs in the industry.
Further, if we look at the real estate sector as a whole, and focus on REIT specific price multiples like the P/FFO and P/AFFO, we can see that MPW's stock is selling at a 50% - 60% discount compared to the sector median.
While we appreciate the risks associated with MPW, based on these multiples we still believe that MPW's stock is undervalued.
To sum up
In Q2, MPW has reported a net loss of -$0.07 per diluted share, down from the net income of $0.32 in the prior year. The main drivers of the net income change have been the amortization related to the early termination of Steward’s leases of five Utah hospitals and the more favourable tax outlook, which is related to establishing a REIT in the United Kingdom. At the same time, adjusted funds from operations have increased from $0.35 per diluted share to $0.41, which indicates that dividends are likely to be covered in the near term.
Tenant concentration remains high, which still represents a significant risk, just as discussed in our previous writings.
Debts maturing in the near term are likely need to be refinanced at a much higher rate, due to the elevated interest rates. This is likely to negative impact the firm's (and potentially its tenant's) financial performance in the coming quarters/years.
Medical Properties Trust, Inc. remains attractive from a valuation point of view. A set of price multiples are indicating a significant discount.
For these reasons and as our bullish thesis is based primarily on dividends, we maintain our "buy" rating.
For further details see:
Medical Properties Trust Stock: Maintaining Our Buy Rating After Q2 Earnings