2023-10-11 05:13:28 ET
Summary
- In my opinion, Medical Properties Trust is facing significant financial difficulties and a potential restructuring is likely.
- The company has a large amount of debt maturing in the coming years, which may need to be refinanced at high yields - most nearly taking out AFFO.
- MPW's potential debt covenant issues may further limit its financial flexibility.
- I am downgrading the stock to "Strong Sell."
Medical Properties Trust ( MPW ) is an example of just how bad things can go wrong for a net lease REIT when things go wrong. At this point, investors should no longer be focused on valuation given the elevated risk of financial insolvency. The rising interest rate environment is likely to pressure MPW's growth rates when refinancing debt maturities, but more importantly, may pressure the health of its tenants. I discuss a potentially concerning debt covenant which may help to further explain the extreme bearishness seen across the common stock, bonds, and options pricing. Investors should not focus solely on the potential upside because the possibility of vicious downside looks quite significant. I am downgrading my rating of the stock to "strong sell" as I view a restructuring to be the most likely outcome.
MPW Stock Price
While all net lease REITs have been pressured by high interest rates, MPW has fallen like it's an office REIT.
I last covered MPW in October of 2022 where I rated the stock a buy on account of the 11% yield. I obviously greatly regret this and my other buy recommendations on the stock. Net lease REITs offer the potential of solid dividend income, but tenant health (and high leverage) is the main harbinger of bad news. In August of this year, MPW finally bit the bullet and cut its dividend to just $0.60 per share annualized. The stock is once again trading at an 11% yield based on the new dividend amount, but I am now of the view that the problems here go far beyond just the potential of another dividend cut.
MPW Stock Key Metrics
There are many other articles on MPW that thoroughly cover the company. In this report, I will focus primarily on the reasons for my sales and ratings downgrade. First, MPW has a large amount of debt maturing over the coming years. $446 million is maturing in 2024 at 3.6% average interest rate, $1.4 billion in 2025 at a 2.7% average interest rate, $2.9 billion in 2026 at a 4.2% average interest rate, and $1.6 billion in 2027 at a 5.2% average interest rate.
MPW will likely have to refinance these debt maturities at double-digit yields if interest rates remain this high. Just as one example, the 4.625% coupon bonds maturing in August 2029 are yielding 11.6% as of recent trading. At a 11.6% refinanced yield, MPW would see a drag of $35 million, $124.6 million, $214.6 million, and $102 million in 2024, 2025, 2026, and 2027, respectively.
MPW is expected to earn around $1.57 in FFO per share for the full year, implying around $1.10 in AFFO per share after accounting for straight-line rents. That implies around $658 million in full-year AFFO. We have just calculated $476 million in drag from refinancing debt through 2027 alone. Given that MPW has cut its dividend, can it use retained cash flow to pay down debt instead? After deducting around $360 million in projected dividend payments, we arrive at approximately $298 million in retained cash after the dividend - and I note that the actual number may be less given that MPW accepted equity in lieu of cash from tenant PHP holdings (which totaled $68 million in the second quarter). We can see that "interest and rent receivables" have been increasing in recent years (it stood at $62 million year to date).
That $298 million in retained cash flow is arguably not enough given the drag outlined above and in itself is a clear signal that MPW is likely to cut its dividend sometime next year in anticipation of its 2025 maturities. Some readers may be wondering why MPW is seeing so much refinancing risk - shouldn't other REITs see similar struggles? Absolutely, but MPW has a far higher leverage ratio than most REITs as well as a high concentration of maturing debt within a short period of time.
There's more, though. If the prospect of dwindling cash flows due to refinancing debt isn't hard enough, investors should also keep a close watch on potential debt covenant risk. As of the latest quarter, financial leverage stood at 50.3%.
As stated in one of the debt prospectuses (all the prospectuses that I checked had similar language), MPW is restricted from issuing debt if it would lead to financial leverage being "greater than 60% of consolidated Adjusted Total Assets of the Issuers and the Restricted Subsidiaries." With financial leverage already close to that 60% number, this means that in the event of any asset value write-downs, MPW may suddenly find its financial flexibility severely limited as it would be unable to increase its leverage ratio (meaning, for example, that stock dilution at lows may be on the drawing board).
Is MPW Stock A Buy, Sell, or Hold?
At first glance, MPW looks deeply undervalued at around 3.5x FFO. Even after deducting straight-line rent, the stock trades at around 5x AFFO, still a notable discount to peers. Investors looking to buy "deep value" stocks should look beyond sticker valuations. For instance, the put options of MPW are pricing in extreme downside - the $1 strike put options expiring in January 2025 are selling for around $0.14 each. Short interest stands at above 20%. Wall Street is clearly expecting a big downside ahead and appears to have labeled this stock as an obvious short.
We also mustn't forget the high debt load. As of the latest quarter, there was $9.5 billion of net debt for an enterprise value of around $12.5 billion. Placed against $1.4 billion of adjusted EBITDA, that implies an EV to EBITDA multiple of 9x, but after accounting for straight-line rent, that number jumps to 11x. Suddenly the stock does not look so cheap against peers like Spirit Realty ( SRC ), which trades at 13x and is not financially distressed. Enterprise Products Partners ( EPD ), a consistent distribution payer in the pipeline sector, trades at 10x EBITDA. While we're on the topic of peer comparables, my top pick in the REIT sector NewLake Capital ( NLCP ) trades at under 8x AFFO with a net cash balance sheet position (and a 12% dividend yield). My point is: MPW is still not that cheap here.
If we exclude equity value, the debt of MPW is worth around 8.6x EBITDA. That is not quite egregious but in this higher interest rate environment, an 11% liquidation yield is not "that crazy," and would imply zero residual value for equity holders.
What might be the downside catalyst (besides the refinancing of debt maturities outlined above)? MPW has high tenant concentration with around 20% of its revenues coming from Steward Healthcare and 20% coming from Prospect Medical Holdings.
We do not have the latest audited financials for Steward Health Care, but as of 2020 , the company had slim profit margins and a highly leveraged balance sheet. It stands within reason to expect that the company (and many of the other tenants) may also face issues with refinancing debt maturities, and I am doubtful that MPW will be able to offer the same cash support to its tenants as it did in the past given its own tight financial position. I am less pessimistic about the outlook for the tenants given the recession-resistant nature of medical expenses, but the main point here is that MPW is already facing issues from its own balance sheet - any further issues from its tenants may pressure its covenants and its ability to issue more leverage.
The stock is cheap and can work out if interest rates suddenly plummet and MPW is able to reduce leverage through equity sales. But outside of that moonshot scenario, my mathematical analysis indicates that both the dividend and cash flows are likely to come under extreme pressure in just a handful of years. I am downgrading the stock to "strong sell" as Wall Street appears to have been right on this stock all along, and remains right today. The stock looks cheap on a dividend yield and FFO basis, but this is a debt problem with potentially dire consequences for equity holders.
For further details see:
Medical Properties Trust: Why I Am Selling At The Lows And Downgrading To 'Strong Sell'