Chinnapong/iStock via Getty Images
Chinnapong/iStock via Getty Images
If you were invested in Medical Properties Trust (NYSE:MPW) toward the end of 2021, when the stock was selling for a little over $24 per share and then look at its recent price level of under $12 per share, you are probably thinking the stock should have had a warning label such as “Owning this stock can be detrimental to your financial health.” If you wanted to lose 50% or more of your investment, you could have invested in MEME stocks, various SPACs, cryptocurrencies, and the ARK funds – and at least you would have been considered visionary and maybe even interviewed on CNBC as a disruptor. And today, if you still own the stock or bought it at one of its declining price points this year, you are probably asking yourself what happened and, more importantly, what happens next.
Well, the answer to both of those questions is not a simple one – though it is not as hard as answering how many analysts can dance on the head of a pin. There has been a confluence of macro factors and factors idiosyncratic to MPW that have come into play. The macro factors have, in general, caused health care REITs to drop 27% YTD and 17% in the last quarter – notice I am not inserting decimal points because as the old joke about economists goes, “a decimal point would only mean I have a sense of humor.” So, what we are talking about here that is unique to MPW is a little less than half of its fall from the 52 week high.
With some effort and a little guesswork, we can reach a reasoned hypothesis of what MPW’s future might be. As a part of that process, it is important to examine at least six areas in some detail.
– The health of MPW’s hospital tenant operators and MPW’s overall portfolio composition
– MPW’s debt posture and capital structure
– MPW’s foreign currency exposure
– MPW’s near-, mid-, and long-term growth potential
– MPW’s liquidity and dividend safety
– MPW’s valuation
The catalysts for MPW’s initial decline appear to be in large part some significant negative press about its operators and MPW’s response to their problems. There was a negative article in the Wall Street Journal, Hedgeye picked MPW as a new short idea, and Jefferies downgraded MPW to a hold. And positive or negative sentiment or momentum engendered by the media, regardless of the underlying fundamental justifications, can be a significant factor in determining the movement of stock price. At some point momentum, much like embedded inflation expectations, takes on a life of its own.
In the case of MPW, the key reasons cited for panning the REIT were previous bad deals, MPW’s investment in their tenants – with the implication that they were disguising problems with rent cover coverage, management exorbitant expenses with three corporate jets, the unusually large gap between FFO and AFFO, and insider selling of shares. The short sellers piled in and as of Sep 15, 2022 there is still 13% short percent of float. Of course, those who held MPW short had no interest in promoting or even hearing a different narrative.
And indeed, there were some valid points made as hospitals were ground zero for the pandemic. The costs of treating Covid patients, the difficulties in staffing a hospital, and the deferral of more profitable elective surgeries were significant headwinds, though not quantified adequately in criticisms of MPW. And while, MPW has diversified facility types over time, it still generates about 77% of its revenues from general acute care hospitals. The critics also pointed out high operator concentrations with three operators individually counting for more than 10% of its revenues: Steward, Circle, and Prospect. Again, this was a valid observation, especially since Steward accounted for around 24% of its assets and 28% of its revenues as represented in the Q2 2022 10Q (the numbers for Steward are a little higher than I have seen quoted other places).
The counter arguments to the negative press have come from both MPW and a number of analysts. A sizeable portion of the Q2 conference call was spent in explaining why rent coverage was adequate. Other points made include the notion that hospitals provide essential services to a community and are frequently the largest employer. They are, therefore, not considered expendable. And while operators occasionally fail, MPW has been successful at rapidly re-leasing or selling hospitals to competent operators over its history at a profit. Facts and figures were provided.
MPW’s basic thesis is that it invests in real estate, with a facility centric underwriting approach. Its financial well-being is not dependent on the consolidated financial performance of its tenants, which frequently have other financial interests. MPW also contends its master lease structure facilitates a rapid transition to more competent operators when needed. MPW also demonstrated that its investments in operators is not at an unusually high level, representing about 7% of its total pro forma gross assets, modestly above its 6% average since IPO. It believes that these investments give it important insights into its tenants it would not otherwise have. Further, MPW believes that it is very well protected should an operator asset be sold as, with few exceptions, cash consideration for any loans or sums due would be paid to MPW immediately out of proceeds.
MPW acknowledged obliquely previous issues at Steward but gave some supporting data, provided by Steward, showing that Steward operations ramped up to a strong run rate during Q2 2022 with a significant increase in volume metrics and a significant decrease in contract labor costs. The bottom-line conclusion MPW reached is that Steward should provide a substantial and sustainable free cash flow run rate beginning in Q4 2022. Whether significant progress has been made will most likely be the focus of Q3 reporting and likely be a major determinant as to the future direction of MPW stock price. A short seller would opine that MPW “doth protest too much”, but what other option did it have.
With the dramatic increase in inflation and the significant increase in interest rates, understanding the debt structure of a company is more critical than ever. In the macro economy, the Fed unwinding a nine trillion-dollar balance sheet, roughly equivalent to 40% of annual GDP, is likely to engender more longer-term pain the Fed Summary of Economic Projections envisions. Analyzing MPW’s debt and capital structure is a relatively transparent exercise. One need only look at its 10-Q from Q2 2022. Figuring how it intersects with the macro events unfolding is not nearly so easy. And the international investments of MPW add even more complexity to the equation.
The following is a summary of debt (dollar amounts in thousands):
As of June 30,
As of December 31,
2022
2021
Revolving credit facility (A)
$
920,245
$
730,000
Interim credit facility
–
869,606
Term loan
200,000
200,000
British pound sterling term loan(B)
852,460
947,240
Australian term loan facility(B)
828,360
871,560
2.550%
Senior Unsecured Notes due 2023(B)
487,120
541,280
3.325%
Senior Unsecured Notes due 2025(B)
524,200
568,500
0.993%
Senior Unsecured Notes due 2026(B)
524,200
568,500
2.500%
Senior Unsecured Notes due 2026(B)
608,900
676,600
5.250%
Senior Unsecured Notes due 2026
500,000
500,000
5.000%
Senior Unsecured Notes due 2027
1,400,000
1,400,000
3.692%
Senior Unsecured Notes due 2028(B)
730,680
811,920
4.625%
Senior Unsecured Notes due 2029
900,000
900,000
3.375%
Senior Unsecured Notes due 2030(B)
426,230
473,620
3.500%
Senior Unsecured Notes due 2031
1,300,000
1,300,000
$
10,202,395
$
11,358,826
Debt issue costs and discount, net
(63,621)
(76,056)
$
10,138,774
$
11,282,770
There are three items worth noting here. The first and most important is the significant debt reduction since the end of 2021. MPW used the $1.3B in cash proceeds from the creation of a partnership with Macquarie Asset Management (MPW sold 50% of its interests) to repay debt. There was a 47% gain on sale. It is hard to find a flaw in this profitable transaction, since one of the criticisms of MPW had been its level of debt. The pay-off of debt shows up as a substantial negative in financing activities cash flow but, especially in this environment, should be viewed as a positive.
The second takeaway is that the near-term maturities are not the major portion of the debt and that the debt is dominantly fixed rate. And longer-term fixed rate low interest rate debt is a good place to be in and inflationary world.
At June 30, 2022, outstanding debt totaled $10.1 billion, which consisted of fixed-rate debt of approximately $9.0 billion (after considering interest rate swaps in-place) and variable rate debt of $1.1 billion.
As of June 30, 2022, principal payments due on debt (which exclude the effects of any discounts, premiums, or debt issue costs recorded) are as follows (amounts in thousands):
2022
$
–
2023
487,120
2024
828,360
2025
1,376,660
2026
2,553,345
Thereafter
4,956,910
Total
$
10,202,395
This debt profile gives both the interest rate environment some time to stabilize and an extended period for MPW to handle relatively low interest rate payments. This should work for a while in MPW’s favor as it has better than typical net lease escalation rates associated with its rents. Its analysis for 2022 cash rent to 2023 cash rent shows about a 4.4% escalation rate.
The final and third point to note is that there is a substantial presence of non-US denominated debt. It was possible to get lower interest rate loans in many foreign currencies than in dollars in the recent past and MPW did this as they invested in international properties. This was a good thing until it comes to having to translate cash flows into dollars from these assets for reporting and covering costs and dividends in the US. More on that later.
The bottom-line on MPW’s debt structure, notwithstanding the fact that MPW is not rated investment grade, is that it appears to be managing debt in a transparent and positive fashion, with liabilities headed in the right direction. When one does comparative debt to equity levels to other net lease REITs, MPW looks as though it could still use some more debt reduction but for now its debt is not the lynch pin to a further decline in stock price. One would like to see MPW achieve investment grade status in this environment of rising interest rates, even at the cost of some growth. One should not assume any near or even mid-term stimulative posture on the part of central banks when their focus is on containing inflation. Indeed, one need only examine the seismic shift upward in mortgage rates over the last six months to imagine the near-term and perhaps mid-term future impacts of central bank actions on corporate finance.
One of the more overlooked statements in MPW’s 2Q 10-Q relates to foreign currency effects on MPW’s financial reporting.
Foreign Currency Sensitivity
With our investments in the United Kingdom, Germany, Spain, Italy, Portugal, Switzerland, Finland, Australia, and Colombia, we are subject to fluctuations in the British pound, euro, Swiss franc, Australian dollar, and Colombian peso to U.S. dollar currency exchange rates. Although we generally deem investments in these countries to be of a long-term nature, are typically able to match any non-U.S. dollar borrowings with investments in such currencies, and historically have not needed to repatriate a material amount of earnings back to the U.S., increases or decreases in the value of the respective non-U.S. dollar currencies to U.S. dollar exchange rates may impact our financial condition and/or our results of operations. Based solely on our 2022 operating results to-date and on an annualized basis, a 10% change to the following exchange rates would have impacted our net income, FFO, and Normalized FFO by the amounts below (in thousands):
Net Income Impact
FFO Impact
NFFO Impact
British pound (£)
$
9,452
$
18,516
$
18,667
Euro (€)
1,967
6,100
6,168
Swiss franc (CHF)
4,796
7,042
3,597
Australian dollar (A$)
1,293
3,397
3,397
Colombian peso (COP)
1,164
1,164
1,164
The British Pound and the Euro have retreated against the dollar from 12/31/21 to 9/27/22 by -20.7% and -15.6%, with the Swiss franc by -8.0% and Australian dollar by -11.4%. One can expect the numbers to move around based on the actions of central banks and world events but right now there is going to be a negative impact on MPW, especially since the majority of the retreat occurred in Q3 as the US Fed accelerated its funds rate increases and Quantitative Tightening balance sheet reduction took off in full force. It would surprise me if one does not hear more about this effect in the third quarter conference call. Reports and conference calls from S&P 500 frequently cited strong dollar conversion effects on reported earnings in dollars.
Interest rate sensitivity does not mean that the international properties are performing poorly in their own currencies. But it does mean that once translated to strong US dollars, there will be a negative impact on metrics that REIT investors use to evaluate the health of their investment. Using MPW’s figures, currency sensitivity would push FFO and Normalized FFO down around $33M to $48M on an annualized basis from estimates made for 2022 before more hawkish pronouncements and actions from the Fed (you remember back in the good old days when inflation was only transitory). This would be somewhere in the range of -3 to -5%. I am assuming that currency sensitivity was part of the calculation that MPW used in establishing the lower end of their guidance, and am hopeful that this will get addressed in more detail in Q3 reporting. Through the first half of 2022, MPW’s FFO and NFFO showed decent increases on a per share basis over the same period last year. So, there is some margin of safety here but currency sensitivity is a headwind that needs to be considered.
No one can look at the history of MPW over the last decade and doubt that this REIT knows how to grow. Its revenues between 2012 and 2021 increased from $198M to $1,545M, its net income from $90M to $656M; its operating cash flow from $105M to $344M. Though not at the same rate, its dividend per share increased from $0.80 to $1.12 and has been increased by another 4 cents this year. And until this year its stock price had steadily increased.
However, it is pretty clear that growth in the next few years will slow down considerably from historic levels. And in fact, MPW CEO, Edward Aldag, addresses this issue in the Q2 conference call, a response I have slightly edited for readability.
Derek Johnston
Ed. So how is your acquisition pipeline standing today? And really, what’s it going to take to drive acquisition volumes — are you seeing any positive developments to get back to like precoded activity levels?
Edward Aldag
So, the pipeline is still there. It didn’t go anywhere. There’s still plenty of things out there that are all just kind of floating around. But I think everybody from the sellers and potential (buyers) like us are all kind of sitting around waiting to see where the world goes. I don’t think there are many deals getting done right now. We certainly (have no) interest in doing any deals right now with the market as confused as it is.
So, I’m not sure I can give you an exact answer for when we get back to the regular normalized-type acquisition levels. It’s not that the opportunities aren’t there. it’s that the world is in such a flux right now. We aren’t actively trying to pursue the levels that we have been historically.
The good news is that MPW has recognized the change from the early highly stimulative environment. The bad news is that they don’t know what is going to happen, and, therefore, do not expect anything like historic levels of growth. And, in fact, I would not expect historic levels of growth in a lot of stocks to occur, especially those that have significant international exposure. I would not expect MPW to issue equity at the present price levels nor borrow a significant sum of money more than they already have. As a current stockholder in MPW, I hope they do neither until profitable investments and a more stable environment clearly emerge from the chaos.
MPW addresses both short-term and long-term liquidity requirements in the Q2 2022 10-Q SEC filing.
Short-term Liquidity Requirements:
At August 5, 2022, our liquidity approximates $1.1 billion. We believe this liquidity, along with our current monthly cash receipts from rent and loan interest and regular distributions from our joint venture arrangements is sufficient to fund our operations, dividends in order to comply with REIT requirements, our current firm commitments (capital expenditures and expected funding requirements on development projects), and debt service obligations for the next twelve months (including contractual interest payments). If Prime were to exercise its purchase option on the 11 properties (as described in Note 3 to Item 1 of this Form 10-Q), we would have $370 million of additional liquidity.
Long-term Liquidity Requirements:
As of August 5, 2022, our liquidity approximates $1.1 billion. We believe that our liquidity, along with monthly cash receipts from rent and loan interest (of which 99% of such leases and mortgage loans include escalation provisions that compound annually), and regular distributions from our joint venture arrangements is sufficient to fund our operations, debt and interest obligations, our firm commitments, and dividends in order to comply with REIT requirements for the foreseeable future. If Prime were to exercise its purchase option on the 11 properties (as described in Note 3 to Item 1 of this Form 10-Q), we would have $370 million of additional liquidity.
In the first two quarter of 2022, MPW had an FFO of $0.92 and Normalized FFO of $0.93 (not a big gap at all) with a dividend payout of $0.58. This payout ratio of about 64% provides a considerable margin of safety before a dividend cut would be probable or necessary. So MPW’s management would have to be seriously wrong about its operators’ ability to cover rent or a major Black Swan would have to occur before a dividend cut would be necessary. Given the high level of short interest, someone must believe differently. I do not rate these events as highly probable or, at least cannot envision them concretely, beyond what MPW has already addressed. I see any reasonable level of bad news as already factored into its share price.
I think it was Warren Buffett or one of his mentors who said something like “Price is what you pay, value is what you get.” According to CFRA data, as of October 3, 2022, MPW’s current price to FFO forward 12-month estimate is 6.3 and its peer average is 11.3. The historical MPW average is 9.7 and the historical peer average is 13.1. Morningstar sees MPW’s fair value at $19.56 rather than its present $12 price and sees its price to fair value ratio as significantly lower than any time in the last ten years. Therefore, in its opinion MPW is selling at about a 41% discount. If one assumes that its ten percent dividend is safe, MPW, with a compounding dividend, may outperform a possibly over-valued S&P 500, which sells today at a PE, based on actual earnings, of about 18 (historic average mean is 16 and median 15). It takes some highly optimistic projections of forward earnings to bring the forward PE of the S&P down to historic levels. Both REITs and other stocks are already facing more stiff competition from fixed income investments.
While the adage “be greedy when others are fearful, and fearful when others are greedy” captures an important contrarian truth, it is not a sufficient foundation for a long-term investing strategy, especially given today’s volatile market. Bond and stock market cycles, heavily influenced by macro conditions, can last for one or more decades. Investment strategies tailored to most individual’s circumstances, needs, and risk tolerances need to be much more nuanced than “buy the dip” or “don’t fight the Fed” or “sell in May and go away.”
Yours Truly started buying MPW shares ten years ago and, as hard as it is to believe, those shares total return is in a positive position. In fact, using Seeking Alpha statistics, MPW’s total return over the last ten years has been 114%, not great relative to the S&P 500 but no disaster either. However, I doubt that there are many people who bought shares in the last few years and failed to sell them at or close to their peak price have much to celebrate. I certainly don’t. I have basically done some tax loss harvesting with some of the lots bought between 2019 and the end of 2021. On the brighter side, MPW does make the rest of my investments look pretty good in relative terms.
Most investing is an activity based on probabilities about an unknown future and not certainties or assertions accepted as certainties. At this point, I have put a little additional skin back in the MPW column but nothing like a full body part. There are other less problematical and controversial investments available. However, for a more speculative soul, who can overlook the negative sentiment and disappointment that a steep decline has fostered, MPW may have some appeal. I do believe, based on the facts as I can see and understand them, that MPW’s price is at or very close to its nadir, that its valuation is compelling, and that the selling is overdone. In a worst case, I do not see MPW further under-performing other health care or net lease REITs. However, you will not see $24 per share again any time soon or even Morningstar fair value. The growth is unlikely to be there. But you might see a $15 share price and a generous dividend. That is my present rationale for making modest additional investments at this point. And cash in your hand will certainly beat a prophecy on a video in a high inflation environment. So, within the context of a well-diversified portfolio, MPW has a reasonable risk/reward profile and could well be a decent investment.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of MPW either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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