In a time of sickness, investors, like patients, should look to hospitals. Medical Properties Trust (MPW) is a real estate investment trust which owns hospitals in America, Germany, the UK, Spain, Portugal and Australia ( it does not own senior living facilities ). It’s tenants are about to be swamped with business, the perceived value of its facilities to their communities is exploding upwards, and last year MPW had implicitly committed to increasing its safe dividend by 20% – 25% in 2020.
I will discuss the case for owning MPW in three parts below. In the first part, I will discuss a signal which management gave in its Q3 2019 earnings call about a significant increase to the dividend in 2020, from a then $1.04/year to about $1.32/year, an increase which is required if they are going to keep up with their target dividend payout ratios. In the second part, I will discuss the financial soundness of the company and the safety of the dividend against the background of the stock’s recent sell-off. In the third part, I will discuss exogenous risks to its business from the pandemic.
Cash Flow Growth Has Far Outpaced Management’s Targets for Dividend Payment
Over the last two years, MPW has systematically strengthened and grown its business. From the end of 2017 to the end of 2019, revenue increased from $715M to $870M. Growth is due to accretive acquisitions which were funded partly by debt and partly by equity. After dilution for the newly issued equity, issued at prices far higher than it is selling today, FFO/share grew from $1.17 to $1.25.
The dividend increased right in line with this, from 96 cents to $1.04, a conservative 8.3%, not far trailing the increase in FFO. But there’s a secret here. The company had a large pipeline of acquisitions last year, most of which didn’t close until late last year or in January. Now that these acquisitions are closed, the company projects FFO for this year to be at least $1.65, a projection it affirmed as recently as early February. As a result, the $1.04 dividend from the end of 2019 represents an exceptionally conservative 63% of forward-looking FFO.
In late 2019, CEO Edward Aldag was asked about this conservative coverage ratio during the Q3 earnings call on 10/31/2019. Here was his answer,
Edward Aldag, “…under current dividend policy right now the run rate guidance is about in the 80% of AFFO cash FFO run rate. And we believe that that’s probably the right number. We have a fairly healthy component of straight-line rent. And so we really do look at AFFO much more focused than we do just FFO keeping that 80% payout ratio on an AFFO basis, gives us room as these properties continue to be acquired and generate results for four quarters… I’ll just reiterate that will wait until we actually not only announce acquisitions, but actually closing them and integrate full quarter receipt of the NOI.”
In recent years, AFFO and FFO have matched closely. This question-and-answer moment in the earnings call went unremarked upon and has been unreported. Yet, its investor implications are astounding. The last acquisition was closed in January 2020, and the 2020 FFO guidance was upped to a low end of $1.65 to reflect it. As Aldag says, this guidance is mostly straight-line rent. According to the mentioned BOD policy, their intention is to raise the dividend to reflect 80% of AFFO as the rent is realized over a number of quarters. 80% of $1.65 is $1.32. The jump from $1.04 to $1.32 would represent about a 25% YOY increase. MPW seemed to confirm their intent by increasing their latest dividend payment from 26 cents to 27 cents, after just increasing it from 25 cents to 26 cents the prior quarter.
To put that in financial perspective, as I write this the market has closed on Friday, March 20th, with MPW selling for about $14/share at close. If we assume these signalled raises are going to happen this year, the forward yield on a $14 purchase price would be 9.5%, in a world where the 10 year treasury is yielding around 1%. The forward earnings yield, using FFO, is 11.7%. This represents a very healthy 10.7% equity risk premium for owning a global hospital provider during a global health crisis. This is a distressed level suitable for a business which is about to see a crash in its earnings. During a health crisis, do hospitals have the distress risks of other types of businesses?
On top of this, MPW’s expansion opportunities seem effectively limitless. In their February 6th call they mentioned another $3B in acquisitions they would try to close in 2020, though those may be on hold given what is happening in the equity and credit markets right now. However, delay is not cancellation. Over the long run, this company is nearly the only game in town for quickly financing new and existing hospital structures and the size of that market across the developed world can support consistent high single digit growth for a very long time.
In a world with 1% T-bonds, what should a company with a safe dividend and 7% – 10% yearly growth opportunities be yielding? I think about 5%, and that is arguably conservative. That puts “fair value” for MPW right now, as I write this, at about $28, or double today’s closing price.
Financially Strong
When the virus panic began, MPW was selling at about $24/share, so it has fallen quite precipitously. At one point earlier this week, it was nearly $12/share, cut in half. Given the very conservative current dividend coverage, the natural inclination is to think they must have balance sheet problems. The market must be signalling something, right?
It turns out they are nearly a fortress. At the end of 2019 they were carrying $1.5B in cash on their balance sheet, some of which they have used to close acquisitions in January. Based on previous years, I’ll estimate they currently have about $200M in cash after closing. Interest expense on their $7.1B debt is about 250M annually, so they have more than enough cash to grant some emergency rent deferrals in the unlikely event a few unlucky tenant’s experience slow reimbursement for patient costs, which might be caused by slow government reimbursement during the pandemic.
Their debt ratios are a solid if not spectacular 5.5 times EBITDA, so nothing to worry about. Their recent acquisitions were made at a cap rate which is a full 5% higher than what they paid on the long term debt financing.
What about EBITDARM? Do their tenants have enough cushion to consistently make rent? Rent coverage for their tenants is a very healthy 2.7x. Their largest tenant, Steward, has EBITDARM over 3, as do the vast majority of their properties. They say the longer they hold properties, that number goes up. The older properties have 4x EBITDARM. Overall EBITDARM is pulled down by some rehab centers which run on thinner margins.
They don’t have any looming, worrisome debt payments.
So, what is it? Why are people panic selling hospitals of all things in the middle of a pandemic?
If you look at MPW’s price chart, you’ll see that it was holding up pretty well until March 11th. On March 11th, a corona virus breakout was reported at a SABRA (SBRA) senior living facility. Immediately, health care real estate across the board began being dumped, MPW included, even though their business has none of the risks that senior living facilities do during this crisis.
From there, a lot of market technical factors must have taken over. REITS in general have been getting dumped, as investors have realized that shut downs and social distancing may mean rent suspension from tenants. Many of these investors hold REIT exposure through ETF’s like Vanguard’s diversified real estate fund (VNQ), and when there is net selling in the market of those ETF positions, this may force the ETF to trim all its holdings formulaically, whether it makes sense or not.
There are also momentum traders, who will pile on by shorting a company or sector experiencing a route. There are margin calls and other investors who just want to raise cash, and are forced to sell at any price.
None of these factors impacts MPW’s value, but can greatly impact its price for a short time. What matters is whether its tenants will continue to meet their obligations. On the surface it certainly seems like they should, since a pandemic will be a boom time for hospitals, who will be running at perhaps more than 100% capacity for months and maybe a year. For example, the British NHS just rented 8000 ICU beds at private hospitals. That’s good for businesses like MPW who own hospitals in the UK.
The Phantom Risk
The one substantial risk factor which could truly impact MPW is the risk its tenants’ coronavirus patients will not pay ( because they are uninsured ) or that it will be serving them at a substantial loss ( because ICU care is not compensated sufficiently relative to elective surgeries ). Recall, this is only a risk to MPW to the extent it would force tennants to violate their facility leases. Simply losing profit margin would not impact MPW in a significant way. Temporarily lower profits for tennants do not release them from lease obligations.
Since the uninsured skew towards younger people, the chief component of this risk is that medicare and medicaid payments will not cover hospital’s costs of caring for those patients. The explicit worry is that more lucrative elective surgeries at hospitals will be crowded out by less lucrative or even money losing intensive care for corona virus patients.
Which brings us to it: In a time of health crisis, when congress is seriously looking at bailing out even movie theaters, what are the odds that it will let hospitals go belly up because medicare and medicaid payments don’t fully cover the costs of intense treatment like what the corona virus requires? Also, although ICU stays can be money losers for hospitals, 2 out of 3 coronavirus patients who need hospitalization do not need an ICU stay.
Medical professionals have taken the initiative in framing themselves as the front-line providers in a war, and talks are already underway with Congress to get them all the money they might need, as The Hill reported on March 19th,
“Hospitals and other front-line medical providers are asking Congress for $100 billion in direct payments in order to appropriately respond to the coronavirus pandemic.”“In a joint letter to congressional leaders, the American Hospital Association, the American Medical Association and the American Nurses Association said Congress should direct the federal agencies “to begin to infuse funds immediately so that they can afford to take the necessary steps to fight the battle against this unseen enemy.””
Which congressperson or senator do you think wants to answer questions about why they let a community’s hospital go into financial distress right as it was needed most, in the middle of a national health emergency? Does the risk of that scenario require a 10.7% equity risk premium? The question answers itself.
Congress’s response will not be a mortgage or rent holiday, either, because the vast majority of hospital administrators own their own facilities and would benefit very little from such a move. The hospitals are going to get paid, so Medical Properties Trust will be paid too.
We see this even in Spain, where a scary headline about Spain “nationalizing its hospitals” may have spooked some investors. But beneath the headline, what has really happened is a temporary measure in which the government has taken control of hospitals for the duration of the emergency and has said it will return them after the crisis, with guaranteed compensation for time used to the facility owners. Government guaranteed rent is a net positive for MPW’s small Spanish presence, even if it will be delayed by some months while Spain handles the emergency.
What are we left to conclude? As a hospital REIT, Medical Properties Trust does not have any of the business risk from tenant shut downs that other REITs do. We’ve seen the risk is to the upside as governments are going to guarantee payments. They do not seem to have any of the business risk in this crisis we see from other businesses. On the contrary, they are in the center of all economic activity for at least the next year, indispensable and irreplaceable. Even better for investors in MPW specifically, there is an unreported but very large catalyst on the horizon this year, which is a significant and permanent increase in the dividend. At worst, they may delay the dividend increase a bit until after the crisis is over because of optics.
There will never be a better time to own hospitals.
Disclosure: I am/we are long MPW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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