Medical Properties Trust: Is the Selloff Justified?

About the company

Medical Properties Trust (MPW, Financial) is a self-managed real estate investment trust with a market capitalization of $7.39 billion and an enterprise value of $16.71 billion. Founded in 2003 to purchase and develop hospitals that are leased to operators on a net basis, the Birmingham, Alabama-based company has grown to become one of the largest owners of hospitals in the world, with 431 facilities and approximately 43,000 licensed beds in nine countries on four different continents. Medical Properties Trust's financing model helps to facilitate acquisitions and recapitalizations and allows hospitals to use the value of their real estate assets to finance facility improvements, technology upgrades and other investments in their operations. Its total portfolio is valued at $21.1 billion.

The current dividend yield for Medical Properties Trust is 9.39% based on both trailing and forward calculations. The dividend payout ratio is 0.55, indicating a strong ability to pay dividends. The growth rate for the past five years was 4.1% and the yield on cost for the past five years was 11.48% The three-year share buyback ratio is -17.2%, which means the REIT has been raising money via sale of shares.

The company's balance sheet appears to be healthy with an equity-to-asset ratio of 46%, a debt-to-equity ratio of 1.09 and a comfortable interest coverage ratio of 2.68.

Bear attack

Medical Properties Trust has come under bear attack by short sellers recently, with allegations of a circular financial relationship with the operators of the hospitals whose real estate Medical Properties Trust owns. The bears allege that Medical Properties Trust is propping up some of these hospital operators (particularly Steward Health, which is Medical Properties Trust's biggest tenant) who are basically insolvent by loaning them money, so they can keep up with the rent payments to Medical Properties Trust. According to the bears, this is a house of cards which will come crashing down.

The following information presented by the company in August 2022 shows the company's investment in Steward. Steward rents over 26% of Medical Properties Trust's assets by value.

The following chart from Morningstar (MORN, Financial) shows that short interest is Medical Properties Trust (lower panel) has risen sharply in recent months, though short interest has declined to 15% from 20% in November.

Source: Morningstar

Management rebuttal

Medical Properties Trust's position is that dividends are well covered and come from inflation-protected cash flows. The company boasts that it has a track record of raising its quarterly dividends for eight consecutive years and that its steady dividends have helped deliver market-leading returns to shareholders and its total returns have significantly outperformed benchmark indices over the long term. It states that following the onset of Covid-19 in the first quarter of 2020, six health care REIT peers reduced their dividends by an average of 31% while Medical Properties Trust's focus on essential hospital infrastructure allowed for a 12% cumulative increase in its quarterly dividend. Medical Properties Trust has improved portfolio diversification and cash flow visibility, and has decreased its exposure to its largest operator (Steward). Fifty-four operators account for 92% of assets and exposure to Steward has been reduced to 26% of assets (vs. 38% in 2018).

In a recent quarterly update, management stated that Medical Properties Trust has collected 99% of contractual rents year-to-date as of Sept. 30, 2022. Some rents have been deferred due to state-specific Supplemental Medicaid programs, totaling $24 million, which will be paid over the next nine quarters. Medical Properties Trust expects to continue this level of rent collection in the future. The company has provided loan facilities to Steward and Prospect and allowed one non-U.S. tenant to defer $7 million of rent over four months, which will be repaid with interest over the next 12 months.

Steward has experienced operational, staffing, Covid-related, revenue, inflationary and other pressures in the past two years, but has managed its cash flow and is now expected to be strongly cash flow positive starting in the fourth quarter of 2022. Pipeline Health is expected to pay rents and continue serving its communities during bankruptcy proceedings. Management emphasized that the company still has a solid balance sheet, low cost of capital and strong liquidity position and will focus on its long-term growth strategy.

Management's position is that Medical Properties Trust's abiltiy to invest in tenant-operators is a feature, not a bug as it gives the company insight into their operations, enables them to invest in an industry they understand and helps them source future real estate deals from a position of advantage.

Bonds are showing stress

Medical Properties Trust's bonds are trading much below par and thus showing some stress, though it's hard to say how much of this stress is due to the fall in stock price or due to the hike in risk free interest rates.

Note: Bonds with a rating of BBB- (on the Standard & Poor's and Fitch scale) or Baa3 (on Moody's) or better are considered "investment-grade." Bonds with lower ratings are considered "speculative" and often referred to as "high-yield" or "junk" bonds.

Source: Finra

Comparisons

Medical Properties Trust was doing quite well compared to its peers until last year, when the stock came under bear attack. In Appendix 1 at the end of this article, I have provided an extensive comparison of Medical Properties Trust with a number of other health care REITs. The results are summed up more succinctly in the chart below:

Valuation

The GuruFocus Valuation box shows solid potential value by several metrics. Since Medical Properties Trust is a REIT, the discounted cash flow metric is not very relevant, but other metrics are positive, like projected fre cash flow and GF Value. The company's stock is trading below tangible book value, though there is risk that tangible book value may be reduced if the some of the major tenants default and the company is unable to find replacement tenant/operators in a timely manner. Overall, the company looks undervalued and is paying a very high divided.

Conclusion

While the bears have a point that concurrent equity and debt investment in tenant operators can amplify risk to the company, I think the market has overreacted to the downside. I believe the short sellers in this case are aiming to create fear in the minds of the retail investors, and they have been successful. Many retail investors who have been attracted to Medical Properties Trust because of the high dividends are being stampeded out of their positions by the bears. Short sellers profit when the stock falls.

Even if a tenant/operator like Steward was to default, Medical Properties Trust should be able to survive as most likely rents would still be collected in the event of a Chapter 11. Moreover, in a bankruptcy, Medical Properties Trust will take over the properties and sell them to another operator. The equity and/or debt investments in the operators is of course higher risk and could be wiped out in an bankruptcy. Medical Properties Trust disclosed in August 2022 that its equity investments in the operators is around 7% of assets. Given that Medical Properties Trust's total equity-to-asset ratio is 42%, there appears to adequate cushion for now.

On the downside, there is no recent insider buying and very little recent guru buying of the stock, even though its fallen a lot, which is a negative.

Therefore, I think I will plan to take a small speculative position in Medical Properties Trust to maintain my interest and watch the situation carefully as to how it evolves.

Appendix 1