Confidence in medical properties: Dividend safety is the biggest question (NYSE:MPW)

Investment thesis

Medical Properties Trust, Inc. (NYSE:MPW) had a raw FQ4’22 earnings call, with the post-sale causing a drastic $1.65 billion loss in the company’s enterprise value since Feb. 15, 2023.

We count on this pessimism can be attributed to two major concerns shared by market analysts and investors alike

First, the possible bankruptcy of MPW’s tenant, Pennsylvania-based Prospect, due to -$171 million of property impairment charges and -$112 million of unbilled rent write-offs in FQ4’22. This builds on other tenant issues the company has faced to date, including Pipeline Health’s bankruptcy and Steward’s cash flow problems.

This leads to our second point, MPW’s dividend safety, attributed to the company’s lower-than-expected FY2023 normalized FFO [NFFO] per share between $1.50 and $1.65. Those numbers suggest a worst-case impact of up to -12.2% year-over-year, compared to FY2022 levels of $1.71.

For now, we’re not overly concerned, in part because of management’s optimistic commentary on realizing “the full return on its ($420 million) investment in Prospects, including any deferred rent.” Notably, the FY2023 guidance in NFFO per share of up to $1.65 excludes rent from Pennsylvania for the next twelve months.

The NFFO per share guidance implies a FY2023 FFO of between $890 million and $990 million, at FY2022 levels of $1.08 billion, with an average impact of approximately -12.9% year-over-year. However, this figure suggests it is able to maintain its current dividends, based on the $696 million (+8.1% annualized) paid out in FY2022.

Nevertheless, we agree that there are significant risks associated with the near-term execution of MPW, attributed to the high long-term debt of $10.26 billion (-9% yoy) and minimal cash/equivalents on the balance sheet of $235.67 million (-48.6% year-over-year). ) by the last quarter. Notably, while most of its debt is well-spaced through 2031, $483.32 million will be due in 2023 and another $944.25 million will be due in 2024, suggesting possible refinancing at higher interest rates.

On the one hand, their hospital assets are essential businesses with current issues attributed to operators. However, there is no denying that headwinds to profitability remain a critical concern for most, if not all, investors due to the possibility of a dividend cut in the near term.

Court records of Pipeline Health’s bankruptcy

On the other hand, a recent lawsuit has shown that MPW will be more than legally qualified to claim its missed rental income from Pipeline Health, albeit on a stretched timeline. This development is indeed crucial as the precedent could apply to other tenants should they choose to file for bankruptcy in the future.

The company has obtained a court ruling declaring the repayment of rent a higher priority than “other distributions or payments”, in addition to receiving prior payments in the event of “any proceeds from the sale of assets or other substantial liquidity” .

In particular, the court’s reaffirmation of a “genuine operating lease rather than a financing arrangement” in the Pipeline case is also proving crucial. It is due to the “pure lease” that protects MPW’s existing REIT business model of leasing physical assets to operators from the finance lease, where all bankruptcy risks can be transferred to the lessee, meaning MPW in this case.

We admit that the legal process can be painful, one that has so far impacted stock price and investor confidence. Prospect’s timeline to profitability in Pennsylvania also appears particularly long at between 12 and 18 months, attributed to the potential recapitalization/sale of its $1 billion managed care business. In our view, these factors point to more volatility in the medium term.

So, MPW Stock is a buysell or hold?

MPW 1Y EV/sales and price/AFFO valuations per share

MPW currently trades at EV/NTM revenue of 11.41x and NTM price/AFFO per share of 8.61x, relatively in line with the 3Y pre-pandemic EV/NTM revenue average of 11.85x, albeit lower then 12.71x respectively.

Based on the expected FY2024 AFFO per share of $1.37 and 1-year price/AFFO per share of 10.62x, we are looking at a moderate price target of $14.54. This also approaches the consensus price target of $14, indicating 32.7% upside potential from current levels.

MPW 1Y share price

Due to the factors discussed above, it is clear that the sell-off has been extreme. Many investors are concerned about MPW’s future dividend cut, which we suspect poses a potential risk, with three of its tenants experiencing cash flow problems or bankruptcy. The company’s situation is further complicated by the fact that Steward represents 24.2% of its assets in FY2022, on top of Prospect’s 7.5%.

Nevertheless, regardless of how things develop for Stewart and Prospect, we are cautiously optimistic that the Pipeline lawsuit may paint a slightly more promising picture for MPW and its future dividend. This is greatly aided by the recycling of current investment capital, where other tenants have operated without any problems so far.

Therefore, with a favorable scenario of $0.29 quarterly dividends through 2023, based on the number of FQ1’23, we may be looking at an extended future return of 11.2%, based on the current share price of $10 .30. This potential return is impressive, compared to the company’s 4Y average of 6.02% and the industry median of 4.34%.

Due to the excellent dividend opportunity, we rate the MPW share here as a speculative buy. Meanwhile, bottom fishing investors may try to wait for a better single-digit entry point as the Fed may announce another rate hike by the end of March 2023, while the macroeconomic outlook remains uncertain throughout the year.

Needless to say, this stock is only suitable for those with a higher risk tolerance, significantly worsened by the elevated short-term interest rate of 17.46% at the time of writing, despite the drastic plunge of -19.85% since February 15, 2023.