Hospital pure-play Medical Properties Trust (MPW) has gotten some bad press, partially responsible for a dip in market price year to date. This article will examine the nature of the bumps to determine if it is a mere hiccup or an interruption of their long-run trajectory. I believe it is just a speed bump and let me walk you through the analysis that led to that conclusion.
What went wrong?
There were two key pieces of news that led to the price decline:
- A negative article in the Wall Street Journal painted MPW in a bad light
- Earnings report was a bit disappointing relative to expectations
I am honestly a bit surprised at how much the stock responded to the WSJ Article but it was down 5% over the 2-day period with no other material news so that is my best guess as to the cause.
As an investor, my only goal is to produce a strong return without taking on undue risk. As such, I have exactly zero loyalty to the companies in the portfolio. If someone uncovers real problems at a company I will see that as an early warning and get out. In fact, I would be happy with the source for bringing to my attention information that I had missed.
I bring this up because this rebuttal is not a knee-jerk response defending a company in which I am invested. I simply see no merit to the WSJ article and view the 5% decline in market price that it caused as an opportunity.
This new bearish article seems strangely similar to an article run in the Wall Street Journal back in June of 2021 by the same author, Brian Spegele. The $800 million of losses at Steward referenced in the subtitle of his article are from 2017-2020.
“Steward lost more than $800 million between 2017 and 2020”
These are the same losses referenced in his previous article.
I debunked it then on Portfolio Income Solutions and I guess I will have to debunk it again since the disinformation has resurfaced.
The information may be factually correct, but it has been distorted to suggest a level of distress that just isn’t present. Three points:
- GAAP earnings are often not reflective of the financial success of a company. It is quite common for companies in growth mode to have large GAAP losses (such as Amazon through much of its history).
- Steward losses do not translate to MPW losses. Steward has paid rent in full to MPW and continues to do so.
- New information trumps old information. I don’t really see what relevance Steward’s 2017-2020 losses have in comparison to newer information.
On the 4Q21 conference call, Ed Aldag (MPW CEO) reported the EBITDAR coverage ratio of Steward.
“Now I’d like to provide some updates on some of our largest operators. Steward, which represents 19% of our portfolio on a pro forma basis, continues to perform well, with coverage near 3x”
3X is normal, healthy, middle of the pack coverage. It is neither great nor reason for concern.
Compare this to Ventas (VTR) which has 1.1X EBITDAR coverage for its senior housing which is the bulk of its portfolio.
Perhaps the portion of the WSJ article that I found most misleading was an insinuation that MPW was somehow giving money to Steward to keep It afloat.
“Since the pandemic began, MPT has struck a series of deals involving Steward and its chief executive that together resulted in hundreds of millions of dollars flowing from MPT to Steward.”
That just isn’t how business works. MPW as a company exists to make money, not to give it away. The referenced flow of hundreds of millions of dollars from MPW to Steward was high cap rate investment that if it works out will result in substantial profits for MPW.
How high cap rate real estate acquisitions work
There are certain sectors of real estate where transactions are very low risk such as buying an in-place long-term triple net lease with an investment grade tenant.
These typically come at cap rates of 4%-5.5%
MPW operates in a much higher cap rate space going for 8%-10% cap rates. Every single purchase MPW makes is a risk – a calculated that the weighted average outcome will be a positive NPV (net present value). bet
There is no doubt that some of MPW’s investments have run into trouble along the way:
- In 2014 the operator of MPW’s Monroe facility declared bankruptcy.
- Adeptus went bankrupt while a major tenant of MPW.
- MPW’s 2020 investment in the Watsonville facility resulted in a loss
That is in many ways just the nature of healthcare. Regulations are frequently changing, reimbursements get reworked and operators are often running on thin margins. MPW generally works with the top healthcare operators, it is just a tough environment.
That is what the high cap rates are for. It compensates companies for investing despite the risks and when a company makes wise choices, as MPW has, it can come out far ahead. Even the failures demonstrate the due diligence MPW puts into underwriting.
When the Monroe tenant went under, MPW successfully transitioned the property to a new tenant (Prime). They could do this because the real estate itself was solid. A large portion of the Adeptus properties was re-leased to new tenants at equal or better rates. The remainder were sold at a loss.
That is strong loss mitigation when things go wrong.
Watsonville was opened right before COVID hit and since COVID relief funds were allocated based on 2019 numbers when the property was not yet fully open, the operator did not get relief. I find it hard to blame either the operator or MPW for this failure as there was no way to see it coming. At the time there was no observable reason to think it was a bad time to start operating a facility.
These losses are more than balanced out by successes that delivered far more than their going in cap rates. MPW has often partnered with their operators, owning an equity stake in the operator along with the real estate. These partnerships have been quite profitable for MPW, most recently seen in the 4Q report in which Aldag reported:
“we also completed the sales of our equity investments in MEDIAN and ATOS for EUR 42 million in gross proceeds, virtually all of which is gain.”
Also in the 4th quarter, MPW had significant real estate gains on sale as seen in the call:
“MPT completed the long-pending sale of Capital Medical Center in Olympia, Washington for $135 million, including a $33 million gain representative of a mid-teens internal rate of return over MPT’s period of investment. We also sold an inpatient rehab facility in Fort Lauderdale for roughly $27 million, reflecting additional strong gains. And we agreed to facilitate our operator sale of a Midwest hospital by selling the related real estate for about $63 million. That also includes an attractive gain. We expect this to close in the second quarter of this year.”
That is the process of high cap rate real estate investing. It will involve both successes and failures, but when done well, it is far more lucrative than the low cap rate counterpart. MPW has demonstrated a track record of strong financial judgment that has led to impressive FFO/share growth.
MPW has risks but this media fascination with Steward seems entirely misplaced. By any metric I can find, Steward is a fairly average tenant. Their EBITDAR coverage of rent is well within the normal range and Steward is quite a large company with 36 hospitals across 10 states.
In my opinion, the thing investors should be watching is the Prime lease expiry in mid-2022. The hospitals are exceptionally profitable so the tenant is unlikely to vacate, but there is a purchase option on the lease in which Prime can rebuy the properties from MPW. If that happens MPW would likely reinvest the proceeds into their pipeline, but there might be a time lag.
Will the growth continue?
MPW has a large pipeline of identified acquisitions measuring in the $1B -$3B range. Cap rates still appear to be around 8% which would make these deals significantly accretive on completion.
The biggest impediment to growth is a stated intent to deleverage. As of the close of 2021, MPW was sitting at 6.4X Debt to EBITDA with a goal range of 5X to 6X.
A couple of already announced dispositions will get MPW most of the way to the 6X but also come with a bit of dilution just by means of being dispositions. It is largely the dilution from the dispositions that held Normalized FFO guidance back at $1.81-$1.85. Once these get replaced and overtaken by acquisitions, I anticipate growth resuming.
MPW is mostly focusing on U.S. acquisitions in 2022 and these will likely have higher equity component to reduce leverage. Using these concepts we can do some back-of-the-napkin math to get a sense for what the pipeline will bring.
At today’s low market price MPW’s cost of equity is about 9% with a cost of debt of about 3.1%.
Assuming a 60/40 split of equity/debt, that would be a weighted average cost of capital (WACC) of about 6.7%
That gives a 130 basis point spread to acquisitions assuming an 8% cap rate.
130 basis point spread on a $2B acquisition pipeline approximates to incremental FFO of $26 million, or about 4 cents per share.
That is a bit slower growth than we are used to with MPW as a result of the deleveraging and the higher cost of equity due to the low share price. Once leverage gets into the target range, MPW will be able to use a bit higher percentage of leverage on acquisitions and restore spreads to the formerly higher level.
Valuation
MPW is trading at just over 11X normalized FFO compared to the healthcare REIT median at 15.6X. I see the discount as unwarranted given that hospitals are generally in better shape than the senior housing and skilled nursing that makes up much of the sector. As such, I think MPW should trade at a multiple closer to the sector average.
This implies a fair value of around $28 per share.
Wrapping it up
While MPW has some risk inherent to its business model, the freshly elevated level of fear seems unwarranted. The lower share price does slow growth slightly by making equity issuance less accretive, but a low share price has never been a reason to not invest in a stock. Last I checked, the proper logic was buy low, sell high.