Low Prices Don't Cause Dividend Cuts: Medical Properties Trust

Co-authored with Beyond Saving

When there is a high degree of short interest in one of your holdings, you must take a moment and consider what the negative viewpoints are on that holding, as well as what facts management tries to highlight.

You must remember that the management team of any company is the ultimate salesperson for that company. Similarly, those who have short positions in the company have a vested interest in seeing the price drop.

Often, the ultimate truth lies somewhere in the middle.

As an investor seeking current income, we're used to working against sentiment to be able to find high yields that are sustainable and will provide us with reliable income for years to come. When the market gets bearish, we often find some of the best investment opportunities. We have been richly rewarded when management teams are able to continue operating their business as expected and provide us with outstanding income, which we've been able to lock in at high yields for years to come.

While bears and short sellers publish all quarter long, earnings are an opportunity for a company to prove itself. We have the official numbers that we can use to measure progress towards the goals that management laid out in the previous quarter. We also have an opportunity to hear from management what their expectations and goals are for the future.

When we look at earnings, what we want to see is a clear plan and management taking reasonable steps toward implementing that plan. The reality is that operating a business requires dealing with obstacles. Every day brings a new challenge. A good manager will identify problems, devise a solution and put that solution into action. Earnings provide tangible results - are the numbers in line with what management guided for last quarter? It also provides an opportunity to hear from management about their efforts to protect our dividends and maximize returns.

Today I want to look at one specific holding that has taken a lot of punishment from short sellers, partially because sentiment has shifted, to see what the management team is doing to rectify the situation and if there is a situation to rectify.

Let's dive in!

New Quarter Means New Data

Medical Properties Trust (NYSE:MPW) is a large medical property focused REIT. They own and lease out a wide array of hospitals to various operators who run, staff, and maintain the facilities. As a REIT, MPW is forced to pay out at least 90% of their taxable income as dividends to their shareholders. The greatest risk to a REIT is being over-leveraged and having poor clients. The greatest benefit to a REIT is that their real estate often climbs in value over time, enabling capital recycling to capture new opportunities.

MPW reported their earnings on April 27. It was a rather uneventful quarter. NFFO, MPW's preferred metric, came in at $0.37/share. AFFO, our preferred metric for dividend coverage, came in at $0.30/share. This is generally in line with the guidance that MPW issued last quarter. They narrowed the guidance range to $1.50-$1.61 NFFO.

As a reminder, guidance at the low end assumes the "worst case scenario" that $0 is collected from Prospect Medical Holdings in 2023. Note this is the company that the Wall Street Journal recently highlighted as hiring advisors for a potential restructuring. MPW management was on top of this and advised investors of this back in February and assumed no revenues from Prospect in 2023 because of a likely restructuring. Even in that scenario, the dividend is still covered.

Management reiterated their belief that they will recover 100% of their investment and missed rent from Prospect due to transactions that are currently in process. They aren't certain whether those funds will be received this year or next year but are confident that the amount recovered will meet or exceed their cost.

Whenever share prices decline, we start seeing people saying a company "should" cut its dividend. They will say the company should cut to buy back shares or reduce debt.

Cutting the dividend to buy back shares is silly. Whether the company is paying out cash as a dividend, or using that same cash to buy back shares, is irrelevant from a cash-flow perspective. That is cash that is leaving the company in both cases. All that would do is make shareholders mad, which could impact their valuation for many years.

Cutting the dividend to pay off debt at least makes sense in some cases. Does it make sense for MPW?

Here is MPW's debt. We've highlighted the debt that is at a variable rate or maturing within the next two years. This is the debt that would be nice for MPW to pay off. Source

MPW has already announced a series of transactions that will result in $1.4 billion in proceeds in addition to their $300 million in cash on hand. As a result of these transactions, MPW intends to pay off its AUD term loan and pay off the majority of its revolver.

The revolver will decline from $1.03 billion to under $200 million. This only includes the announced sales and does not include the remaining recovery that MPW expects from its Prospect properties. Overall, management stated they expect to receive enough to pay off all of their debt maturing in 2023/2024. Not refinance.... pay off.

Since MPW plans to pay off this debt completely, the discussion about how horribly high their interest rate would be if they refinanced is moot. It doesn't matter what interest rates are because that debt will be paid off, and MPW will be deleveraged below 6.5x debt/EBITDA. Which was its long-term plan long before all the current hysteria started, and MPW was trading above $20/share. In other words, the change in MPW's share price didn't change the plan at all.

Would a dividend cut help? MPW is paying out $173.5 million/quarter in dividends. So if you assume a 30% cut, That would be about $50 million/quarter or $200 million/year. MPW already has $1.4 billion in asset sales and expects over $2 billion in debt payoffs in 12-18 months. Does an extra $200 million make a material difference? No.

Hence, the market is "surprised" that MPW didn't cut its dividend, but we aren't surprised at all that MPW announced Q2's dividend would be unchanged. Yes, coverage is tight at 103% of AFFO, yet that is with what management expects to be the worst quarter of the year. The debt concerns aren't a concern as MPW has already mapped a path to pay off its upcoming maturities, meaning it will need to issue little to no new debt at current rates.

MPW is facing some real challenges with Pipeline and Prospect running into issues. Yet in both cases, MPW expects a full recovery of all contractual rent. Additionally, portfolio rent coverage was stable at 2.4x EBITDARM coverage and is expected to improve in Q2.

This is a case where the fears of the market have reached irrational levels, and when that happens, we sometimes see an earnings report that wasn't great, causing the price to shoot up. It's a little bit rainy, but the world isn't ending.

Conclusion

With MPW, we see there is a mixed bag of information. While short sellers focus only on the negative, management is trying to play up only the strong positives. The truth lies in the middle.

Yes, it appears that some of MPW's tenants are experiencing difficulties. 2022 was undeniably a difficult year for hospitals as they face rapidly rising labor costs, and they are dependent upon the government and insurance companies for most of their revenue. Both of these have long bureaucratic processes before increasing reimbursements. Today, those labor pressures are easing, and the payment increases are starting.

MPW has a couple of tenants that were struggling with these pressures but expects to recover 100% of the rent. In the meantime, MPW's dividend is still covered by AFFO, and as the hospital sector reaches a new normal, we can expect to see future dividend hikes from MPW.

Earnings season is an excellent time to review your holdings and get updates on what's happening. It is a time to listen to management, look at the numbers and understand the challenges and rewards that your holdings face. The market has been overly bearish on MPW, even as management continues to follow the plan they laid out to deleverage and strengthen its balance sheet. While the market is busy being surprised that management is doing what they said they would do, we are happy to collect our income and wait for the market to realize how underpriced MPW shares have become.

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