Medical Properties Trust Q3 Earnings: Bargain Time

Article Thesis

Medical Properties Trust, Inc. (NYSE:MPW) has reported its most recent quarterly earnings results on Thursday morning. The company beat profit estimates and updated its guidance, which is stronger than what the market expected. With Medical Properties Trust trading at an incredibly low 3x FFO (funds from operations) multiple, shares could be a very rewarding investment as long as the deleveraging efforts are paying off.

What Happened?

Medical Properties Trust, a real estate investment trust that primarily invests in hospitals in North America and Europe, reported its most recent quarterly earnings results on Thursday morning, prior to the market open. The headline numbers can be seen in the following screenshot:

We see that revenues were weaker than expected, and they also declined compared to one year earlier. At the same time, profits (in terms of FFO) were higher than expected -- which is a good thing, of course. After all, dividends and debt reduction require cash flow and profits, so a better performance on the bottom line bodes well for the company's ability to reward shareholders while cleaning up its balance sheet at the same time.

The market reacted positively to these results, as shares are trading up by 3% at the time of writing. It is likely that some investors had feared worse results, and that this is a bit of a relief rally as it has turned out that Medical Properties Trust did not perform as badly as some had feared.

MPW: There Are Challenges

Medical Properties Trust has seen its shares slump tremendously over the last year, and there were reasons for that poor share price performance. First, as a real estate investment trust ("REIT"), Medical Properties Trust naturally employs considerable leverage. The company has financed some of its real estate assets with debt in the past, which is why there are billions of dollars of debt on the company's balance sheet.

At the end of the third quarter, debt stood at $10.2 billion, down from $10.3 billion at the beginning of the year. Debt thus declined, but not by a very large amount. But there are other positives:

First, Medical Properties Trust saw its cash balance grow by $100 million so far this year, thus net debt (adjusted for cash held on the balance sheet) declined by $200 million so far this year -- this still isn't an overly large amount, but things are moving in the right direction.

Second, it is highly likely that debt will continue to decline going forward. The company has closed the sale of its remaining Australian hospitals in October, thus this transaction is not yet reflected in the Q3 numbers. Medical Properties Trust has generated more than US$300 million via this asset sale and has already spent some of these cash proceeds to buy back its own bonds. These bond buybacks happened at a price below par, which means that Medical Properties Trust's debt declines by more than $1 per each $1 the company spends on bond buybacks. Between the bond buybacks and the cash inflow from this asset sale, Medical Properties Trust's net debt position should have improved considerably in October, and the company could end the current year with a total debt position of less than $10 billion. On a net basis, i.e., adjusted for cash held on the balance sheet, the company was below the $10 billion line during the third quarter already.

Over the last couple of years, we have seen interest rates rise considerably. For an indebted company such as Medical Properties Trust, that definitely is a headwind. But the company is making progress in cleaning up its balance sheet, and I do not believe that refinancing maturing bonds will be a major problem for the company.

Medical Properties Trust has argued that it has several ways to access additional liquidity going forward. This includes asset sales, both when it comes to properties and when it comes to stakes in joint ventures. Medical Properties Trust could also issue secured debt, with its vast real estate portfolio guaranteeing the safety of this debt. In total, Medical Properties Trust could access a hefty $2 billion in new liquidity over the coming year, according to management (emphasis by author):

Having utilized proceeds from its exit from Australia to reduce the balance of its revolving credit facility and to increase cash availability, MPT is flexible to manage near-term maturities with existing liquidity and projected retained cash flow. However, in the interest of expediting the repayment of these maturities, significantly reducing its revolving credit facility balance and repaying additional maturities, the Company is evaluating divestiture and joint venture opportunities for which indications of marketability are encouraging. MPT is also exploring limited secured debt financing options which similarly would provide immediate liquidity based on asset value. In the aggregate, MPT expects to raise approximately $2 billion in new liquidity over the next twelve months.

It remains to be seen what the interest rate would look like when Medical Properties Trust issues secured debt -- depending on the rate, this might turn into a profit headwind next year. But it seems highly unlikely to me that Medical Properties Trust will run into major liquidity problems thanks to its several ways of accessing massive amounts of liquidity, thus bankruptcy seems very unlikely to me. The value of the real estate portfolio is also much larger than the total debt position, which also indicates that bankruptcy is unlikely for MPW.

MPW's debt load has not been the only headwind in the recent past. Some of its tenants had also had problems, e.g., due to extra costs due to the pandemic, and due to fewer elective surgeries. With these profit headwinds for hospital operators, there were some issues when it came to collecting rent from some of the weaker tenants. But things are improving here as well. During the third quarter, Medical Properties Trust received rent from Prospect Medical Holdings, which is one of the at-risk tenants. Prospect will pay rent of around $3.5 million per month next year, which makes for an attractive cap rate of more than 8% on the assets that are leased to Prospect.

Steward Health Care System, another at-risk tenant, has also shown improvement in the recent past. According to MPW, Steward's GAAP EBITDARM rent coverage was 2.7 during the quarter that ended June 30, which is a pretty solid rent coverage ratio. This implies that Steward's hospital business is quite profitable at the facility level, which makes it unlikely that Steward will not pay rent in the future. Steward's operations should also improve going forward due to more elective surgeries and normalizing employee costs.

While not all of Medical Properties Trust's tenants are doing very well, things are improving, I believe. Both Prospect and Steward are on a solid track, and it does not look like MPW will face big rent counterparty risk in the near term.

MPW: An Absolute Bargain

Medical Properties Trust faces headwinds, as shown above, so it would not make a lot of sense if the company traded at 10, 12, or 15x FFO today. But we have also seen that these headwinds are manageable and that MPW is working things out: Debt levels are declining, its riskier tenants are looking more solid than they did a while ago, and the dividend reduction has freed up considerable amounts of cash which gives MPW additional funds for reducing debt. Last but not least, there are several sources of liquidity, and bankruptcy is unlikely.

Considering these facts, the current valuation seems very low. Based on current guidance for this year -- MPW forecasts a normalized FFO of around $1.57 per share -- the company is trading for just 2.8x this year's FFO. This pencils out to an FFO yield of 36%, which is incredibly high. In other words, if one puts $1000 into MPW stock today, the proportionate FFO one can expect is around $360 -- per year!

I do not expect that MPW will trade at 10x FFO or more in the near term, but the current valuation is ultra-low and not justified based on the progress MPW is making in reducing debt levels, etc. I believe that there is a good chance that the MPW valuation will expand -- even a 4x FFO multiple, which would still make for a very high 25% FFO yield, would allow for a share price increase of more than 30%.

At current prices, Medical Properties Trust also offers a pretty high dividend yield of 13.5%, which adds nicely to the total return potential.

While MPW is not a low-risk stock, it also does not seem ultra-risky -- after all, the headwinds seem manageable. Diversification is key, and I wouldn't put too much money into MPW. However, due to the bargain valuation and the high dividend yield, the total return potential over a multi-year time frame is very substantial as long as Medical Properties Trust, Inc. continues to improve its balance sheet and as long as its tenants get stronger over time.

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