Medical Properties Trust, Inc. (NYSE: MPW) is a self-managed real estate investment company established in 2003 to acquire and develop net-lease hospital facilities. Since the beginning of the year, the company has lost almost 50% of its market value and, as a result, the stock is currently yielding more than 9% per year. For this reason, we decided to take a look at how much you should actually pay for the stock, whether you are a dividend or dividend growth investor. We will also elaborate on the results for the third quarter and the main risks that you must take into account if you consider investing.
To answer the valuation question, we will use the Gordon Growth model.
Gordon’s growth model
The Gordon Growth Model (“GGM”) is a simple and well-known dividend discount model used to value the equity of companies that pay dividends. The main assumption of this model is that the dividend payment increases indefinitely at a constant rate. Because of this criterion, the growth model is particularly suitable for companies that are:
1.) Pay dividends
2.) In the mature growth phase
3.) Relatively insensitive to the economic cycle
A solid track record of steadily increasing dividend payouts at a steady rate of growth could also serve as a practical yardstick should the trend continue in the future.
So, should MPW be valued?
Although MPW may be susceptible to economic cycles, we believe that its strong track record of paying dividends makes it an ideal candidate to be assessed by the GGM. The company has been paying quarterly dividends every year since 2008 and they have managed to increase the payouts every year for the past 9 years.
To better understand valuation, the following formula shows the math behind the model:
In order to make a meaningful assessment of the fair value of MPW’s equity, we need to make a few assumptions:
1.) Required rate of return
We normally prefer to use WACC as the required rate of return. In the case of MPW, this figure is estimated at 11.5%.
2.) Dividend growth rate in perpetuity
A reasonable long-term trend can often be defined using the company’s historical dividend payments and their growth. It is important to emphasize that the assumed growth rate has a significant impact on the calculated fair value. The assumption of unrealistic high growth rates can lead to a significant overstatement of fair value. For this reason, we rather like to stay on the conservative side.
Based on these numbers, we think a conservative range for dividend growth rates could be 1% to 3%.
The following table shows the results of our calculation of fair value (in USD per share) using a required rate of return of 11.5% and the above-defined range of constant and sustainable dividend growth rate.
As MPW shares are currently trading around $12.2 per share, at the lower end of our conservative fair value range, we believe there is substantial room for upside, based on this pattern. dividend discount.
For this reason, based on the valuation, we believe MPW stock is an attractive option.
To understand whether these dividends are sustainable in the short term, we also need to look at the company’s operations and financial results. In this section, we will summarize the key findings from MPW’s latest quarterly earnings report.
The company’s net profit and NFFO for the third quarter of 2022 reached 30% and 3.4%, respectively. MPW also announced that they are raising their expectations for 2022 net earnings per share to $1.99 to $2.01, representing year-to-date gains on sales of approximately $537 million. dollars, while also reducing their 2022 estimate per NFFO share, towards the top of the range, to $1.80 to $1.82 from a previous range of $1.78 to $1.82. For now, estimates for 2023 have not been provided. These figures are expected to be announced with the fourth quarter results.
In our view, despite the challenging macro environment and all the risks MPW faces, they delivered strong results in the third quarter. Estimates for 2022 are also promising. We believe that based on these numbers, returns to shareholders in the form of dividend payouts and share buybacks should remain intact for the foreseeable future.
During the previous quarter, MPW’s portfolio also underwent a substantial transformation. Through these transactions, MPW was able to raise a significant amount of cash, which should be used to reduce debt, potentially buy back shares and fund selective investments.
Including total proceeds received from its first quarter real estate partnership transaction with Macquarie Asset Management, proceeds from third quarter asset sales and loan repayments and other transactions, MPT raised approximately $1.8 billion. dollars in cash thanks to capital recycling transactions since the beginning of the year. Additionally, as previously announced, the Company expects to receive over $650 million in revenue in 2023 from other binding agreements.
In addition, important developments took place in the third quarter regarding Steward:
Steward completed expedited repayment of amounts owed related to approximately $450 million in COVID-related advances and collected approximately $70 million in overdue repayments under the Texas Medicaid program. With these cash losses now over, positive revenue trends, significant declines in contract labor utilization, and projected annual savings resulting from adjustments to Steward’s cost structure should result in a cash flow. positive and sustainable free cash flow.
We were delighted to learn of this development as Steward is one of MPW’s largest tenants, and its financial health can have a significant impact on MPW’s financial performance. We also believe that this development may give shareholders a little more confidence that the dividend is likely to be safe and sustainable in the near future. This statement is also consistent with MPW’s recent announcement of the authorization of a $500 million share buyback program.
Bank of America analysts also recently upgraded MPW shares to buy from neutral.
Of course, the valuation and the latest quarterly results are not much help if we do not understand the underlying risks and their potential consequences on the company and on investors. We will highlight some of the risks that we believe are most crucial to understand. A comprehensive list of risks can be found in the firm’s 10-K.
1. Revenue depends on relationship with and success of tenants, especially larger tenants including Steward, Circle, Prospect, Swiss Medical Network and HCA.
As of December 31, 2021, these tenants – Steward, Circle, Prospect, Swiss Medical Network and HCA – represented 18.5%, 11.1%, 7.3%, 5.8% and 5.6% of total assets, respectively. MPW’s pro forma crudes.
Needless to say, the failure of one of these tenants could have serious consequences. In the event of a default, the FFO could suffer a severe blow leading directly to a potential reduction in the dividend. If this were to happen, our assumption regarding the infinite growth rate of dividend payments would also no longer be valid and the calculated fair value would be an overestimate.
But what if the worst happens and the default of one of these tenants becomes a reality? Well, MPW probably needs to replace the tenant with a new one who is able to pay. And that brings us to our second risk.
2. It can be expensive to replace defaulting tenants and we may not be able to find suitable replacements on suitable terms.
A few important points to mention regarding this risk as outlined in the firm’s 2021 10-K report.
The process of terminating a lease with a defaulting tenant and repossessing the applicable facility can be costly and require disproportionate management attention.
In addition, litigation could be brought by the tenants against MPW in connection with the lease.
The transfer of healthcare facilities is highly regulated, which can lead to delays and increased costs in finding a suitable replacement tenant. Renting these properties to non-medical operators can be difficult due to the added cost and time of redevelopment of the properties.
If no suitable new tenants are found, the property will likely have to be sold, which may result in a loss depending on the sale price of the property. Indeed, this risk is not only valid in the event of default by a tenant, but also when a fixed-term lease expires and the parties do not renew the lease.
3. Facilities Located Outside the United States
While a larger geographic footprint can have benefits, we will now highlight some of the risks associated with it.
Approximately 40% of MPW’s total pro forma gross assets are located outside of the United States.
Currently, the macroeconomic environment in Europe is difficult due to the ongoing geopolitical conflict between Russia and Ukraine. The continent’s energy supply is also quite uncertain in the near future. The relative weakness of the euro against the dollar is creating headwinds for the company. Recent changes in British politics have also had a substantial impact on the relative strength of the British pound, which has also had a negative impact on the MPW.
For these reasons, we believe that the uncertainty associated with European operations should be taken into account before considering investing.
MPW’s stock looks attractive from a valuation perspective. In our view, the upside potential is substantial.
On the other hand, one must understand the main risks associated with MPW activities before starting a new position. These include, but are not limited to: heavy reliance on the top 5 tenants, replacement of failing tenants can be costly, and facilities located in Europe may be affected by the ongoing energy crisis and geopolitical tensions in the Eastern European region.
Currently, we believe the risk-reward profile is attractive and therefore rate MPW’s stock as a ‘buy’.