Medical Properties Trust: The Safest Dividend Is Probably The One That’s Just Been Cut
A short while ago, I wrote an article about Medical Properties Trust (NYSE:MPW) in which I voiced my suspicions that the healthcare real estate investment trust was on its way to slash its dividend.
Indeed, just a couple days after the publication of my article Medical Properties Trust: Dividend Cut Incoming (Downgrade), management announced that it slashed its dividend to $0.15 per share which reflects a 48.3% cut compared to the previous dividend of $0.29 per share.
However, given that the market did not respond very negatively to the dividend announcement, I think the market may be ready to reward the healthcare trust with an upside move in the stock price as the REIT is set to prioritize its balance sheet restructuring.
My Prior Medical Properties Trust Recommendations
The strategy of buying out-of-favor trusts for income can backfire, even in cases of good underlying dividend coverage, as I learned the hard way with MPW. I doubled down on Medical Properties Trust aggressively during the first quarter and recommended the trust for passive income investors a number of times (see, as an example, Why I Am Acquiring This 13.2% Yield Aggressively), primarily because I regarded dividend fears as exaggerated in light of a dividend pay-out ratio in the neighborhood of 80-85%. Since my contrarian recommendation in February, the stock price has declined more than 30%, and in my personal portfolio, I am 38% below my cost base on MPW. In short, my contrarian buy calls in 1Q-23 were a bust. However, this is not to say that an investment in MPW is a lost cause or that the stock has no value for passive income investors.
What I underestimated and, thus, got wrong about Medical Properties Trust was the need for balance sheet repair. Medical Properties Trust, as I will explain in more detail below, accumulated too much debt over time, which ultimately required a change in capital allocation strategy and may result in ongoing asset sales moving forward.
Though I was wrong about my buy calls in 2023 and mistimed my purchases of MPW, I maintain that Medical Properties Trust still offers passive income investors an attractive (and well-covered) dividend yield.
After the dividend cut, the margin of safety has actually increased, as the implied AFFO pay-out ratio is only 37%. Taking into account that investor sentiment might also change as the trust announces new property sales and restructures its balance sheet, I think that the value proposition in the long run has not necessarily been negatively affected after the dividend cut.
Dividend Reset, Shrinking Portfolio, Deleveraging Balance Sheet
I warned of an incoming dividend cut for Medical Properties Trust and wrote the following:
The easiest way to raise cash, however, would be to cut the dividend which costs the REIT about $175 million a quarter. To take pressure off of Medical Properties Trust’s cash flow, the trust could decide to lower its dividend by 50% which would save the company $88 million each quarter.”
In an announcement made on August 21, 2023, Medical Properties Trust said that it was slashing its dividend from $0.29 per share per quarter to $0.15 per share per quarter, effectively reducing the healthcare REIT’s dividend by half yield to 8.6%. The strategic action was taken to alleviate the trust’s liquidity and focus on the deleveraging of Medical Properties Trust’s balance sheet.
A few words about Medical Properties Trust’s balance sheet and debt situation. The healthcare REIT had a considerable amount of financial obligations as of the end of the second quarter, a total of $10.24 billion and the trust, as I explained in my last article, had a considerable amount of debt coming due in the next 2 years.
With that said, however, the trust may have to sell more assets in order to achieve meaningful progress in terms of its accelerated debt repayments.
Thus, I would expect Medical Properties Trust’s real estate portfolio to continue to shrink in the near future as the trust uses excess liquidity to lower its financial obligations. As of August 4, 2023, Medical Properties Trust had 598.4 million shares of common stock outstanding, meaning the dividend reset saves the trust $84 million per quarter, or $336 million per year in cash flow.
This is a small sum relative to the $10.24 billion in debt, so I would think that management will ultimately decide to sell more hospital assets. The trust already sold its Australian hospitals and expects to close the sale of its Connecticut hospitals to Yale New Haven Health for $355 million.
Moving forward, I could see Medical Properties Trust either selling a number of its less-performing General Acute Care Hospitals or following the blueprint of exiting regional markets altogether, like Australia.
Potential markets that Medical Properties Trust might want to leave could include Spain, Switzerland, and Germany, where the trust has only a very limited presence (asset representation of less than 3% of the total portfolio). Block sales could be an opportunity for the healthcare REIT to quickly divest unwanted, non-core assets and raise a substantial amount of cash that could be used to deleverage the trust’s balance sheet.
37% New Dividend Pay-Out Ratio, Implied 24% AFFO Yield
Medical Properties Trust’s decisions have gotten passive income investors to this point, and the increase in debt is clearly the fault of management. But that is not to say that Medical Properties Trust might not be a compelling restructuring or recovery investment whose business can recover on the back of a reworked balance sheet.
At its core, Medical Properties Trust’s AFFO are growing: They were up 17% YoY in 2Q-23 to $0.41 per share. Annualized, that’s $1.64 per share, meaning the $0.15 per share new dividend implies an estimated new pay-out ratio of 37%, down from 71% based on its old dividend pay-out.
With $1.64 per share in estimated AFFO, Medical Properties Trust’s AFFO multiple is 4.1x which equates to an AFFO yield of 24%. So even if AFFO declines due to asset sales, passive income investors get to take advantage of a large margin of safety here.
Why Medical Properties Trust Might See An Even Lower Valuation
Passive income investors have taken a series of hits lately with Medical Properties Trust and management must now deliver results or risk MPW’s valuation suffering even more.
With that said, however, I think that things are about to improve for the healthcare REIT.
Those passive income investors that feared a dividend cut have likely already sold and re-balanced their portfolios, and the remaining investors still get an 8.6% dividend yield. This, of course, is not the best outcome for passive income investors, many of whom have bought into the REIT at a substantially higher valuation, but I don’t see why passive income investors would want to sell near the latest lows.
With a portfolio restructuring already announced and the trust now focused on balance sheet repair (and saving cash), I think that the stage is set for a stock price recovery in the short and medium-term.
This is an opportunity for a rating change and to go all-in, in my view.
My recommendation at this point, taking into account that the market did not react particularly negatively after the dividend reset announcement (meaning the market expected it), is to buy and do so greedily.
My earlier recommendation was a hold, but given that the dividend reset cleared the air, I think this might be a good time to adopt an aggressive contrarian position with respect to the healthcare REIT.
The safest dividend is always the one that has just been on the chopping block, and I am confident that a stock upgrade will translate into attractive total return potential over the next 1 or 2 years.