Medical Properties Trust Stock: 2 Big Reasons Why I Have Yet To Buy (NYSE:MPW)

Medical Properties Trust (NYSE:MPW) is dirt cheap according to virtually every valuation metric. Moreover, the company has been taking concrete steps to overcome its tenant issues. That said, there are two big reasons why I have yet to buy the stock, which we will discuss in this article.

Why MPW Stock Appears To Be Dirt Cheap

It trades at an EV/EBITDA of 11.88x compared to its five year average of 14.42x. It trades at a P/FFO of 5.17x (a nearly 20% cash flow yield!), which is less than half its five year average of 10.99x. It trades at less than half its five year average P/AFFO ratio of 13.66x as well at 6.42x presently. Last, but not least, it trades at a mere 0.57x its consensus estimated NAV per share in contrast to its five year average price to NAV ratio of 1.12x. The dividend yield is 14% compared to its five year average yield of 6.4%.

Based on these metrics, it would appear to be pretty clear from the surface that MPW is trading at around a 50% discount to its intrinsic value, making it a very compelling buy.

How MPW Is Navigating Its Tenant Issues

While the bear case on MPW has centered on its tenant issues, the company has been taking concrete steps to overcome these.

MPW appears to have a clear path to recover deferred rent from its tenants, which would result in a more stable cash flow profile. If they do indeed fully recover this deferred rent, their effective 2023 FFO per share will grow at 4%, which would be a positive result given the current industry conditions. MPW’s track record in dealing with such issues does lend some credibility to management’s projections for this outcome, and if it plays out according to their guidance, MPW’s value proposition will improve significantly.

Furthermore, management signaled on the latest earnings call that conditions were improving for its tenants:

We find the outlook for our tenants extremely encouraging on all fronts. Recent public comments from US operators confirm the optimism about the industry.

Staffing costs are dramatically improved going into 2023, as is access to qualified patient care staff. And our tenants are implementing innovative means to develop and retain employees. Contract labor costs peaked last March and have come down approximately 33%.

As we move into 2023, the prognosis for generalized margin improvement across the entire industry on an increasing volume is encouraging. Our operators are experiencing low to mid-single-digit comparable revenue increases, depending on the diagnosis, acuity and payer, which, along with improving volumes and expanding reimbursement programs all along the scale are expected to generate an attractive 2023 for MPT’s tenants.

Third, MPW continues to reduce its exposure to higher risk tenants while also selling off assets at values that are vastly superior to the current implied value being assigned by Mr. Market to its shares.

For example, MPW recently announced that a subsidiary of CommonSpirit will take over operations for Steward (their largest and highest profile troubled tenant) at their Utah properties. This benefits MPW by reducing their rent exposure to Steward, improving Steward’s liquidity and overall rent coverage ratio, validating the value of MPW’s Steward properties, and replacing Steward with an A-rated tenant.

Another recent development along these lines was MPW’s agreement to sell its Australian real estate investments operated by Healthscope to affiliates of HMC Capital. The cash proceeds from the sale are expected to pay off the A$1.2 billion term loan used to fund the 2019 acquisition of 11 hospitals leased to Healthscope. The sale was made through a competitive process and demonstrates the demand for hospital infrastructure assets while further strengthening MPW’s balance sheet.

Why I Am Still Not Long MPW Stock

That said, despite these positives among its tenants and the clear value proposition in the shares, there are two reasons why I am not long the stock.

First and foremost is the fact that there remains a very high degree of uncertainty surrounding the business model, making it a high risk investment. On the eve of a recession – which could very possibly be quite severe and/or prolonged given the lingering inflation issues plaguing the economy – this is the sort of business that might not make it to the other side without suffering severe impairment.

While it is true that MPW continues to fight through its tenant issues, some dominoes have already begun to fall and there is a high probability that they will continue to do so, especially as the toll of an economic downturn begins to weigh on hospital profitability (as elective medical procedures plummet, for example).

For example, MPW had to write-off straight-lined rent due to a major tenant, Prospect, ceasing rent payments in Pennsylvania and partially stopping payments in California. This has led to a lower FFO per share guidance from MPW for 2023.

Moreover, the healthcare industry has been struggling with rising labor costs, inflation in supplies and drugs, and interest expenses, leading to shrinking margins and a consolidation of operations in the healthcare space. This has caused major hits to profitability for many operators in the low-margin industry, including hospitals.

Moreover, MPW’s financial struggles are not just limited to Prospect, with other tenants, including Steward, Springstone, MEDIAN, Priory, Aspris Children’s, and Pipeline, also facing financial difficulties, increasing the risk to MPW’s cash flow profile. While MPW has navigated tenant issues in the past, the risks to the company are significant, and the announcement about Prospect signals that material hits to the bottom line are beginning to become a reality.

This leads to my second reason for refusing to buy MPW at this point: MPW is highly leveraged and its financial standing is far from secure given its junk (BB from S&P) credit rating. According to TIKR.com, its net debt to EBITDA ratio is 7.25x and its FFO interest coverage ratio is only 2.06x. While we are far from predicting bankruptcy for MPW, our point is simply that any further meaningful tenant issues (which we think has a high probability of occurring, especially in a recession) will have a substantial impact on its FFO per share given how much debt is on the balance sheet. This means that the dividend is far from safe and a cut is actually quite likely in our view.

Moreover, it means that the discount to NAV is probably not as appealing as it may seem on paper. Yes, they have been selling some assets at attractive valuations, which reaffirms the NAV estimates to a certain extent. However, as pressures mount on the industry and financial conditions continue to tighten, it is probably that the pool of buyers for these assets will decline substantially, pushing cap rates up a bit, if not significantly. Given the large amount of leverage on its balance sheet, even a 100 basis point expansion in cap rates would have a very substantial impact on the NAV per share.

Investor Takeaway

While we think that the discount in MPW shares has gotten so large that shares are likely truly discounted relative to their intrinsic value, it is also very true that MPW’s investment thesis is as risky as ever today. This is because economic conditions continue to worsen and MPW’s access to cheap capital continues to decline. Moreover, its tenant issues appear to be finally manifesting themselves in tangible hits to cash flow for the REIT. Meanwhile, leverage remains elevated, amplifying the effect that these negative developments will have on MPW’s cash flow statement and NAV per share. Last, but not least, we think that if a recession hits in the coming quarters, MPW will slash its dividend.

While a dividend cut is already priced in, the likelihood of a cut also means that the stock is not truly as cheap as it appears on the surface. Moreover, the fairly tight interest coverage ratio and poor credit rating mean that the stock is hardly a safe haven during rocky economic times. As a result, while we rate the stock a speculative Buy, we remain on the sidelines in favor of sleep well at night REITs that have recently become extremely undervalued due to the general sell-off in the REIT sector.