Medical Properties Trust (NYSE:MPW), a REIT involved with medical properties, recently reported its Q4-2023 earnings results. In a nutshell, the company recorded significant non-cash impairments related to tenants undergoing restructuring. Nevertheless, I reckon Medical Properties Trust remains undervalued relative to peers and recent disposal terms. Furthermore, the Federal Reserve is broadly expected to start cutting rates in a few months. As a highly indebted company, Medical Properties Trust will be one of the key beneficiaries.
I am bullish on the stock due to its attractive valuation on a firm-wide basis and the defensive nature of its hospital portfolio. Nevertheless, investors need to be mindful of its high leverage and the need for management to preserve liquidity.
Medical Properties Trust’s Operational Overview
Medical Properties Trust, or MPT, is one of the largest owners of hospital real estate. The company is active in 31 U.S. states and several international markets. As of Q4 2023, 71% of its assets, or $11 billion, were in the stabilized portfolio, while 29%, or $4.6 billion, were classified in the cash-basis portfolio where more conservative accounting is applied. The main difference is that the cash-basis portfolio only recognizes revenue when cash rent and interest are received.
MPT’s Q4 2023 results were characterized by significant impairments and write-offs related to the cash-basis portfolio. Together, these charges had a negative impact of $670 million on MPT’s bottom line. To adjust for these effects, MPT reports normalized funds from operations (an indicator similar to adjusted funds from operations, or AFFO, a cash-flow metric commonly reported by REITs).
In Q4, normalized funds from operations were $0.36/share, down 16.3% year-over-year. The decrease was the result of both lower revenues as well as higher interest costs. Net debt amounted to $9.8 billion at the end of Q4 2023, significantly above the company’s $2.1 billion market capitalization. As a result, generating liquidity through asset sales and retained earnings remains a priority for the company.
In January 2024, the company raised $115 million from the sale of a syndicated loan facility. The tendency of MPW to fund struggling tenants has been a point of attention for analysts, given the mixed results the practice has delivered so far.
Elevated uncertainty related primarily to the cash basis portfolio and ongoing disposals resulted in management not issuing 2024 financial guidance.
Medical Properties Trust’s Capitalization Rate
It is always important to consider the capitalization rate (the rate of return on a real estate investment property based on its expected cash flows) of a REIT you invest in and not just the yield based on normalized funds from operations. Usually, to increase returns, REITs borrow from banks and other lenders. This often results in high normalized funds from operations yield.
However, if the REIT needs to sell a property on the market, the buyer will consider the capitalization rate, as it encompasses all cash flows of the property to equity and debt holders combined.
To arrive at Medical Properties Trust’s capitalization rate, we can combine the current normalized funds from operations run-rate amount and interest expense, multiply it by four since it is a quarterly number, and divide the result by the company’s enterprise value.
In Q4 2023, normalized funds from operations amounted to $218 million, while the company’s interest expense was $102 million. As a result, MPT currently produces about $1.28 billion on an annual basis, available to pay interest on debt and dividends to shareholders. Against an enterprise value of about $11.9 billion, the market-implied capitalization rate is about 10.8%.
The capitalization rate allows investors to compare REITs with different levels of financial leverage (the portion of the enterprise value funded by debt, which, at Medical Properties Trust, is about 82%, a very high amount) since it looks at cash flows at the enterprise level rather than to shareholders specifically. The high amount of financial leverage exposes MPT to excessive interest rate risk.
The cap rate is also useful when comparing the absolute return potential of Medical Properties Trust as an investment and makes it easy to compare it to other alternatives, such as government bonds. For instance, the 10-year U.S. government bonds yield around 4.26% currently.
Recent disposals can also be benchmarked on a cap-rate basis. For instance, in Q4 2023, MPW closed on the sale of its Australian assets at a cap rate of 5.7%. In February 2024, MPW entered into an agreement to sell five hospitals in the United States at an economic cap rate of 7.4% for $350 million.
Last but not least, the 10.8% cap rate can be seen as the expected return before the use of leverage, inflation indexation, or rental growth.
Disposal Opportunities in Europe
55% of Medical Properties Trust’s stabilized portfolio is actually located in Europe. Yields in Europe are normally below those in the United States — marginally so in the United Kingdom and more evident in the Eurozone.
For instance, a company with 74% of its assets in healthcare facilities in the Eurozone is Cofinimmo (DB:COF). It currently trades at a cap rate of around 7.1%. Hence, I estimate that if needed, MPW can draw liquidity from European markets at a capitalization rate well below its market-implied cap rate of 10.8%. Of course, selling the stabilized portfolio will only increase reliance on the company’s cash-basis portfolio, magnifying operational and cash flow uncertainty.
Federal Reserve Interest Rate Cuts Coming
While initial expectations for the Federal Reserve to cut interest rates in March proved too optimistic, the broad market consensus now expects the long-awaited monetary policy easing cycle to commence in May/June, with futures pricing indicating a Fed funds rate of 4.25-4.50% in December 2024, or 1% lower from today’s 5.25-5.50% target range.
Not only will interest rate cuts reduce the company’s financial burden, but its relative attractiveness as a fixed-income investment will only increase. Lower interest rates may also help MPW achieve more attractive terms on its disposals.
Is MPW Stock a Buy, According to Analysts?
Turning to Wall Street, Medical Properties Trust earns a Hold consensus rating based on one Buy, four Holds, and three Sell ratings. Additionally, Medical Properties stock’s average price target is $4.43, implying 16.6% upside potential.
The Takeaway
Despite difficulties related to the cash-basis portfolio, MPW did not further reduce its dividend, which is still set at $0.15/share per quarter (or about $359 million on an annual basis, consuming 41% of its normalized funds from operations).
While the company is able to raise financing at attractive terms relative to its implied capitalization rate, significant operational uncertainty related to the cash-basis portfolio, coupled with ongoing disposals and an uncertain path for monetary policy, has resulted in management not issuing a 2024 outlook.
Nevertheless, recent disposals at cap rates between 5.7%-7.4%, coupled with cap rates of public peers at about 7.1%, indicate a significant margin of safety relative to MPW’s implied cap rate of about 10.8%. As a result, I reckon the shares are worth buying, notwithstanding the still elevated leverage of the company.
