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Before we entered 2024, I issued an interesting piece on Medical Properties Trust (NYSE:MPW) – Medical Properties Trust: Outlining An Optimal Way To Capture Double-Digit Yield – outlining my views on how the investors could play this distressed case in a more risk-averse manner. In my view, going higher in MPW’s capital structure offered still enticing yield potential (coupons plus price appreciation from the convergence back to par), while at the same time keeping the risk of a shareholder permanent capital impairment lower.
Since that time, MPW’s shares have continued to go down (albeit through major ups and downs) decreasing by ~5%, but the bonds have been fully serviced according to the schedule.
Nevertheless, looking at the recent news around how Steward has opened Chapter 11 and what the Q1, 2024 data points reveal, I have decided that now it is the right time to allocate into MPW’s equity.
Before I dissect the data from Q1, 2024 earnings report and contextualize Steward’s case with the investment thesis, let me make several disclosures:
- Going long MPW significantly deviates from my core investment strategy to focus on above-average yielding securities that are underpinned by fortress balance sheets and predictable cash generation profile.
- MPW’s position will be placed under a specific bucket in my portfolio, which is meant for non-core investments that together can account for a maximum of 5% of my total exposure.
- Based on the current values, MPW’s position will consume roughly 1.5% of my total portfolio.
With that being said, let’s jump to the reasons, which have motivated me to invest a relatively minor amount into MPW.
Thesis update
The thesis at the core is predicated on a very simple concept, where given the current FFO and even assuming a heavy discount on rents, which are currently stipulated with Steward, MPW would still be able to service its debt and accommodate the existing dividend. On top of that, MPW trades at P/FFO of just 4.2x, which clearly implies that there is much heavier upside potential than further downside, especially against the backdrop of the recent news on Steward and MPW’s underlying financial performance.
In other words, the risk and reward ratio is favorably tilted towards supporting the bull camp, and even if incremental data points are negative to MPW, the current multiple largely puts a floor as to how low the share price can plunge. Please do not get me wrong – if, for example, MPW announced that another meaningful tenant has suddenly failed and has stopped paying rents, the share price would obviously suffer a lot.
Let me know put some meat on the bones, by highlighting three specific aspects, which, in my opinion, render the risk and reward ratio favorable.
First, On May 6, 2024, Steward Health Care System filed for Chapter 11, thus initiating a well-needed recovery process. What this practically means is that there will be a notable restructuring of the business, starting from the lender and owner list, the capital structure and ending with the changes in the underlying operations in terms of how the supply chain is organized, in which markets the operations are placed, what services are outsourced etc.
For MPW, this is beneficial due to the following reasons:
- The process of Steward getting its operations back on track has finally started, which will over the foreseeable future (after the restructuring is clear) introduce stability and predictably in MPW’s rent collection for specific properties.
- It is very likely that the outcomes of this Chapter 11 phase will result in Steward stepping away from several lease agreements with MPW, that, in turn, will enable MPW to get these properties on the market (selling them or attracting new tenants), and thus continue the monetization process. Even if the new rents came at a discount to the ones that MPW has signed with Steward now, it would still provide a major boost to the current FFO generation profile.
- Similarly, the properties that will be kept on Steward’s books will start to bring in cash flows to MPW and do so in a more stable manner. I highly doubt that after the restructuring MPW will be able to capture the same level of rents, but, again, any incremental flows should benefit the Company from here.
The bottom line is that having Chapter 11 opened is a positive thing for MPW, which should incrementally improve MPW’s situation, even if the new terms and conditions on the rents are less attractive than the current ones. It would be different if MPW traded at, say, P/FFO of 10x, but given the deep-value territory in which the Company is now, any cash flow from Steward or opened opportunity to sell assets should send MPW’s stock price higher.
With that being said, we have to be fully aware that it is extremely likely that for MPW, this process will result in a permanent impairment of its capital. This could also be the case (albeit with lower probability) for the further debtor-in-possession financing from MPW of $75 million. However, the benefit of MPW being able to resume the monetization process of its asset base that is currently frozen should clearly outweigh any further writedowns.
Second, during Q1, 2024 MPW made a strong and I would say better than expected progress on its liquidity program. So far, MPW has executed asset sales and monetization of JV structures (by selling majority stakes) of $1.6 billion, which leaves only $400 million left to meet the $2 billion target that was announced going into 2024.
The important nuance here is that none of these were executed in a fire sale fashion in which MPW would have to suffer huge discounts to the underlying value of the properties. While there is no concrete data in the earnings supplemental deck, Steven Hamner – Executive Vice President & Chief Financial Officer – in the recent earnings call mentioned that on average, the properties were sold at mid 7% cap rates.
And we said that the negotiations we were under going at that time, and frankly, we remain where we closed one of those and we remain negotiating others. That cap rate in the mid-7s plus or minus, is very indicative when adjusted for geography and size and quality of assets to what we expect to achieve on the additional sales or financings that we have mentioned.
Let’s just take a step back here and recognize that mid 7% cap rate is way lower than what the market is currently assigning to MPW’s equity. Given the positive traction in the M&A market and the fact that through asset sales, MPW is able to unlock a great value (through the received liquidity eventually forcing the market to decrease the embedded discount), I would not be surprised that we will see much higher inflows of fresh liquidity than $2 billion for 2024.
As a result of the success on the liquidity front, MPW has managed to de-risk its balance sheet by neutralizing 2024 debt wall and meaningfully bringing down the 2025 debt maturities. While 2026 is a big one in terms of the amount of debt that is set to expire, there is still a plenty of time for MPW to get the FFO generation on track and find fresh liquidity to handle this.
We have to also note that ending Q1, 2024 MPW had not used all the liquidity proceeds as it still carried $900 million in cash, which on top of at least an additional $400 million from further asset sales should help MPW mitigate any refinancing risk completely.
Third, even considering the fact that MPW’s largest tenant Steward is not accommodating any rent payments rendering ~18% of MPW’s assets idle (or rather with negative cash generation profile given the debt expense and some OpEx), the FFO per share is still sufficient to cover the current dividend and leave roughly 40% of the FFO in the Company. What this means is that MPW without receiving any cash flows from Steward (albeit minor amounts were collected in the first month of 2024) was able to register a quarterly FFO per share of $0.24, which is materially above the current quarterly dividend of $0.15 per share. Here it is also worth noting that the presented FFO per share metric in this quarter is really adjusted for the non-cash like items as opposed to the previous MPW’s practice of recognizing revenue that did not match with the actual inflows of rents. If we annualized the Q1, 2024 FFO figure and assumed that no dividend increases will take place (which is very likely), we would arrive at roughly $220 million in retained FFO after servicing the prevailing dividend. This is a notable amount in the context of forthcoming debt maturities and should enable MPW to conduct a more accelerated de-leveraging process.
Moreover, the FFO for this quarter had come in slightly stronger if MPW managed to retire some of the outstanding liabilities at the start of Q1. Yet, the Q2, 2024 interest expense component should be lowered after the notable deleveraging steps.
So, in essence, if no additional tenant bankruptcies are announced (for which there are no indications now), the quarterly FFO per share figure should improve from here given that the interest expense component is set to go down due to several debt paydowns and also considering that from the cash flow perspective the things related to Steward’s properties cannot get worse than they are now when no cash is flowing.
The bottom line
The combination of Steward entering the Chapter 11 phase and MPW’s success in asset monetization has really made the case more interesting. The case with Steward now has finally started the well-needed process of getting the operation back on track that will enable MPW to continue collecting rents from some of its properties and also put on sale (or attract new tenants) those from which Steward will step back. The success on the liquidity front has been better than expected, allowing MPW to not only unlock great value but also completely de-risk its refinancing profile in 2024. Given that MPW still holds $900 million in cash and that the liquidity program is still in force, there is very limited risk for MPW to struggle with its debt service going forward.
Besides this, the P/FFO of just 4.2x is truly low and in the light of improving Steward’s situation (it cannot get worse than this, where MPW is not collecting any rents) and FFO that easily covers the dividend, while leaving ~40% in internal equity, the risk and reward ratio clearly favors the bull camp.
For all the aforementioned reasons, I am lifting the rating to buy and allocating part of my assets in Medical Properties Trust.
