Medical Properties Trust Stock: Far Safer Than Bears Claim (NYSE:MPW)

Poor old beaten down Medical Properties Trust (NYSE:MPW). The market shows no love and many analysts have questions about transparency, risk, and credibility. Let’s lay out the swirling issues:

• None of MPW’s largest tenants are publicly traded and none report financial information;
• Steward, among the largest hospital operators in the US, struggles so regularly that maybe their operating model is a risk;
• Prospect Medical Holdings, MPW’s second largest tenant, has reportedly struggled during Q1 2022;
• MPW has to make investments in and loans to some of its tenants based on tenant weakness;
• Hospitals have largely regained their pre-pandemic footing with respect to demand, however, labor and inflationary pressures have created new challenges based on HCA Healthcare’s (HCA) Q2 earnings call which is our proxy for the current hospital operating environment; and
• MPW limits most of its disclosures to what is required rather than pushing as hard as analysts would like in disclosing more tenant operating information.

Sounds like a perfect stew for fear, skepticism, and doubt to congeal into distrust. MPW’s stock price discount when compared to other REITs certainly confirms this.

In making our comparison, we recognize that no other REIT has as dominant a position in hospital real estate, so we use the following indirect competitors: Healthcare Realty Trust (HR), Omega Healthcare Investors (OHI), Physicians Realty Trust (DOC), Sabra Health Care (SBRA), and National Health Investors (NHI).

Ticker	Price/Book (TTM)	Price/AFFO (TTM)
MPW	.93x	9.64x
HR	1.60	16.2
OHI	1.9	10.45
DOC	1.29	15.97
SBRA	.95	9
NHI	1.99	13.94

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Source: SA

Our valuation measures will be familiar to most REIT investors. Price/Book gives us a trailing 12 months Net Asset Value discount or premium while Price/AFFO (Adjusted Funds From Operations) gives us the cap rate or implied yield from the portfolio on a cash flow basis.

To eliminate an overly skewed comparison, we knockout the high and low comparisons to see how things cluster. SBRA is too low for Price/Book and Price/AFFO and also, we wipe away NHI’s Price/Book and HR’s Price/AFFO to give us the following comparison:

Ticker	Price/Book (TTM)	Price/AFFO (TTM)
MPW	.93	9.64
Average	1.6	13.45

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Is this discount deserved?

Investment Thesis

Medical Properties Trust holds a unique position in REITland as the largest owner of hospital real estate. One could argue over the past three years that no one really wanted hospital risk, but is that a permanent downward shift in asset value? We don’t think so. Rather, we see the aftereffects of market disruption working its way through the healthcare industry.

Hospitals, in our opinion, are a special class of community assets – they are typically large footprint aircraft carriers around which a host of escort buildings develop to create a healthcare armada in a central location. Patients then cluster around the area because the hospital provides many services the satellite services cannot. Thus, all things being equal, we would ascribe an asset premium to hospitals over skilled nursing, drug abuse and other ancillary healthcare services that can exist both near hospitals and in communities lacking hospitals.

Ancillary healthcare services like doctors’ offices and acute care facilities move around more easily because they do not require the same real estate footprint or even to be purpose built. It’s not unusual to find several competing buildings near a hospital or in developed medical centers or campuses that have been renovated from a prior use.

Competition mobility among ancillary health service providers, in our view, makes it a riskier real estate sector than hospitals, so what is MPW doing wrong?

Under The Hood

We can get a better idea by looking at some financial metrics among our comparable competitors (all on a TTM basis):

Ticker	AFFO Margin	AFFO Payout Ratio	Interest Coverage	Rents/ Avg. Gross Properties	Return On Total Assets	Leverage Ratio
MPW	55.05%	82.12%	3.02x	11.64%	6.07%	53.35%
HR	101.41	86.19	1.44	11.81	1.49	50.42
OHI	64.15	96.13	2.27	11.64	4.74	57.41
DOC	49.29	89.82	1.82	9.74	1.53	40.47
SBRA	61.24	81.20	.42	7.36	0.73	42.78
NHI	67.19	80.72	2.73	9.42	2.60	43.87

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Source: SA

If we knockout the high and low AFFO Margins given their wide swings, we get an average around 64%, materially higher than MPW’s 55%.

We can see MPW is in line and prudent with respect to its payout ratio to shareholders, and we judge this rate as sustainable within the REIT industry.

Confoundingly, MPW has a low cash flow margin but the best interest coverage on a relatively higher leverage ratio. The answer is that MPW creates more revenue per asset, which also explains MPWs superior return on assets. Higher overall cash flow at a lower profit margin can offset higher margin returns on other assets, and MPW cash is benefitting from some exotic deals by normal healthcare REIT standards.

MPW doesn’t just receive among the highest lease payment on their facilities based on rents/avg. gross properties, above, they also get kickers and provide financing with secured loans. Providing mortgage loans is not unusual but MPW also makes asset backed loans secured by hospital receivables from US government programs – super safe. And they take equity pieces from time to time to fill the gap when MPW likes the deal risk.

These little extras create more cash flow per asset with a balance of risks – the equity kickers are obviously the riskiest cash flow and those loans are secured against real and valuable assets.

When we consider how much MPW is squeezing from their average asset, we can see why they sustain a higher leverage ratio than its peers with the best interest coverage in our comparison set.

We are not seeing a big problem here other than operator default risk, which is admittedly hard to measure when all we have is what MPW management tells us their operators told them – not good for predicting that risk.

Tenant Default Risk

If I look for the fear hole down which the stock has traveled this year, I think this is it. Is the risk overblown?

MPW has several advantages:

• Focus on hospital real estate plus supporting ancillary real estate;
• Master lease structure for largest tenant groups;
• Reduced tenant concentration and debt leverage this year; and
• Long experience in the sector.

We wrote earlier that hospitals are a special class of community asset. All sorts of values are tied to the presence of a hospital – supports housing values and neighborhood desirability as well as stimulating other healthcare services and infrastructure investment. That means stronger communities in danger of losing their hospital take action to preserve it. In fact, that’s mostly how MPW acquires new properties through Steward, its largest and most controversial tenant.

Steward Risk

As a private operator, Steward discloses very little about its business other than it turns around struggling properties through sale/leaseback deals with financing partners like MPW.

When Steward takes on an already struggling property, it’s already “in the hole” and where MPW lends a hand through creative deal making. MPW takes extra bits like equity kickers with payment triggers and very secured loans backed by US government receivables to make deal to work.

We do not imagine that the moment Steward takes over a hospital it magically recovers, that’s neither reasonable nor would it require MPW to help with financing. Turnarounds take time and Steward has a good track record which buys some room for us to extend trust. Turning around a hospital, even if you are among the best at it, had to be Herculean the last two years – how could one make meaningful progress when COVID-19 was jamming the system?

For a current state of the US hospital market, we use HCA’s earnings call transcript as our proxy. They report COVID-19 related admissions dropped 70% from 2022 Q1 and that current demand exceeded pre-pandemic traffic in most departments. That means resources and beds freed to meet more profitable demand, some of which must have been pent-up from the peak of the COVID crisis.

We think that augurs well for MPW tenant revenues for the balance of 2022 and going into 2023. Of course that assumes we continue to manage better the variety of virus outbreaks threatening US communities (recent increases in Polio and Monkey Pox in addition to the Omicron COVID variant) as well as covering labor shortages that have plagued healthcare since 2020.

Even as we see Steward managing its way through the current economic environment, let’s imagine we have a bad recession in 2023. Let’s further assume that Steward seeks Ch.11 protection. Not all Steward property leases would be rejected, just those Steward felt it could negotiate beyond the master lease without triggering cross-defaults. That cross-default clause is a big hammer for MPW to hold – they can require Steward to vacate all the properties and sell the portfolio as a single entity, which a bankruptcy judge might very well block as too draconian a resolution. So the likely path is a negotiated package of hospitals come back to MPW.

If MPW takes back several hospitals, we could see a dividend cut until the property is either sold or re-tenanted. Re-leasing could be hard if the market perceives that Steward’s failure was more market than management related. At a current forward yield of almost 8.5%, one can argue a Steward Ch.11 filing is already priced into the stock. While Steward is not a threat to MPW’s survival or even its continued growth, it does pose a near term unknowable risk that has not gone unnoticed.

Conclusions

We get the concerns – trying to understand MPW tenant financial risk is like staring at a blank wall. We believe MPW does its level best to disclose what it can. We know there is some suspicion MPW entered a very profitable joint venture just to reduce Steward’s concentration and avoid a form 10-K disclosure for Steward. Frankly, we would understand any private company guarding its secrets and going to lengths to ensure its privacy. Full disclosure of how Steward operates only helps Stewards’ competitors – an unforced error if that happened.

We also skeptically believe the Macquarie deal contained a package of the best Steward assets with respect to value, leaving us with higher risk exposure on Steward assets.

Counterbalancing these issues is a REIT that creates more cash per asset than its competitor group. That extra cash comes from both high-risk equity kickers and low risk secured loans. That extra cash further justifies higher leverage and MPW has no material refinancing needed until 2026 – smart debt management.

We see a unique collection of largely special community assets trading as though its largest tenant has filed bankruptcy, which has not happened or is even threatened. While the fears over Steward’s ability to complete its various turnarounds without further help from MPW maybe justified, treating the stock price as though it has already happened is not. Moreover, patient demand forces are now moving in MPW’s direction despite labor challenges. Finally, rising interest rates are not a near term threat given how MPW has laddered its maturities.

MPW is a Buy today.