All Lights Flashing Green For Medical Properties Trust

Summary

• One of the most critical property sectors within the range of healthcare facilities is hospitals.
• Hospitals are essential for emergencies, intensive care, and higher-end procedures. The critical demand components offer a compelling runway for growth opportunities.
• The hospital services sector is highly fragmented, and there is an opportunity for continued consolidation.
• Even though MPW has hit an all-time high, I believe there’s more room to run, so I’m maintaining a buy.
• This idea was discussed in more depth with members of my private investing community, Rhino Real Estate Advisors. Get started today »

Last week I was speaking to investors at a packed house at the MoneyShow in Orlando, and I referenced the best property sectors to invest in during recessions. Although I’m not fearful of a recession in 2019, I am becoming increasingly hawkish that a modest recession could begin to unfold in late 2020.

As I told the crowd, there’s no need to ring the alarm bell yet, and even when the next recession rings, I am confident that most REITs are better prepared than they were in the Great Recession of 2008. I told the group one of the most defensive plays is the healthcare sector.

The dominant proposition is that consumers will continue to spend money on their healthcare even during economic or market downturns. Catalysts like an aging population and longer life expectancy are also relevant, and point to increased demand for healthcare services.

One of the most critical property sectors within the range of healthcare facilities is hospitals, which are the “hub of every comprehensive health system,” according to MPW. Hospitals are essential for emergencies, intensive care, and higher-end procedures, and the critical demand components offer a compelling runway for growth opportunities. In addition, hospitals are difficult to relocate, due to regulatory approvals, funding, and permitting.

The supply and demand fundamentals make hospitals an attractive asset class. Hospitals generate strong revenues even if beds are not filled; unlike skilled nursing operators, hospital lease payments are contractual and cannot be unilaterally adjusted by the operator.

The hospital sector represents the single largest category of personal healthcare spending in the U.S. In 2017. Total hospital care expenditures increased by around 4.6% over 2016, amounting to over $1.1 trillion. CMS estimates the hospital services category will amount to nearly $1.2 trillion in 2018 and projects growth in this category at an average of 5.5% annually from 2018 through 2026.

The hospital services sector is highly fragmented, and there is an opportunity for continued consolidation. According to data from the 2016 American Hospital Association (or AHA) Annual Survey, published in 2018, there are approximately 5,500 inpatient hospitals in the United States.

The U.S. hospital services sector is broadly defined to include acute care, rehabilitation and psychiatric facilities that are either public (government owned and operated), not-for-profit (private, religious or secular) or for-profit (privately held or publicly traded) institutions.

By number, excluding federal, long-term care, and certain specialty hospitals, non-government not-for-profit hospitals comprise 51% of the market, followed by for-profit hospitals representing approximately 19% and state and local government hospitals representing 17%, according to the AHA.

Within the healthcare REIT spectrum there are a few ways to gain access to hospitals, including Ventas Inc. (VTR) a diversified enterprise that has invested around 7% of the portfolio in hospitals through its partnership with Ardent Health Partners (proposed: ARDT), recently filed to raise $100 million in a U.S.

Also, Omega Healthcare Investors (OHI) recently announced it was acquiring MedEquities Realty Trust (MRT) in a $600 million merger, and of the 33 properties that MedEquities owns there’s a hospital leased to Baylor Healthcare. The property is 75,000 square feet and is located in a suburb outside of Austin, Texas (Lakeway, Texas).

But the only “pure play” hospital REIT is Medical Properties Trust (NYSE:MPW), and of course that’s the company that I’m featuring in this article. I stopped by the company’s booth last week while I was attending the MoneyShow. Now let’s shine the light on Medical Properties Trust so you can see why the lights are flashing green.

Source: Here and Brad Thomas (photo at the MoneyShow in Orlando)

Let’s Start From The Top

Medical Properties (herein referred to as MPT) has carved a unique niche in the largest and fastest-growing segment of the U.S. economy. The Alabama-based REIT focuses exclusively on investing in hospitals leased under long-term net leases. Here's how it compares with the peer group (based on Total Capitalization):

Source: Rhino Real Estate Advisors

MPW was founded in 2003 with a vision to provide capital to cash-strapped hospitals and rehab centers. Since that time, MPW has grown to over $8.8 billion size (total assets).

MPW focuses exclusively on providing capital to acute care facilities of all kinds through long-term triple-net leases. The company provides 100% financing to reduce the hospitals overall cost of capital by unlocking the value of its real estate assets (via a sale-leaseback).

By allowing healthcare operators to tap the value of their real estate and channel that capital into facility improvements, technology upgrades, staff additions, and new construction, MPW bridges the gap between the growing demand for high-quality healthcare. In 2018, MPW was the second-best performing REIT (OHI was the top performer in 2018).

In September 2018 I decided to upgrade MPW from a HOLD to a BUY and in a Seeking Alpha article I explained “the company is likely to generate mid double-digit returns over the next 12-24 months” and “offers substantial, near-term and accretive growth opportunities”.

Boom! As you can see (above), MPW shares are up +24.5% since my last article and last week the shares hit an all-time high. It pays to do homework and as you can see below, MPW has returned 15.2% so far in 2019 (year-to-date):

As you can see below, around 74.4% of MPW's revenue is leased to general acute care hospitals and 22% is leased to inpatient rehab hospitals. The remaining (3.6%) is leased to long-term acute care hospitals.

Source: MPW Investor Supplemental

Steward remains MPW's largest tenant at approximately 37.9% of revenue, followed by Prime Healthcare (15.6%) and MEDIAN (15.0%). Steward is the largest private, for-profit hospital system in the U.S. and one of the country’s most innovative and successful operators (nearly 40,000 employees and more than 7,300 hospital beds under management in the U.S.). In MPW’s 2017 Annual Report, MPW’s CEO, Edward K. Aldag, Jr., said “We made the decision to work with them (Steward) years ago, when their network was small, because we believed in the management team.”

Source: MPW Supplemental

MPW has high concentration with Steward (36.3%), Median (14.2%), and Prime Healthcare (15.6%), but the most important concentration number is on a property-by-property basis because each facility is underwritten on its own merits. From a geographical perspective, MPW has investments across the U.S. (~82.1%) and in Europe (~17.9%).

Source: MPW Supplemental

Europe (primarily Germany, UK, Italy, and Spain) represents an attractive market in which to invest. Germany is an attractive investment opportunity given its strong macroeconomic position and healthcare environment.

Germany's gross domestic product, which is approximately $3.5 trillion according to World Bank 2016 data, has been relatively more stable than other countries in the European Union due to Germany's stable business practices and monetary policy.

Source: MPW Website

In addition to cultural influences, government policies emphasizing sound public finance and a significant presence of small and medium-sized enterprises (which employ 61% of the employment base) also have contributed to Germany's strong and sustainable economic position.

Also, Germany's unemployment rate is just 3.3% as of December 2018, which is significantly less than the 6.7% unemployment rate in the European Union at the end of 2018, according to Trading Economics. Since opening the European office in 2013, MPW has outsourced the accounting and administration of its European operations, relying on U.S.-based employees to source new acquisitions.

Also, MPW recently entered into a agreement to acquire 11 Australian hospitals from Healthscope. Like other European countries where MPW has expanded, Australia has a healthcare system that is similar to the U.S. As MPW’s CEO explains,

Healthcare in Australia is among the best in the world and we are delighted to add these quality Healthscope assets to our portfolio. We have been watching and analyzing the Healthscope assets for more than 10 years now.

Of the 11 Australian facilities, eight are general acute care hospitals representing 86% of total investment, one is a rehab hospital representing 6%, and two are psychiatric facilities representing 7%. MPW is paying approximately $859 million and lease the acquired real estate back to Healthscope. In a related transaction, Brookfield Business Partners (BBU) and other partners have agreed to acquire 100% of Healthscope’s outstanding shares.

A ‘Pure-Play’ Producing Profits

MPW continues to be the leader in acute care real estate and has amassed approximately $10 billion pro forma gross assets with 30 different operators spanning three continents. The existing portfolio continues to perform well, and in Q4-18 the company added 10 properties to its same-store reporting.

MPW’s same-store total portfolio EBITDARM coverage for the trailing 12-months Q3-18 is 3.1x, which represents a 10% increase year-over-year. Same-store acute care EBITDARM coverage is 3.6x, which represents a 12% increase year-over-year. Inpatient rehabilitation EBITDARM coverage increased to 1.9x, which represents a 2.5% year-over-year coverage improvement.

Source: MPW Supplemental

Acute care hospitals continue to make-up the bulk of MPW’s investments domestically at 80%, which is in-line with the company’s target range. It’s to recognize that approximately 93.6% of MPW’s same-store portfolio is master leased, cross defaulted or includes a parent guarantee.

Source: MPW Supplemental

For Q4-18 MPW reported normalized FFO per share of $0.31 and $1.37 for the 2018. These annual results do not include approximately $671 million in gains on the sale of real estate, including a $1.4 million, fourth quarter true-up of the previously completed German JV transaction. Here’s a snapshot of MPW’s historical FFO:

As you can see, MPW has an attractive record of FFO growth, and now take a look at the company’s FFO per share history:

As you can see, FFO per share is not as impressive, and of course that’s because the last recession sparked caution, that resulted in a decline in earnings:

Naturally, MPW’s 34% decline in FFO per share forced a dividend cut, as viewed below:

Impressively, MPW has since been able to grow its dividend, as viewed below:

MPW reported that increased its 2019 acquisitions expectations by about $500 million to $2.5 billion over its previous estimate. Consequently, MPW’s new annualized in-place normalized FFO will be $1.54 per share (the last quarter estimate was for approximately $1.50 per share) through 2021. Here’s our FFO per share forecast for 2019-2021:

MPW estimates that the blended GAAP yield of its 2019 acquisitions will fall between 7.5% and 8.5% (an average portfolio yield weighted by investment value). Let’s take a closer look at MPW’s cost of capital to determine the company’s sustainability for future profits and dividend growth.

The Improved Balance Sheet

MPW expects that nominal capitalization rates will likely be lower in areas outside the United States, where the cost of capital is similarly lower than in the U.S. The Australian opportunity is a good example where MPW invests to achieve yields substantially above its cost of capital. The best recent example of this last benefit is the creation of $600 million in virtually free capital through MPW’s German JV.

In December and January, anticipating capital needs for the Australian portfolio (and other likely acquisitions) MPW activated its $750 million at-the-market equity program and sold approximately 11.9 million shares at an average price of $16.75 (or about $200 million in proceeds). As a result, the company had cash balances of approximating $900 million, along with $1.3 billion availability under its revolving credit facility.

Source: MPW Supplemental

Given MPW’s estimate of in-place EBITDA and outstanding borrowings, the current net debt-to-EBITDA ratio is approximates 4.4x. MPW has continued to improve its balance sheet, as viewed below:

Source: MPW Supplemental

Keep in mind, MPW does not enjoy the same unsecured pricing power as Ventas Inc. (rated BBB+ by S&P) but it’s comparable to Omega Healthcare (also rated BBB- by S&P). Given MPW’s “pure play” selectivity and high fragmentation (company said it has a $2 billion acquisition pipeline for 2019) I expect to see continued growth in 2019 and beyond.

All Lights Flashing Green For Medical Properties Trust

Last week while speak to investors at the MoneyShow I explained that one of the most important metrics that I use is the dividend payout ratio. It provides evidence as to whether the company’s dividend is safe and sustainable. Here’s the Payout Ratio history (using FFO per share) for MPW:

As you can see, MPW has done an excellent job of maintaining a healthy payout ratio (since 2009) and this suggests that the dividend is sustainable. Now consider the current dividend yield:

As you see, MPW is now yielding 5.4%, and remember that the shares have recently hit an all-time high. Now let’s examine the P/FFO multiple below:

As you can see (above) MPW is still trading below the peer average, but you must also consider risks such as concentration (MPW’s largest tenant represents ~35% of the revenue) and the balance sheet is inferior to other REITs such a Healthcare Trust of America (HTA), Ventas, Welltower (WELL), HCP Inc. (HCP), and Physicians Realty (DOC). But, as noted in the introduction,” hospitals are essential for emergencies, intensive care and higher-end procedures and the critical demand components offer a compelling runway for growth opportunities”.

So in closing, even though MPW has hit an all-time high, I believe there’s more room to run, and this means that I’m upgraded to a BUY (with a new target price of $16.75 per share)…all lights are flashing green.

Update: The language has been updated to reflect that the buy recommendation is an upgrade; the originally published version said "maintaining a buy."

Author's note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos and be assured that he will do his best to correct any errors if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.

Analyst’s Disclosure: I am/we are long OHI, MPW, VTR, NHI, HTA, DOC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.