Medical Properties Trust Is Hitting All Cylinders And More

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About: Medical Properties Trust, Inc. (MPW), Includes: DOC, HTA, OHI, VTR
by: Brad Thomas
Summary

As we scout the universe for value, we have always been attracted to the hospital sector because of healthy fundamentals.

Since the upgrade, Medical Properties Trust has returned ~24% and the stars have lined up beautifully.

I’m glad we caught the wave early, and we will continue to ride the upsurge as hospital consolidation continues.

With equity markets in a “flight to quality” transition and demographic tailwinds on the horizon, the healthcare REIT sector was somewhat of a surprise outperformer in 2018 despite mixed fundamentals and struggling tenants. With rising share prices come more external growth opportunities, a key driver for the sector.

Who would have believed that Omega Healthcare Investors (OHI) would have been a top performer in 2018 (shares returned a whopping 37%), as the pure-play skilled nursing REIT has continued to mitigate restructuring risks with prudent portfolio recycling?

One of the reasons we maintain research across many property categories is because it provides us with a competitive advantage in which we can screen for the best opportunities. Within our coverage universe, we gather data and research on over 150 companies with a granular focus on harvesting the best risk-adjusted returns. (In a few weeks, I am excited to launch my decade-long quest in which iREIT Investor will become the bellwether for REIT Research).

We continue to have high confidence in healthcare REITs with the most durable sources of income, namely companies like Healthcare Trust of America (HTA), Physicians Realty Trust (DOC), and Ventas, Inc. (VTR). High-quality life science and MOBs (medical office buildings) are the two healthcare asset classes in which REITs have realized sizable cash gains in recent years.

However, as we scout the universe for value, we have always been attracted to the hospital sector because of healthy fundamentals. Across the sector, net revenues have steadily increased approximately 5.5% each year, from $580 billion in 2006 to $975 billion in 2016, according to American Hospital Association Statistics. Operating margins have been stable, and the Centers for Medicare and Medicaid Services (or CMS) project’s hospital expenditures will grow from $1.1 trillion in 2016 to nearly $1.8 trillion in 2026 as an aging population increasingly consumes hospital services.

In addition, Medicare reimbursement to hospitals is expected to grow by more than 7% compounded annually through 2026. For many years, a growing percentage of hospital revenue has come from treating patients on an outpatient basis. This long-term trend is expected to continue, and hospital operators will capture a substantial portion of this expanding revenue. There is a common misconception that outpatient revenue decreases the total revenue of a hospital, but the reality is just the opposite.

One of our top picks in 2018 was Medical Properties Trust (MPW), a “pure-play” REIT that focuses exclusively on hospitals (because they represent the largest opportunity for profitable growth). We upgraded the company from a HOLD to a BUY in September 2018, and in an article I explained that the “company is likely to generate mid double-digit returns over the next 12-24 months. We are now recommending upgrading from HOLD to BUY.”

Since the upgrade, MPW has returned ~24% and the stars have lined up beautifully. We believe that this Alabama-based REIT has all of the ingredients to continue to outperform, as the management team is doing an excellent job balancing revenues, cost of capital, and dividend growth. And now that 2018 is in the rear-view mirror, it’s time to take a closer look at 2019...

(Photo Source)

Why This REIT?

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

(Source: MPW Supplemental)

MPW’s largest tenant is Steward Health Care, one of the premier hospital operators in the U.S. Its integrated model of health care delivery, with acute care hospitals at the hub of its health system, has resulted in Steward becoming the country’s largest privately owned operator with 33 hospitals spread across six distinct regions.

(Source: MPW Supplemental)

MPW recently estimated its pipeline of potential acquisitions to exceed $5.0 billion, half of which it hopes to complete in 2019. Almost every operator in that pipeline, starting with the recently announced $859 million Australian transaction, is new to the company. It expects Steward’s portion total assets will improve to approximately 30% in the near term and even further as MPW continues to grow through acquisitions around the globe.

According to MPW’s CEO (in a Forbes interview), “the U.S. offers the most advanced health care in the world and people travel here from all countries to receive the best possible care. It’s a huge market and we have tremendous opportunities in the U.S. for continued growth. Sometimes, though, legislative and regulatory actions interfere with operators’ abilities to plan strategically”.

(Source: MPW Website)

The company continues to target approximately 30-35% of investments internationally in countries where there is a deep respect for the rule of law, political and economic stability, and a strong commitment to health care for the country’s populace. As Edward Aldag explained, “results since our initial international investment in 2013 have been outstanding, including the gain of more than $500 million we realized last year when we sold part of our German portfolio into a joint venture”.

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(Source: MPW Website)

The Balance Sheet

MPW’s current blended cost of capital allows the company to achieve very attractive investment spreads in each country it operates in. There are few REITs that are able to rapidly grow while generating immediate accretion per share results.

Keep in mind that one of the purposes of the German transaction was to open up a new source of capital that takes advantage of growing investor demand for MPW’s assets and lowers the cost of capital even further. This joint venture with a large, sophisticated institutional investor demonstrated a value for the assets that created an approximate €500 million gain and an unlevered internal rate of return exceeding 15% since the acquisition of the assets.

(Source: MPW Investor Supplemental)

At the end of Q4-18, MPW had cash balances of approximately $900 million along with $1.3 billion of availability under the revolving credit facility. Given the estimate of in-place EBITDA and outstanding borrowings, the current net debt-to-EBITDA ratio is approximately 4.4x.

(Source: MPW Investor Supplemental)

MPW currently has an acquisition pipeline close to $5 billion, of which it expects to close one-half in 2019. The company has created a market for hospital real estate that did not previously exist, and the size of opportunity in that market is virtually immeasurable. As it continues to grow, more investors are attracted and more operators understand the benefits of the sale and leaseback structure.

(Source: MPW Investor Supplemental)

Latest Earnings Results

In Q4-18, MPW reported normalized FFO per share of $0.31 and $1.37 for the year. 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 German joint venture transaction.

The company reported that it increased the 2019 acquisitions expectations by about $500 million to $2.5 billion over the estimate from the third quarter. Thus, MPW now estimates that upon completion of the $2.5 billion in expected 2019 acquisitions, its annualized in-place normalized FFO will be about $1.54 per share.

MPW continues to improve its long-term dividend payout ratio while increasing annual dividends. The payout ratio is in the low 70% range, where it expects to remain over the foreseeable future as the company systematically increases the dividend according to the growth in normalized FFO per share.

(Source: Rhino Real Estate Advisors)

Impressively, MPW has since been able to grow its dividend, as can be seen in the chart below:

(Source: Rhino Real Estate Advisors)

How To Play This Pure-Play REIT

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) in this regard. Given MPW’s “pure-play” selectivity and high fragmentation (the company said it has a $2.5 billion acquisition pipeline for 2019), I expect to see continued growth in 2019 and beyond. As can be seen below, it has done an excellent job of balancing capital requirements and dividend safety:

(Source: Rhino Real Estate Advisors)

As you can see below, MPW trades at 13.2x P/FFO and the historical multiple has been 12.1x. This suggests that the shares have become a bit expensive, comparatively speaking:

(Source: F.A.S.T. Graphs)

However, I am attracted to MPW’s growth prospects. As seen above and highlighted in yellow, the company is forecasted to grow FFO per share by 9% in 2020. Given that outsized growth opportunity, I am definitely holding onto my cheaper shares. We are still maintaining a BUY on MPW, but we would not “back up the truck” at this time (wait on a pullback). Our model (below) suggests that investors could expect to see returns of around 10% from now through the end of 2019. I’m glad we caught the wave early, and we will continue to ride the upsurge as hospital consolidation continues.

(Source: F.A.S.T. Graphs)

Author's note: Brad Thomas is a Wall Street writer, and that means he's 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.

Disclosure: I am/we are long MPW. 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.