North American real estate investment trust Medical Properties Trust Inc. (MPW, Financial) shed up to 4% of its market value on Monday morning after RBC Capital downgraded its outlook on the asset.
Michael Carroll spoke on behalf of RBC's sell-side recently, stating the bank believes "management will need to be more proactive in reducing leverage and improving liquidity via dispositions, and a near-term dividend cut is likely needed." He also added that RBC will be "incrementally more concerned if these don't occur."
Although RBC Capital's stance is understandable, it seems slightly reactive to a singular event, namely the REIT's second-quarter earnings report. As such, I decided to assess the matter in more depth.
Let's traverse into a deeper conversation about Medical Properties Trust.
Second-quarter earnings and outlook
Medical Properties Trust's second-quarter earnings settled above expectations. However, investors were troubled by its outlook as management tightened estimates, concurrently raising speculation about a dividend cut.
During Medical Properties Trust's second quarter, the entity achieved normalized funds from operations per share of 48 cents, topping estimates by 11 cents. Furthermore, the company achieved quarterly revenue of $337.4 million, falling just short of the $348.4 million consensus.
Following its core earnings release, Medical Properties Trust dropped its full-year guidance, which shocked the market as the company has lost more than 10% of its value ever since. According to the REIT's renewed full-year guidance, it will likely achieve net income per share of 33 cents, 4 cents lower than its initial guidance.
Cost of capital concerns
One of the primary analytical talking points from Medical Properties Trust's earnings is the juxtaposition between the cost of capital and dividend sustainability.
As shown in the diagram below, Medical Properties Trust is battling exceptionally high borrowing costs relative to other mature REITs. Moreover, the vehicle's dividend yield of 14.36% is high, yet can be sustained during a period of elevated borrowing costs as Medical Properties Trust has a low payout ratio; however, maintaining its dividend might, as a result, stem a higher cost on equity capital due to elevated residual claims risk.
If Medical Properties Trust's equity risk premium rises, its fair market value will likely depreciate.
Source: Medical Properties Trust
Portfolio updates
Let's take a look at Medical Properties Trust's latest portfolio updates.
For those unaware, the company's largest operating partner is Stewards Health Care Systems, which specializes in general acute health care facilities. Although generally a fruitful relationship, Steward is considered a drag on the rest of the portfolio as it runs the REIT's concentration risk high.
Source: Medical Properties Trust
However, short-term positives have emerged as Steward recently refinanced its revolving credit facility after paying back debt five months ahead of schedule, in turn improving the outlook on counterparty risk between Steward and Medical Properties Trust. As part of Steward's refinancing, Medical Properties Trust committed $140 million in capital to the tenant as part of a syndicated loan, which includes Sound Point Capital Management and Brigade Capital Management.
Many seem concerned about the Medical Properties Trust-Steward credit agreement. However, I believe it unlocks additional value as a high-yield diversification strategy.
Other downgrades on Wall Street
In addition to RBC Capital's downbeat announcement, Medical Properties Trust received numerous bearish calls from Wall Street analysts. For instance, Bank of America (BAC, Financial) recently assigned an underweight rating to Medical Properties Trust, citing increasing tenant concentration as a critical risk amid a looming recession.
Furthermore, Jonathan Hughes from Raymond James slashed his outlook, stating that the firm "believes MPW management will be spending years trying to regain its cost of capital, subsequently impacting the ability to grow, and it can no longer recommend even a neutral rating."
Although sell-side analysts' analyses are questionable at times, their announcements have a significant effect on market sentiment. As such, I believe investors would be wise considering Wall Street analysts' net bearish outlook on Medical Properties Trust.
Valuation
Liquid real estate analysts generally utilize two interchangeable valuation metrics to determine the fair value of a real estate investment trust. The first is the price-to-funds from operations multiple, which is the easiest to interpret. In contrast, the second, the price-to-adjusted funds from operations multiple, is used by analysts trying to make economic sense of a REIT's valuation.
Medical Properties Trust's price-to-funds from operations ratio of 4.74 is well-placed as it ranks within the 90th sector percentile. In addition, its price-to-adjusted funds from operations ratio of 5.73 is equally alluring as it is below its five-year cyclical average of 14.55.
Relative valuation is often an abstract concept as it attempts to draw conclusions based on the interface of an asset's accounting metrics. Nevertheless, it is a methodological process that has proven to be a key indicator. Thus, Medical Properties Trust's alluring price multiples present a sense of encouragement.
Final word
RBC Capital's take on Medical Properties Trust seems warranted, given its lackluster capital structure and obligation to sustain its dividend payout, which might coalesce and result in an elevated idiosyncratic equity risk premium. Moreover, lower earnings guidance and a barrage of downgrades on Wall Street add significant headwinds to the REIT's market value.
Although positives such as a new high-yield credit endeavor and compelling valuation multiples exist, Medical Properties Trust seems up against it going into the back end of 2023.
