MPW's Dividend Coverage Further Pressured by Australian Asset Sale, Tighter Financial Conditions

Medical Properties Trust (MPW) on Wednesday announced a deal to sell its 11 Australian hospitals leased to Healthscope for roughly $800 million, the same price it paid to acquire this real estate in 2019 (ignoring exchange rate fluctuations).

Proceeds from the sale will be used to prepay a term loan maturing in 2024 that MPW had taken out to fund its acquisition of the Healthscope portfolio.

This transaction improves MPW's liquidity but will reduce the REIT's cash flow as these 11 hospitals contributed approximately $54 million of rent (3.7% of total revenue), but annual interest on the 2.45% term loan was just $20 million.

All else equal, we estimate this transaction will increase MPW's payout ratio to around 95%.

As we discussed in February, asset sales pose a threat to MPW's dividend even though they can help the REIT manage its debt profile:

 
While the divided could technically remain covered by cash flow this year, tighter financial conditions from recent stress in the banking sector muddy the outlook.
 
After Silicon Valley Bank failed in early March, just one U.S. borrower with a junk credit rating has tapped the high-yield market, according to the Financial Times. Interest rates for risky U.S. bonds now average almost 9%, up from less than 6% just over a year ago.

Some of MPW's weaker tenants, already challenged by high labor costs, could find borrowing more difficult and expensive, straining their ability to continue paying rent.

Steward, which will account for around 20% of MPW's revenue after selling its Utah operations, already had trouble renegotiating its maturing credit facility last year. The firm ultimately extended the facility by one year but may require additional financial support in the future. 

Tighter lending conditions aren't great for MPW either, which earlier this month saw S&P downgrade its credit rating further into junk territory from BB+ to BB.

Proceeds from the Healthscope divestiture and previously announced asset sales should cover the REIT's 2023 and 2024 debt maturities. And while less than 10% of MPW's debt has variable rates, approximately $1.4 billion of fixed-rate debt comes due in the first quarter of 2025.

These loans carry an interest rate near 2.5%. If this debt was refinanced at an interest rate of 8%, MPW would face additional borrowing costs of $75 million.

That would offset incremental cash flow earned from contractual rent increases over the next two years, keeping MPW's payout ratio near 100%. And that assumes no additional divestitures or missed rent payments occur, which would put more pressure on dividend coverage.
 
MPW's liquidity, including $235 million of cash and nearly $900 million of availability on its variable-rate credit revolver, provide some breathing room to manage its debt over the next few years if longer-term financing is unavailable.

But management may feel increasingly uncomfortable maintaining elevated leverage and a rising payout ratio given tighter borrowing conditions and lingering tenant credit concerns.

Recognizing MPW's diminishing margin of safety, we are downgrading the company's Dividend Safety Score from Borderline Safe to Unsafe.

If management eventually decides to reduce the dividend, a cut of around 30% seems most likely. That would put MPW's payout ratio closer to 70% and retain over $200 million of cash flow for debt reduction or accretive acquisitions.

MPW's shares would still yield near 10% if the dividend was lowered by 30%. Some income investors who still believe in the value of the REIT's hospital real estate may be comfortable accepting that risk given the stock's depressed valuation.

Shares of MPW trade at about half of their book value ($14.38 per share), down from a multiple near 1 just a few months ago. Book value represents the recorded value of a company's assets, net of all liabilities.

Investors are pessimistic that MPW's properties are worth what the firm paid for them. Selling the REIT's Australian hospitals at a breakeven price could inspire more confidence in the value of MPW's real estate and help the stock's valuation multiple recover, though these properties are just one part of the portfolio.

If we owned shares of MPW, we would be tempted to keep holding the stock (with a tight leash) since its valuation has been so punished and the company does not appear to face any imminent liquidity concerns.

Longer term, if we had to reach for yield with a small portion of our portfolio, we'd prefer to own investment-grade-rated business development companies like Ares Capital (ARCC) and Sixth Street Specialty Lending (TSLX) over MPW.

As always, we will keep an eye on MPW and provide updates as needed. The firm will release its first-quarter earnings report in late April and declare its next dividend payment around a month later.