|Shares Out. (in M):||161||P/E||12.2x||11.1x|
|Market Cap (in $M):||1,982||P/FCF||12.2x||11.1x|
|Net Debt (in $M):||1,320||EBIT||177||232|
|TEV (in $M):||3,302||TEV/EBIT||19.0x||14.0x|
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Basic Thesis – Long MPW
Medical Properties Trust is a severely beaten up hospital REIT that has traded down substantially on rate fears, a recent equity offering and an acquisition at an “unattractive” 8% cap rate (typically management targets a 9-11% cap rate on deals). While management perhaps erred in issuing shares at an oversold level in mid August, I deem the offering/acquisition a wash, one not justifying a 15% pullback in the stock. Since late May, MPW is down 35% and now trades at 12.0x TTM FFO, a 9% cap rate, and a 6.5% dividend yield. Not only that, but it is one of the least levered REITs at 5.2x Debt/EBITDA, and has a payout ratio of only 72% on 2014 numbers. Proforma for its recent acquisitions, FFO/share has grown at a CAGR of 14% since 2010.
I also believe rate fears are overbaked into MPW. Looking the company on a spread to treasuries basis, MPW’s median spread to the 10 year has been 475bps since 2006. Today’s spread is at 625bps. MPW seemingly implies 150bps in further widening in the 10 year – e.g. the market is pricing in 4.25% yields even though forward curves don’t imply that kind of level until 2017.
While MPW has 10+ year duration leases, inflation risk is minimal here. The company has full CPI escalators on 80% of its rents (30% of which do have a 5% cap, but many with floors too), with the other 20% having average annual rent increases of 2.9%. Compare that to many office REITs with 1-2% fixed rate escalators and very little in the way of CPI adjustments.
As far as Obamacare is concerned, while there might be some lower pricing for hospitals and rehab facilities, higher volume (as insurance coverage grows) likely offsets much of this. In any case, demographics are huge tailwinds to MPT’s lessees going forward, and much of the reimbursement pain has already happened (2% cut to all Medicare payments for example hit in March 2013).
MPW is a self managed REIT focused on owning net leased healthcare facilities, primarily hospitals. Its portfolio consists of 82 facilities: 27 hospitals, 24 long term acute care hospitals, 15 inpatient rehab centers, 2 medical office buildings, and 6 wellness centers. They recently acquired 3 more hospitals from Iasis Healthcare for $283mm, an 8+% cap rate according to management. Just last Friday, MPW announced a deal to acquire 11 German rehab hospitals, a deal which by my math is at least 3c accretive and will be debt financed. 91% of their facilities are in urban/suburban locations.
No single property accounted for more than 5% of revenue, but there is concentration among the portfolio in terms of lessees. The biggest lessees are:
1) Prime Hospital Services, with 11 facilities pursuant to a master lease agreement that expires July 2022 (with 5 year extension options). CPI escalators are in place with 2% minimums. MPW also holds mortgage loans on 3 other properties, totaling 22% of the portfolio by assets. Prime has generated some bad press, primarily from the union that represents its workers, and that has led to several past investigations from California as well as from Federal regulators. To date, Prime has been cleared of any and all overbilling claims, and given that rent coverage is between 3.5 and 4.0x according to my conversations with management, it’s hard to see how fines or reimbursement cuts for the alleged overbillings would be enough to impact rent payments or MPW directly. Even in the event of a worst case scenario (extrapolating a Tenet-sized % fine on Prime), would only lower rent coverage by 1 turn (from say 3.75x to 2.75x). On the flip side, Prime has been voted a top 15 hospital system in the US by Truven Health Analytics (out of 328 hospital systems). Several Prime hospitals also have made the top 100 individual hospitals. Having a master lease structure also means that Prime cannot file for Chapter 11 and cherry pick which leases to assume or reject – it’s all or none. Overall, I deem Prime a good tenant with well-located facilities, about half in southern California.
2) Ernest Health leases 12 facilities pursuant to a master lease agreement. As of Dec 2012, there are 19 years remaining under these leases. Generally MPW has funded the construction of several new rehab facilities/LTACs for Ernest. EBITDAR coverage is lower while these facilities ramp up, but newer facilities generally will be more attractive and should improve over time.
3) Lifecare Hospitals has one hospitals rented from MPW. Last Dec 2012, Lifecare (owned by Carlyle Group), filed for Chapter 11. Fortunately for MPW, the lease was immediately affirmed in bankruptcy and the company has not missed a payment.
4) One facility in Monroe, Indiana just went on non-accrual status. St Vincents, a big chain, just purchased this hospital. If no rent is paid in 2013, it would impact FFO by 2-3c. A working capital loan to Monroe has already been marked down.
Others include Kindred Healthcare, Iasis Healthcare, Community Health Systems (2nd largest for profit chain in the US), Healthsouth (largest rehab hospital chain).
Medical Properties was founded by real estate investor Edward Aldag in 2003. The company IPO’d in 2004, and since has completed approximately 1 equity offering per year to fund growth. In the early years, MPW capitalized themselves fairly aggressively, with high leverage (8-11x) and a payout ratio that was often over 100%.
Several events transpired to reduce FFO in 2009 and 2010. First, Hurricane Ike damaged 2 Houston hospitals in Sept 2008, and they remained vacant for 18 months or so. The company was insured but spent $3.5mm on property related expenses while collecting zero rent. Second, 3 Hospitals defaulted on payments in 2008 due to the financial crisis (HPA was the tenant). MPW also took a $12mm impairment charge on a $30mm working capital loan to its Monroe Hospital in Indiana in 2010.
At almost 9x leverage, MPW needed capital and raised $68mm in equity at a heavily dilutive price of $5.40/share in January 2009. FFO declined from $1.13 in 2008 to $0.66 by 2010.
Post crisis, management embarked on a deleveraging strategy. From a peak of 11x debt/EBITDA, MPW brought leverage down to 4.3x by end of 2012. Today, management has guided to a range of 5-5.5x EBITDA, reasonably conservative levels in REIT-dom. Proforma for the 3 hospitals acquired this summer and the German rehab hospitals, MPW will be 5.2x debt/EBITDA.
One criticism of the company has been its dividend policy. In essence, the dividend has remained flat from 2009 to today at 80c/year. Given the share dilution and hospital issues, it’s surprising that management continued to pay the 80c. Today the company targets an 80% payout ratio. By my math, FFO on a next 12 month basis (proforma) will be around $1.11. Conversations with management lead me to believe that is possible that the next quarter will include a long awaited dividend bump, probably to 84-88c. At 86c, the yield would be 7.0% and still only a 77% payout ratio on go forward numbers.
Overall lease coverage has improved substantially from 2006 to today, and 4.2x lease coverage is considered quite good.
Debt wise, there are no maturities until 2016 and 89% of its debt is fixed rate.
Valuation & Comps:
Best comps include Health Care REIT (27% SNFs, 29% ALFs, 6% Hospital), HCP, Ventas and Healthcare Realty Trust (mostly medical offices).
At an 86c dividend for MPW, the stock would yield 7.0% vs comps at 4.8% today. At similar yields as the comps (4.8%), MPW would trade at $18.00, up 46% from current prices without dividends.
On an FFO basis, MPW at 14x (a 10% discount to comps valuation) would trade at $15.80, up 32%.
According to Real Capital Analytics, prices paid for medical offices in private transactions have averaged 7.6% cap rates over the past year. Public REITs tend to operated better quality and larger facilities than those privately held, but assuming this kind of cap rate would imply $14.75 in fair value for MPW - up 20%.
The downside could be $10 per share assuming missed earnings and a weak 10x FFO multiple. With 80c in dividends, that implies 10-12% down over a year vs upside cases of 22 to 45%.
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