Hospital Operators Face Financial Pressure, Clouding MPW's Short-term Outlook

Formed in 2003, Medical Properties Trust (MPW) is one of the world's largest owners of hospitals with around 400 facilities and more than 40,000 beds. The REIT's properties are leased or mortgaged by hospital operating companies.

MPW's largest tenant, Steward Health Care, accounts for close to 25% of its portfolio (down from 38% at the end of 2018). Its next two largest tenants represent 13% and 10%, respectively, and no single property accounts for more than 2.3% of the portfolio.

Approximately 67% of MPW's are located in the U.S., followed by the U.K. (16%), Germany (7%), and Australia (5%).

The coronavirus pandemic has put MPW's tenants (mostly acute care hospitals) under immense financial pressure.

The CDC in March recommended that non-essential surgical procedures and appointments be rescheduled in order to keep beds available for a potential surge in COVID-19 patients and to conserve protective equipment.

Even without government guidelines, many people are doing all they can to avoid non-essential hospital visits to reduce their risk of contracting the virus.

Hospitals make most of their money on elective procedures, so they have seen their largest revenue stream dry up, according to the Wall Street Journal.

For example, Atrius Health, the largest independent physician group in Massachusetts, said recently that patient volume has plunged 75% since mid-March.

Meanwhile, MPW's largest tenant, Steward Health Care, told its hospital employees that it is experiencing a "seismic financial shock" and expects furloughs focused on non-clinical staff, per NPR.

The good news is that the federal government's $2 trillion stimulus package passed last month included $100 billion earmarked for hospitals, and another $75 billion for these facilities is being discussed as part of a new stimulus plan.

However, as MPW stated in a filing on April 8, "it is too soon to accurately predict how and when these government funds will flow to our tenant operators (if at all) and the effect these funds may have in offsetting the cash flow disruptions experienced by our tenant operators."

Over 90% of MPW's properties had a rent coverage ratio (i.e. cash flow, or EBITDARM, to rent expense) between 2x and 3x at the end of 2019. Before the pandemic, this provided a reasonable margin of safety.

MPW also doesn't focus on rural hospitals, which tend to have weaker financial positions. Urban hospitals often have more money in the bank, with up to 400 days of cash on-hand.

But with many hospital operators now struggling to earn a profit, the question is whether this pressure is enough to impact tenants' ability or willingness to pay their full rent or perhaps even force some of them to close certain facilities.

Given the unprecedented financial pressure facing MPW's tenants, we are downgrading MPW's Dividend Safety Score from Safe to Borderline Safe.

The REIT's score could be upgraded quickly if its tenants remain strong enough to continue meeting their rent obligations and demand for elective procedures recovers in the months ahead, helping hospitals climb out of this financial hole.

It's also worth noting that MPW remains in decent financial shape. The company doesn't have any debt that matures before 2022, and less than 1% of its leases expire in 2020 and 2021.

Over 95% of MPW's properties are under long-term master lease agreements with cross-default provisions or parent guarantees as well. 

These terms allow MPW to replace a struggling tenant with a different operator "long before there is a payment default" to minimize disruption, according to management. 

However, if needed, it could be more challenging to find a new operator in this environment, reducing MPW's leverage in any potential negotiations.

Perhaps the biggest uncertainty is caused by MPW's acquisitive nature. Only a small percentage of the world's acute hospitals are leased, so management is eager to continue buying more facilities.

In 2019, MPW made $4.5 billion of acquisitions, and this year management saw potential to buy up to $5 billion of properties. For context, MPW's market cap is about $9 billion today.

With annual retained cash flow after paying dividends of only around $150 million (an adjusted payout ratio of 75%), MPW relies heavily on issuing debt and equity to fund its growth.

Once MPW closes its $2 billion acquisition announced in late 2019 for 30 acute care facilities in the U.K., the firm's net debt to adjusted EBITDA ratio will rise to 6x.

Management planned to deleverage back to 5.5x this year, so there may not be as much flexibility to reduce debt, continue making acquisitions, and pay a generous dividend in the event that any of MPW's major tenants run into significant financial difficulties.

We will find out more about the state of MPW's tenants when the firm next reports earnings in early May. Management increased the dividend by 4% in February and should be able to continue the payout with ease assuming there are no major surprises. 

MPW's long-term outlook arguably hasn't changed either. As new information becomes available, we will provide updates as needed.