Medical Properties Trust: We Maintain Our Buy Rating (NYSE:MPW)

Introduction

Medical Properties Trust, Inc. (NYSE:MPW) is a self-advised real estate investment trust formed in 2003 to acquire and develop net-leased hospital facilities. The firm has been the center of many investors’ attention in the past weeks as one of the largest tenants of MPW has been showing signs of financial weakness. Several contributors on Seeking Alpha have already addressed this problem and gave their unique views on the topic, so we will not be focusing on this anymore. Some of the articles that we enjoyed reading were:

Medical Properties Trust Yields 11%, But Don’t Be Greedy (Sell rating)

Medical Properties Trust: Get Around Equity Risks With 10% Yielding Debt (Hold rating)

Medical Properties Trust Q4: 2 Very Important Takeaways (Strong buy rating)

Our primary focus will be related to the valuation of MPW, using dividend discount models and scenario analysis to try to define a range of realistic fair values. We have also published an article on MPW already in November 2022, titled: Medical Properties Trust: Substantial Upside Potential With A 9% Yield. Back then, we were using the Gordon Growth Model, a relatively simple, one-stage dividend discount mode to come up with the fair value for MPW’s stock. The estimated fair value per share has been between $11 and $14, indicating a potential undervaluation compared to the share price at that time.

Since then, however, due to the above-highlighted tenant-related issues, the share price has plummeted, resulting in a dividend yield of more than 13%.

In light of these developments, we have decided to revisit our valuation on MPW and give an updated view. Once again, our valuation will be based on dividend discount models, but we will be using multi-stage and not single-stage models.

Required rate of return

The required rate of return that we will be using for our calculations will be the same across all scenarios. As in our previous article, right now the required rate of return will also be based on the firm’s weighted average cost of capital (‘WACC’).

Currently, the estimated weighted average cost of capital is somewhat higher than our previously used 11.5%.

Scenario 1

Our first scenario will involve a dividend cut, which the majority of the investors seem to fear the most at the moment. The extent of the assumed dividend cut here is going to be based on MPW’s exposure to Prospect Medical Holdings, the firm which is financially troubled at the moment.

11.5% of the total revenue generated by MPW has been provided by Prospect Medical Holdings.

In this scenario, we assume that revenue in the coming three years will be reduced by this amount. As a result, in the first stage of our dividend discount model, we will be using a dividend, which is reduced also by 11.5% from the current levels, for a period of three years. Beyond the three years, we assume a perpetual dividend growth rate of 1.5%, which corresponds to the firm’s long-term dividend growth rate.

Using these assumptions, we get a fair value of $8.2 for MPW’s stock.

As the stock is currently trading at $8.7 per share, this calculation indicates an additional 6% downside may be possible. Important to point out, that the perpetual growth rate from 2026 onwards has a quite large impact on the calculated fair value. Due to the current uncertainty, however, we are not comfortable with assuming a higher than 1.5% dividend growth rate in perpetuity for the scenario.

Scenario 2

This scenario will be our worst-case estimate. In this case, we will assume that the dividend will need to be paused completely for the rest of the quarters in 2023 plus for 2024 and 2025. From 2026 onwards, we assume that the firm starts paying dividends again, in the same amount as today, meaning $0.29 per share quarterly or $1.16 annually.

For this worst-case scenario, the fair value comes in at $6.7 per share, representing a potential downside of 23% from the current price levels.

In our opinion, this scenario should indeed be treated as a worst-case scenario. Although Prospect is a large tenant of MPW, it only accounts for 11.5% of the total revenue. Even if Prospect will be unable to pay, the likelihood of pausing the dividend is relatively small. If other tenants are also going to have financial difficulties, then we may start to consider this scenario more in-depth.

Scenario 3

This scenario will be a somewhat more optimistic variant. For this case, we assume that the dividend will not have to be cut, and MPW will have enough resources to cover the current dividend payments, however, we are assuming a growth of 0% for the next three years. Afterwards, we expect the dividend growth to continue at a 2.5% rate, somewhat above the firm’s long-term average, but close to the growth rate of the overall economy.

In this scenario, the estimated fair value is $9.9 per share, representing a potential upside of 14% from the current price levels. While this is the most optimistic scenario of the three, we believe it is not unrealistic. Management has been able to largely resolve the issue with Steward, and we are optimistic that they will also be able to do so with Prospect.

To sum up

Based on three different scenarios, assuming different dividend payments in the next three years and also in perpetuity, we have calculated a range of fair values for MPW’s stock. These fair values range between $6.7 and $9.9, with the middle estimate being at $8.3 per share.

So how does it compare with our previous writing? In our previous article, we have estimated the fair value to be in the range of $11 to $14. Back then, the required rate of return, based on the WACC was only 11.5%, more than 2 percentage lower than the current estimate used. The increase in the required rate of return, and therefore the decrease in the estimated fair value, can be directly related to the increased risks related to the tenants and also the current interest rate environment. Both of these factors are likely causing an upward pressure on the cost of capital.

All in all, we believe that the stock is fairly valued at the current price levels with potential upside. While our worst-case scenario is indicating a more than 20% downside, we believe the likelihood of this scenario is relatively small.