Shares of Medical Properties Trust (MPW -1.10%) have taken a beating during the current bear market. The healthcare REIT's stock price is down more than 60% from its peak since the market swoon began in early 2022. While the company is facing some significant headwinds, it believes the market has taken its valuation way down too far.
Driving that view is the wide discount between its current valuation, historical trading ranges, and those of its healthcare REIT peers. They imply Medical Properties Trust could have more than 100% upside potential once its current headwinds fade and its valuation recovers closer to its historical norms.
Diagnosing the problem
Medical Properties Trust's stock has plummeted due to a range of problems, including:
- Surging interest rates: Higher interest rates have affected Medical Properties Trust's ability to borrow money to refinance debt and make acquisitions. That has put pressure on its balance sheet and affected its ability to make acquisitions. It has been selling properties to pay down debt and fund new investments.
- Tennant issues: The REIT's top two tenants, Steward Health Care and Prospect Medical, are under significant financial pressure following the pandemic. It has affected their ability to fund their operations and refinance debt. Prospect isn't paying rent but will resume partial payments this fall.
- Short-seller attacks: Investors who have shorted Medical Properties' stock have published what the company has called "false and misleading claims" about its strategy. It has filed a lawsuit against them.
The market remains worried that higher interest rates and tenant issues will eventually force the REIT to slash its dividend. That's why it currently yields more than 10%. The REIT believes it can continue paying its dividend. However, a cut isn't completely off the table.
A massive disconnect
Despite the issues, Medical Properties Trust's underlying business has held up relatively well. Higher interest rates have yet to have much impact because the REIT primarily has long-term fixed-rate debt. Meanwhile, it continues to have solid rental collection rates outside of rent due from Prospect Medical.
The REIT accordingly expects to generate between $1.50 and $1.61 per share of normalized funds from operations (FFO) this year. That compares with $1.82 per share last year, implying a 12% to 18% year-over-year decline. That decline is due to property sales and the current rent deferral agreement with Prospect Medical. Meanwhile, adjusted FFO, a better proxy for the free cash flow generated to pay dividends, would be $1.29 per share at the low end of the range. That's more than its current annual dividend outlay of $1.16 per share.
With shares falling more than 60% even though earnings will decline by only a mid-teens rate, the company currently trades at a deeply discounted valuation:
Image source: Medical Properties Trust.
As that slide showcases, the REIT currently trades at about 5.3 times normalized FFO and 6.6 times adjusted FFO. That's a significant discount from its historical trading level and the current peer group average. The company also trades at a wide discount to the net asset value (NAV) of its hospital portfolio, even though hospital property values have held up well during the current downturn, as evidenced by recent asset sales.
These metrics suggest the company's share price has more than 100% upside potential as the discount between its current valuation and historical value narrows. That should occur as the headwinds holding down its stock fade. For that to happen, interest rates must stabilize, giving the market more insight into the company's future cost to refinance existing debt. In addition, Prospect Medical must resume paying rent -- partial payments should begin in September, with full rent starting next March -- and the REIT needs to eventually monetize its interest in that company's managed care business.
A high-risk, high-upside opportunity
Medical Properties Trust isn't for the faint of heart. It's facing significant headwinds that could eventually cause the company to slash its dividend.
However, the hospital REIT trades at a massive discount to the underlying value of its hospital properties and cash flows. It has significant upside potential for investors willing to take on the near-term risk of more volatility and a possible dividend cut in exchange for what could be a sizable long-term payoff.
