Shares of Medical Properties Trust (MPW -1.10%) have taken a shellacking over the past 18 months. The hospital real estate investment trust's (REIT's) stock price has plummeted 60% since the start of 2022. Many factors have weighed on the company, including higher interest rates and tenant issues.
That sell-off has pushed the REIT's dividend yield up to nearly 13%. A yield in the double digits is often a sign that the market doesn't believe the payout is sustainable.
However, Medical Properties Trust begs to differ. Here's why the REIT believes it can maintain its payout in a range of inflationary and interest-rate scenarios.
Working hard to overcome its challenges
Medical Properties Trust's cash flow has come under pressure this year due to tenant-related issues and higher interest rates. Its second-largest tenant, Prospect Medical Holdings, currently isn't paying rent. Meanwhile, higher interest rates are making it more expensive for the REIT to refinance maturing debt.
The company has toiled tirelessly to navigate these challenges. It has worked closely with Prospect, helping that company recapitalize its business and putting it in a better position for success. That should allow Prospect to resume paying partial rent in September and full rent next March.
Meanwhile, it has sold several hospital properties, including some leased to Prospect, to help pay off upcoming debt before it matures. It has now addressed all its maturities through next year.
The asset sales and rent deferrals are putting some near-term pressure on its cash flow. Medical Properties Trust only expects to generate about $1.29 per share of adjusted funds from operations (FFO) this year at the low end of its guidance range. That's barely enough to cover its dividend payments of $0.29 per share each quarter ($1.16 annually).
It also puts its dividend payout ratio at 90%. While it could pay out up to 100% of its adjusted FFO, most REITs like to see that number below 80% to provide a cushion and retain some cash for reinvestment.
Tight but manageable
While 2023 will be a tight year for dividend coverage, Medical Properties Trust expects it to improve next year as Prospect fully resumes rent payments. Further, the company has stress-tested its business model for future changes in inflation and interest rates:
Image source: Medical Properties Trust.
As that slide showcases, the company can generate enough cash to cover its dividend and rising interest payments with room to spare each year over the next decade. That outlook assumes no additional investments in acquisitions or capital projects outside those already secured.
The forecasts assume that rent across the company's existing portfolio will rise along with inflation, given the inflation escalation clauses embedded within its leases. The higher the inflation rate, the faster rents grow. That should help offset the impact of higher interest rates as existing debt matures and Medical Properties Trust refinances those borrowings at higher rates.
However, these scenarios also assume that existing tenants continue to pay their contractual rents, which, as we've seen with Prospect, isn't guaranteed. Further, it presumes that Medical Properties Trust can refinance debt at a reasonable rate, which might not be the case during a credit crisis.
Still, if everything goes according to plan, Medical Properties Trust can continue paying its dividend. While coverage would tighten in 2025 through 2028 as the company addresses a significant amount of debt maturities during that time frame, excess cash is projected to grow significantly in 2029 and beyond, driven by rent growth.
It's possible the payout survives
Medical Properties Trust believes it can continue paying its current dividend rate, even as it battles tenant issues and higher interest rates. While dividend coverage will remain tight, rising rents will help offset the impact of higher rates as it refinances debt in the coming years.
However, all that assumes it doesn't run into any other obstacles, which is no guarantee. Because of that, investors shouldn't bank on this dividend. There remains a high risk that the REIT might eventually need to reduce the payout if it runs into another problem.
