Income investors must tread lightly when a stock's dividend yield is around double digits. It's often a warning sign that the market doesn't believe the payout is sustainable.
A dividend cut is certainly on the table for Medical Properties Trust's (MPW 0.40%) ultra-high-yielding payout, and that means income-focused investors should avoid the healthcare REIT. However, the opposite is true for Energy Transfer's (ET 0.06%) massive distribution, which seems likely to keep rising. That makes it an optional choice for those seeking a sizable passive income stream.
An unhealthy payout
Shares of Medical Properties Trust have tumbled more than 40% from their 52-week high because of headwinds from higher interest rates and tenant-related issues. That has driven its dividend yield up over 14%.
NYSE: MPW
Key Data Points
The REIT has taken actions to address its issues, including providing financial support to ailing tenants and selling assets to repay maturing debt. However, its financial profile continues to deteriorate. That leaves everything on the table, including a dividend reduction.
A payout cut seems likely. While the REIT is currently generating enough cash to cover its dividend, it faces a shortfall in the third quarter when its adjusted FFO could dip below its current dividend payment. On the one hand, that's likely a temporary blip because it expects a key tenant to resume making partial rent payments in September with full repayments on track to resume next March. Meanwhile, inflation-linked rate escalation clauses in existing leases should boost its rental income next year.
On the other hand, the REIT has a mountain of debt to address. Its leverage ratio is currently around 7, which is high for a REIT. On a positive note, leverage will come down as the company completes some pending property sales to eliminate its debt maturities through next year. However, it has a lot of debt maturing in 2025 and beyond. One of its options is to cut the dividend now and use that cash to reduce debt while it works on alternatives like asset sales. That's becoming an increasingly likely scenario.
Back on a firm foundation
Energy Transfer was in Medical Properties Trust's situation a few years ago. The energy midstream company made the difficult decision to slash its payout by 50% in 2020 to reallocate that cash flow toward debt reduction. That strategy worked. It has paid off a lot of debt in recent years. As a result, leverage is now trending toward the lower end of its 4.0 to 4.5 target range.
NYSE: ET
Key Data Points
With leverage improving, Energy Transfer has been able to increase its distribution payments to investors. It returned the payout to its pre-pandemic level earlier this year and has since increased it a few more times. Energy Transfer aims to increase its distribution, which currently yields 9.5%, at a 3% to 5% annual rate.
The master limited partnership (MLP) can easily afford its big-time payout. It generated nearly $1.6 billion in cash during the second quarter, enough to cover its distribution with $579 million to spare. It used the retained money to finance expansion projects ($387 million of growth capital expenses) and strengthened its balance sheet.
The MLP has a growing list of expansion projects that should grow its cash flow in the future. Meanwhile, it has ample financial flexibility to make opportunistic acquisitions. It recently completed its nearly $1.5 billion acquisition of Lotus Midstream. The leverage-neutral transaction will be accretive to its distributable and free cash flow, providing further support for distribution growth.
The choice is clear
While Medical Properties Trust and Energy Transfer currently offer big-time yields, they appear to be heading in different directions. Medical Properties' payout seems ripe for a reduction, while Energy Transfer has ample fuel to continue increasing its distribution. Investors should avoid buying Medical Properties for income and instead consider investing in Energy Transfer.
