Medical Properties Trust (MPW -1.10%) is quite the controversial stock, especially considering its relatively banal business model of buying and renting out healthcare spaces. But there's no scandal piquing investors' strong feelings, just a rather straightforward debate about whether it can perform well financially or not.
So, without further ado, let's look at the case in favor of buying this stock right now to see what all the fuss is about.
Why you might want to buy this stock
The thing that draws a lot of investors to Medical Properties Trust stock is its outrageously high forward dividend yield of 14.9%. With a yield like that, you'd only need to drop around $6,734 to secure $1,000 in annual dividend income. And over the last 10 years, it's hiked its dividend by 45%, so there might be a possibility of further growth down the line.
To pay that dividend, it buys and invests in hospital and clinical real estate, renting out its properties to companies that deliver care. In total, it owns 444 properties, which in 2022 generated free cash flow (FCF) of $739 million. Buying this stock means banking on the continued demand for such floor space, not to mention the sound judgment of management when it comes to picking attractive assets for acquisition. And since people will need to receive healthcare services somewhere, especially more advanced services like surgery, it's reasonable to assume that there will still be at least some hospital companies that will need to rent space from MPT in the future.
In terms of its growth potential, this real estate investment trust's (REIT) business model makes the playbook quite simple. To grow, MPT acquires properties using debt, and then generates rental income to cover both its debt payments and dividend commitments to shareholders. After that, its leases contain built-in annual rent escalators that will contribute to its cash flow more and more over time. Then, as the REIT eventually pays down debt to acceptable levels, it repeats the process. So while it probably won't be expanding very fast anytime soon, many investors probably find the sensation of mathematical certainty about this company's approach to be reassuring.
It's better to pass on this one
The trouble with buying shares of Medical Properties Trust right now is that it's facing down a slew of big macro factors just as its financial constraints intensify. Most of the stated and unstated assumptions investors have about it are likely to be severely tested or invalidated, starting with its core business model. According to a report by Erdman, a healthcare strategy business, hospital admissions will shrink by as much as 25% between 2020 and 2025. So demand for bedspace is slated to fall, which ups the ante because it means MPT might need to compete for tenants.
Beyond that, it's facing an extremely bearish economic environment in which its borrowing costs will be very high. As the Federal Funds rate is currently high due to attempts to control inflation, every loan that the REIT takes out will be far costlier to pay off than its batch of loans from when interest rates were low, which is to say for all debt from the prior 20 years. For reference, the weighted average interest rate for its $10.2 billion in debt is 3.9%, so it is believable that it might be paying twice as much interest per dollar of additional debt until rates fall again. And that's going to put a major crimp on its ability to buy new properties, and also its ability to return capital to shareholders, as its distributable cash flow will be far lower per additional source of income.
On that note, its payout ratio is currently far above 100%, which means that it's regularly paying its shareholders far more than its earnings can support. It's already selling off some of its holdings, like some clinics in Australia, as well as hospitals in Kansas and Texas, to make enough money to cover its debt and dividend obligations in the short term. But every sale reduces the amount of rental income, too. So the coming years will almost certainly see its top and bottom lines contract, and a dividend cut is likely on the table, as it already opted not to raise its payment for 2023.
Don't get distracted by the dividend yield. The dividend may not be there when you need it. Nor is there any guarantee of the shares holding their value over time; they're down by 50% in the last three years, and they might further go south.
So this stock is not a buy, in my view. And you might want to think about selling it before it loses more value.
