Medical Properties Trust (MPW +0.00%) recently made the difficult decision to slash its dividend by nearly 50%. That reduced its current yield from the mid-teens to around 9%. The massive payout cut is a huge blow to income-seeking investors because it will cut a chunk out of their passive income.
However, while the dividend reduction is a tough pill to swallow, it's the necessary medicine for a company that needs to shore up its financial situation. Here's a look at why the healthcare REIT's dividend cut could benefit the company over the long run.
NYSE: MPW
Key Data Points
A look at what prompted the cut
Medical Properties Trust has battled many headwinds over the past couple of years. Several of its tenants have experienced financial pressures following the pandemic, making it more difficult for them to pay rent. That has weighed on the REIT's cash flow, putting pressure on its balance sheet.
Meanwhile, rising interest rates are making it more expensive for the company to borrow money. Add in the REIT's balance sheet issues, and it's facing challenges in refinancing maturing debt. As a result, the company has had to sell properties to repay debt. Those sales have put more downward pressure on its cash flow, leaving its leverage ratio elevated at 6.9 after adjusting for recent transactions.
Those issues recently led Medical Properties Trust to take additional actions to shore up its financial situation. It's cutting the quarterly dividend from $0.29 to $0.15 per share, or by 48.3%. That will reduce its dividend payout ratio from more than 100% of its adjusted funds from operations (FFO) to less than 60%. The cut will enable the company to retain more than 40% of its cash flow for debt reduction, allowing it to deleverage its balance sheet more quickly.
Medical Properties Trust also plans to pursue additional asset sales. It intends to evaluate opportunities to sell more hospital properties outright or via joint ventures. In addition, the company has identified some non-leased and non-real estate assets it can sell. Those latter sales would convert assets that don't currently generate income into cash to repay debt, accelerating its deleveraging.
Following a successful blueprint
Many companies have cut their dividends over the years. Some never recovered from the reduction. However, for others, the cut enabled them to return to a much firmer financial foundation.
One recent dividend cut success story is Energy Transfer (ET 1.77%). The master limited partnership (MLP) slashed its payout by 50% during 2020 to retain additional cash for debt reduction. That strategy has worked perfectly as Energy Transfer has steadily paid off debt over the past couple of years.
NYSE: ET
Key Data Points
The company's leverage ratio is now down toward the lower end of its target range of 4.0 to 4.5. That improving leverage ratio has enabled Energy Transfer to steadily increase its distribution. It returned the payout to its pre-pandemic level earlier this year.
Meanwhile, it's now targeting to increase its payout by 3% to 5% per year in the future. Energy Transfer can afford to grow its distribution because it has a much lower leverage level. That stronger financial profile also allows it to invest in expansion projects and make value-enhancing acquisitions that increase its cash flow.
The hope is that Medical Properties Trust's dividend cut delivers a similar result. It should allow the REIT to retain cash to repay debt more quickly. As leverage improves, it will be in a better position to capitalize on opportunities to make value-enhancing new investments that grow its cash flow. Those factors could eventually enable the company to start increasing its dividend.
The right medicine to heal its balance sheet
Medical Properties Trust's financial situation has deteriorated to the point where it needs to take additional steps to shore up its balance sheet. Cutting its dividend should enable the REIT to return to a healthy financial profile faster. That could eventually put it in the position where it can start sending more money back to investors.
