A dividend cut isn't something income investors want to see. A reduction in a payout can be a big blow to their portfolios, but sometimes it's necessary. Last week, Medical Properties Trust (MPW -1.10%) announced it would be slashing its payouts by nearly 50%. It's a move the real estate investment trust (REIT) likely needed to make, however. And by doing so, it could win back some investors. Here's why the dividend cut may end up helping this beaten-down stock.
Investors may have been anticipating it
Medical Properties Trust is an income stock whose portfolio focuses on hospitals. Hospitals, unfortunately, have been struggling since the start of the pandemic and that has put the REIT into a tough situation. And on Aug. 21, it announced it would be reducing its quarterly dividend from $0.29 per share to $0.15. Yet despite such a massive decrease in its quarterly payout, shares of the company didn't nosedive. In fact, the stock finished the week at $7.01 -- higher than the $6.93 it was at a week earlier.
The dividend cut didn't lead to a massive sell-off in the share price, which is a sign that the move didn't surprise the market. With a former dividend yield approaching 17%, many investors may have been wary of the extremely high payout to begin with. Once a yield is up over 5%, investors start to question whether it's sustainable. At more than 10%, a dividend cut often appears inevitable.
If management holds off on making a reduction to the payout when the yield is so high, investors may lose confidence in the company and its ability to make the tough decisions and do what's right for the business, which could then negatively impact the stock price. Year to date, shares of Medical Properties Trust are down 37%.
The move frees up resources and gives Medical Properties Trust more breathing room
In the company's most recent earnings report, which was for the period ending June 30, Medical Properties Trust posted adjusted funds from operations of $0.41 per share, up from $0.35 per share in the prior-year period. That's better than the $0.29 per share that Medical Properties was paying in quarterly dividends. But with the company still facing headwinds due to worsening economic conditions and some of its tenants already struggling to pay their full rent, the REIT wasn't in terribly great shape moving forward.
What can often be more indicative of a company's ability to pay dividends is how much free cash flow it has left over after paying dividends. And that number was negative last quarter.
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In the press release announcing its decision, Medical Properties Trust stated that the REIT believes it will now benefit from greater financial flexibility, allowing it to pay down its debt, which tops $10.2 billion.
Is Medical Properties Trust a buy?
Shares of Medical Properties Trust are trading near their 52-week low. And although the dividend is much lower now, even at $0.15 per share quarterly, it's yielding 8.6%, which remains well above the S&P 500 average of 1.5%. Investors may also look to the consensus analyst price target for the stock, which is above $11, as proof that the REIT is undervalued. However, price targets have been coming down for Medical Properties Trust in recent months, and more downgrades could be coming.
Ultimately, while the dividend cut is a good move for the business, it's not enough to make Medical Properties Trust a good buy right now. The REIT still has a lot of work to do in showing investors it's on the right track, such as improving cash flow and making strides in bringing down its debt load. As of now, this is a company that's in the midst of a transition and it remains a risky investment. Investors are better off taking a wait-and-see approach with the business.
