(Note: This was in the October 27, 2022 newsletter.)
Medical Estate Trust (New York Stock Exchange:MPW) management has gone to great lengths to reassure investors that all is well. But despite an upbeat third quarter report, the market seems focused on the increasing rate of children hospitalized for rhinovirus and associated complications. While this event is concerning, it is important to distinguish what is happening now from what happened during the pandemic.
There is a normal peak season for this industry that goes with “flu season”. In this case, many normal critters did not “do the rounds” with the children because they were at home. So children are now “catching up” on the latest viruses and more than usual are going to the hospital at an unusual time. Still, there is little to no sign of a hospital overflow on the scale of what has happened during the pandemic.
Nonetheless, Mr. Market is only too happy to hit the panic button with stories of outlandish and painful deaths. The pandemic canceled many profitable operations and replaced many patients who couldn’t pay. The government did help, as this administration clearly pointed out in the last conference call. But the absence of profitable parts of the business clearly hurt the operators. The market fears another spike in critical cases that would once again shut down profitable parts of hospitals, causing many financial problems for operators too soon after the latest round of trouble.
But pandemics are generally a once-in-a-lifetime event (if often). Whereas flu season fever (in this case, rhinovirus and associated childhood illnesses) is generally a much lower level affair. There is an unknown that constitutes a risk because things could escalate unexpectedly. But it is very likely that operators will continue to recover from the challenges of the pandemic like any other industry that has hit rock bottom.
Management mentioned an operator that filed for bankruptcy. But they also mentioned that the same operator was likely to continue services at the relevant hospitals and pay the bills that matter to the Medical Properties Trust. This points out that bankruptcy does not have to be a financially destructive affair for related parties. In fact, bankruptcy is often not an issue for a secured lender. Instead, what often happens with secured lenders is that the cash flow may initially be delayed, but usually remains intact. Management has taken that position in the current case and it seems reasonable.
In fact, management surprised the market by largely removing the bottom end of a large amount of guidance, while slightly raising some other numbers.
“The company is increasing its 2022 net income per share estimate from $1.99 to $2.01, including year-to-date earnings on sales of approximately $537 million, and is also adjusting its NFFO per share estimate to 2022 of $1.80 to $1.82 from a previous range of $1.78 to $1.82 MPT plans to provide initial estimates of net earnings per share and NFFO for 2023 when it reports fourth quarter earnings.”
Source: Medical Properties Trust, Third Quarter 2022, Earnings Press Release
For a company whose operators are all “headed for bankruptcy” according to the market, this was unexpected. In fact, management preliminarily seems confident enough about 2023 (subject to unknown developments, of course) that a dividend hike looks like a good possibility within the next twelve months.
Clearly, the market has other ideas, with a return of more than 10% on common stock.
management mentioned that there is a transition from the pandemic and grants available during the pandemic to “normal” operations. That makes any comparison above problematic because there doesn’t have to be a smooth transition.
But the market loves positive comparisons, and management has achieved exactly that. Adjusted funds from operations show growth and that is exactly what it should show regardless of changing industry conditions.
More importantly, that real estate sales gain in the current year points to anything but absolute destitution followed by financial destruction. Instead, that gain points to a return to normalcy that management has been claiming for some time. So while the market is concerned, it seems buyers of hospitals and related businesses have a different attitude.
Management has addressed market fears to some extent. There have been announcements of sales of some hospitals for roughly the same amount as the purchase price, along with promises to buy back shares.
Address market fears:
this discussion it was followed by very limited disclosure of what management knew about Steward’s situation. But it goes with what usually happens in the early stages of any industry recovery. The market generally fears a quick reversal from the recession that just ended. That rarely happens.
The short attack focuses firmly on the financial strength of the industry after a pandemic followed by possible financial stress from rhinovirus with the arrival of flu season. But honestly, the industry has handled situations like the current one for a long time. Many industries have peak seasons. That is very different from what happened during the pandemic.
As shown above, the operators clearly have the funds to pay the bill. That is really all that is necessary. The above ratios do not lead to the conclusion that there is an industry-wide problem that would destroy the business model. For all of the market’s concerns about Steward’s exposure, the numbers above would lead an investor to believe those concerns are overblown.
The shorts have focused on bank line extension for Steward because the lenders asked for more information. But bank line problems seldom lead to serious problems, and Steward is confident in following through with the paperwork requirements. Honestly, this issue sounds like a kind of routine request for additional information because the carrier, like many, is reeling from the challenges of the pandemic.
Based on current events, the current dividend of $0.29 paid quarterly looks safe compared to the cash flow shown above. If anything, management is likely to make continued cash flow progress that would lead to increased dividends. Finances appear to be fine.
The last time the company reduced that distribution was in 2008 when the economy collapsed. There are fears of a recession because some feel that the first six months of economic decline met the simple definition of a recession. Yet economic activity is, by most measures, very high, and unemployment remains very low. This is likely to be one of the easiest recessions to get through the way things are going.
In short, there is no reason to justify the current stock price action unless a potential short-seller attack is factored in. This attack is made possible by fears of an operator going bankrupt, followed by fears of overwhelmed hospitals with the current rhinovirus situation and flu season on the way. There are other considerations as well. But it seems much more likely that the current challenges will allow business to essentially return to normal with a peak season. That is very different from what happened during the pandemic. Sooner or later, Mr. Mercado will realize the difference and the stock price will recover.