The Universal Health Realty Income Trust (UHT) faces some internal and external challenges, but I’m convinced they won’t make a difference to the company’s long-term profitability. The short-term rise in the cost of capital is already hurting the company’s income and some tenants are terminating their leases in 2021 which will be lost income this year until they find adequate new income. The company is undervalued with a dividend yield of 4.8% and is probably one of the best choices among its peers in the low market capitalization REIT sector for income investors.
The Universal Health Realty Income Trust, a real estate investment trust, invests in health care and human services facilities including acute care hospitals, behavioral health care facilities, rehabilitation hospitals, subacute care facilities, surgery centers, child care centers, and medical office buildings . The trust has seventy-two investments in twenty states. Of these 72 buildings, the lion’s share is medical office buildings and clinics. The company recognizes revenue from two streams but the main income comes from rental income from real estate.
Finance and profits
Company money from operations (“FFO”) was $12.6 million or $0.92 per diluted share during the third quarter of 2021 compared to $11.9 million or $0.86 per diluted share during the third quarter of 2020. Increase in UHT net income of $151,000 , or $0.01 per diluted share, during the third quarter of 2021, was due to income generated from various properties, including income recorded in connection with the newly constructed Clive Behavioral Health facility, a 100-bed behavioral health care facility located in Clive, Yes. On September 30, 2021, the company had $276.8 million of loans outstanding under the terms of their credit agreement and $94.6 million of available borrowing capacity as of that date, net of outstanding loans and letters of credit. UHT also earned a gain of $1.3 million during the second quarter of 2021 from the sale of a medical office building located in Springdale, AR.
A wholly owned subsidiary of UHS notified the company of its intent to terminate the existing lease agreement for its Southwest Healthcare System, Inland Valley campus, upon the scheduled expiration of the existing lease on December 31, 2021. UHS has agreed to exchange the alternative property, with a total fair market value equal to Largely those of the Southwest Healthcare System, Inland Valley Campus, as opposed to the real estate assets of the Inland Valley Campus. The current lease of Kindred Chicago Central Hospital, a 95-bed specialty hospital located in Chicago, Illinois, is scheduled to expire on December 31, 2021. The tenant is no longer renewing the lease and this will result in some losses for the company in 2022 due to their acquisition of approximately $1.6 million in rental income for the twelve months ended December 31, 2021.
Right now, UHT is an absolute buy for me because the stock is undervalued. Inventory is valued at less than 20 times the annual FFO to date. Compared to pre-pandemic numbers, UHT was trading in a 30x high FFO area. I don’t expect the company to quickly return to pre-pandemic levels due to many factors such as the recent lease termination of Kindred Hospital, the high cost of capital and interest rates, but for income investors wanting to stick with UHT I think it could be a great option. Especially since the company has been trading in the top 10% in terms of dividends for the last 3 years. Only at the end of 2020 did it give investors the opportunity (and some days in 2021) to buy UHT at more than a 5% dividend yield.
Additionally, the company is going from the highest valuation at the beginning of 2020 among its peers to nearly the best at the beginning of 2022. And yes, that compelling valuation is the impact of the pandemic, termination of lease with a UHT property, and termination of another lease at the end of 2021. But there are no internal issues with the company, we have a stable and secure dividend, an attractive valuation with great FFO numbers, so I consider UHT a good buy.
Company’s own risks
Their business is very competitive and management anticipates that it may become more competitive in the future. They compete to acquire, lease and finance healthcare-related facilities. These developments may reduce the company’s investment opportunities and lower profit margins on its cost of capital, which could hurt growth.
- A significant portion of UHT’s revenue is dependent on a single operator, and UHS accounted for approximately 33% of the company’s consolidated revenue. If UHS runs into financial difficulty, otherwise fails to make payments to it or chooses not to renew leases at its three acute care hospitals, the company’s revenue could be materially reduced. In addition, UHS has leased three of the six UHT-owned hospitals with terms expiring in 2021 and 2026. The lease for Southwest Healthcare System, Inland Valley Campus was terminated at the end of 2021.
- Healthcare facilities are usually highly customized and may not be easily adapted for non-healthcare uses. Improvements generally required to match a property with a healthcare use, such as upgrading electrical, gas, and plumbing infrastructure, are costly and sometimes rent-specific. If the current operator or tenant is unable to pay the rent and vacate the property, the company may incur significant expenses to modify the property before it can secure another operator or tenant. Such expenditures or renewals may materially adversely affect the business, results of operations and financial condition. Kindred Hospital Chicago Central was not an unexpected termination of the lease, but it would nonetheless cause some loss of income until the company could find a suitable new tenant.
- The company saw a decrease of $286,000, or $0.02 per diluted share, in the third quarter, due to an increase in interest expense due to an increase in their average loans outstanding under their credit agreement. An additional interest rate hike can damage the company’s existing loans and also increase the cost of capital.
Take UHT Profits
Universal Health is a stable and secure dividend payer with a 30 consecutive year dividend history and the company is well on its way to becoming a dividend aristocrat (more than 25 years of consecutive dividend growth). Currently, UHT has been raising earnings for 20 straight years. This fact actually makes them a good target for income-seeking investors. UHT declared a quarterly dividend of $0.705/share, an increase of 0.7% over the previous dividend of $0.700 in December 2021. Currently, the company is earning 4.8% which is 3.7 times greater than the S&P 500’s (1.27%) dividend yield. Both the yield and dividend policy of the Board of Trustees make UHT a primary target for income investors.
Management has room to increase the dividend and they are unlikely to lower the dividend increase streak for 20 years. In addition, there are no external factors that indicate that the company needs to cut its dividend in the coming years. At first glance, we might see an unsustainable payout ratio of 171.99% according to Research Alpha. EPS is also very low but since UHT is a REIT, the EPS numbers are irrelevant. Funds from operations numbers are on a slow but steady rise which is why we’re seeing a modest ratio of about 75%. This indicates that the internal factors are sound to continue to increase profits.
UHT can be a prime choice for income-seeking investors. They have a relatively high dividend yield with a favorable dividend policy for the shareholders. The business is geographically well diversified and has sufficient free capital to purchase real estate. I think all the risks arising can hurt the company in the short term like termination of lease and higher average cost of borrowing, but it won’t make a difference to UHT’s long term success. I’m optimistic about Universal Health as long as the dividend yield is in the 4.7-5.2% region.