Universal Health Realty Income Trust (UHT) faces internal and external challenges, but I’m confident it will make no difference to the company’s long-term profitability. The short-term rise in the cost of capital is already weighing on the company’s income and some of their tenants have terminated leases in 2021, which will be missing income this year until they find suitable new ones . The company is undervalued with a 4.8% dividend yield and probably one of the best picks among its peers in the small-cap healthcare REIT sector for income investors.
Universal Health Realty Income Trust, a real estate investment trust, invests in health care and social service facilities including acute care hospitals, behavioral health care facilities, rehabilitation hospitals, subacute care facilities , surgery centers, day care centers and medical office buildings. The Trust has seventy-two investments in twenty states. Of these 72 buildings, the lion’s share goes to medical office buildings and clinics. The company recognizes income from 2 streams, but the main income comes from rental income from the properties.
Finances and income
The company’s funds from operations (“FFO”) were $12.6 million, or $0.92 per diluted share, in the third quarter of 2021, compared to $11.9 million, or 0 $.86 per diluted share, during the third quarter of 2020. The increase in UHT’s net income of $151,000, or $0.01 per diluted share, during the third quarter of 2021 was due to revenue generated at various properties, including revenue recorded as part of the new Clive Behavioral Health Facility, a 100-bed behavioral health care facility. facility located in Clive, Iowa. As of September 30, 2021, the Company had $276.8 million of borrowings outstanding under its credit agreement and $94.6 million of borrowing capacity available at that date, net of borrowings outstanding and letters of credit. UHT also realized a gain of $1.3 million during the second quarter of 2021 on the sale of a medical office building located in Springdale, AR.
A wholly-owned subsidiary of UHS has notified the company of its intention to terminate the existing lease on the Southwest Healthcare System, Inland Valley Campus, upon the scheduled expiration of the current lease term on December 31, 2021. UHS has agreed to exchange substitute properties, with an aggregate fair market value substantially equal to that of the Southwest Healthcare System, Inland Valley Campus, in exchange for the real estate assets of the Inland Valley Campus. The existing lease at Kindred Hospital Chicago Central, a 95-bed specialty hospital in Chicago, Illinois, is set to expire on December 31, 2021. The tenant is no longer renewing its lease and this will result in losses to the business in 2022 as they generated approximately $1.6 million in rental revenue during the twelve-month period ended December 31, 2021.
At the moment, UHT is an absolute buy for me as the stock is undervalued. The stock is valued at less than 20 times annualized FFO year-to-date. Compared to pre-pandemic figures, UHT was trading in the high territory of 30x FFO. I do not expect the business to return to pre-pandemic levels quickly due to many factors such as the recent termination of the Kindred Hospital lease, rising cost of capital and rates of interest, but for income investors who are willing to hold UHT I think it can be a great choice. Especially because the company is trading in its upper 10% range in terms of dividend yield over the last 3 years. It wasn’t until late 2020 that investors (and a few days into 2021) had the option to buy UHT with a 5% dividend yield.
In addition, the company goes from the most overvalued in early 2020 among its peers to almost the best valued in early 2022. And yes, this attractive valuation is the effect of the pandemic, lease termination with a UHT property, and another termination lease at the end of 2021. But there are no internal company issues, we have a stable and secure dividend, an attractive valuation with excellent FFO numbers, so I consider UHT a good buy.
Company specific risks
Their business is very competitive and management expects it to become more competitive in the future. They compete with each other for the acquisition, leasing and financing of healthcare-related facilities. These developments could result in fewer investment opportunities for the company and lower spreads on their cost of capital, which would hurt growth.
- A significant portion of UHT’s revenue is dependent on a single operator, with UHS accounting for approximately 33% of the company’s consolidated revenue. If UHS runs into financial difficulties, or fails to pay them or chooses not to renew the leases of its three acute care hospitals, the company’s revenues could be significantly reduced. Additionally, UHS has leased three of six UHT-owned hospital facilities with terms expiring in 2021 and 2026. Southwest Healthcare System, Inland Valley Campus lease has already been terminated at the end of 2021.
- Healthcare facilities are typically highly personalized and may not be easily adapted for non-healthcare uses. Improvements typically needed to adapt a property for healthcare use, such as electrical, gas, and plumbing infrastructure upgrades, are expensive and sometimes tenant-specific. If a current operator or tenant is unable to pay rent and vacates a property, the company may incur significant expense to alter a property before it can find another operator or tenant. Such expenditures or renovations could have a material adverse effect on the business, results of operations and financial condition. Kindred Hospital Chicago Central was not an unexpected lease termination, but it will still result in lost revenue until the company can find a suitable new tenant.
- The company recorded a decline of $286,000, or $0.02 per diluted share in Q3, due to higher interest expense primarily due to an increase in their average outstanding borrowings under their credit. A further rise in interest rates may hurt the company’s current loans and will also increase the cost of capital.
My take on UHT’s dividend
Universal Health is a stable and secure dividend payer with a 30-year history of consecutive dividend payments and the company is also on its way to becoming a dividend aristocrat (over 25 years of consecutive dividend growth). At present, UHT has been increasing the dividend for 20 consecutive years. This fact already makes it a good target for investors looking for income. UHT declared a quarterly dividend of $0.705/share, an increase of 0.7% from the previous dividend of $0.700 in December 2021. Currently, the company is yielding 4.8%, or 3.7 times more than the yield of the S&P 500 dividend (1.27%). The board’s yield and dividend policy make UHT a prime target for income investors.
Management has room to increase dividends and is very unlikely to cut back the 20-year streak of rising dividends. Moreover, no external factors suggest that the company should reduce the dividend in the coming years. At first glance, one could see that the payout rate is unsustainable at 171.99% according to Seeking Alpha. The EPS is also very low, but since UHT is a REIT, the EPS numbers are irrelevant. Funds from operating figures are slowly but steadily increasing, which is why we can see a modest payout ratio of around 75%. This suggests that internal factors are healthy to pursue dividend increases.
UHT can be a top choice for investors looking for income. They have a relatively high dividend yield with a shareholder-friendly dividend policy. The business is well diversified geographically and the company has sufficient capital available to purchase properties. I think any risks that emerge may harm the business in the short term, such as lease terminations and increased average cost of borrowing, but will make no difference to the long term success of UHT . I’m bullish on universal health as long as the dividend yield is between 4.7 and 5.2%.