Description

Summary

Global Medical REIT (GMRE) is a healthcare industry stock that not going to make you rich overnight. However, it is a stable, high-yielding security for investors looking for an alternative to bonds and other income-oriented stocks with potential for 30%+ upside appreciation while clipping an attractive 7.5%-8% yield. As the company continues to raise capital and executed on its acquisition strategy to grow earnings, the market will reward it with a higher valuation in line with Medical Properties Trust, Inc. (MPW), a $6B medical property REIT, trading at a 5.5% yield; Physicians Realty Trust (DOC), a $3.3B medical property REIT, trading at a 5% dividend yield; and other higher quality REITs.  If GMRE were to trade closer to the dividend yield of MPW & DOC with today’s earnings, it would be trading over $13/share. Even with a discount for being a smallcap company, GMRE would warrant a valuation of $12-13. As the company’s earnings grow through accretive acquisitions and trading liquidity improves with earnings growth, we believe the valuation will eventually be much higher.

The long-term playbook for a small-cap REIT is to increase earnings over time by strategically raising capital (debt & equity) and making well-underwritten accretive acquisitions. As the company grows, the earnings increase and the liquidity of the stock improves, further driving down the cost of capital and improving earnings and opportunities for growth by accretive acquisitions. If executed well, this virtuous cycle can play out to the benefit of long term investors of the REIT as they reap the benefits of increasing earnings and the higher valuations afforded to well-run, high liquidity REITs.  We believe that GMRE will succeed in following this playbook to achieve long-term capital appreciation while generating attractive current income for investors.

Company Description

At December 31, 2018, GMRE owned and operated 83 purpose‐built healthcare buildings that are primarily leased on a triple‐net basis, containing over 2.1 million net leasable square feet and generating approximately $50.2 million in annualized base rent, and represent an approximate weighted average cap rate of 7.87%. The portfolio was 100% occupied and leased to 48 high‐quality tenants with a weighted average lease term of approximately 10.1 years.

The portfolio base is very diversified in terms of tenant and state, with the largest tenant being only 11% of total revenues and the largest state, Texas, being only 23%.

GMRE leases these facilities to leading clinical operators with dominant market share. GMRE leases each of its facilities to single market-leading operators under a long-term triple-net lease.  Almost 50% of its leases have a term longer than 10 years, and ~75% of leases have terms longer than 7 years. Because of the long term nature of the leases and the fact that these types of healthcare operations are typically more resistant to economic cycles as the need for healthcare services is not typically dependent on the economy, GMRE is subject to much less fluctuations in income through a recession.

In addition, the company operates in the healthcare industry, which has favorable long term demographic and market trends. The healthcare industry is supported by aging of the population. The industry faces some notable tailwinds:

• 65+ age group expected to double between 2015 and 2060;

• 85+ age group expected to triple between 2015 and 2060;

• Approximately 90% of adults over 65 have one or more chronic condition such as diabetes, heart disease, arthritis, depression, and hypertension; and

• Better healthcare services and better health outcomes lead to more consumption of healthcare, in a feed-forward manner.

GMRE’s growth is driven by capital raising and acquisitions. The company has a robust pipeline of acquisitions and is committed to making smart acquisitions that are accretive to earnings, not just empire building.  At any given time, the company is evaluating a pipeline of $200 million worth of deals, which are at various stages of review.

In the CEO’s words, the strategy of the company is to “create a property portfolio comprised substantially of off-campus, purpose-built, licensed medical facilities such as MOBs, specialty hospitals, IRFs and ASCs, that are geographically situated to take advantage of the aging U.S. population and the decentralization of healthcare.”

The characteristics of the properties they are looking to acquire are:

• Institutional quality, purpose-built real estate, class A/recent construction or renovation and long-term leases with annual rent escalations.

• Properties occupied by strong healthcare providers with leading market share, rent guarantees and other credit protection, specialization in age-related procedures, operators with regional footprints, and strong and diversified payer mix and history.

• A growing and defensible market dynamic, positioned to benefit from ongoing decentralization trends in healthcare, proximity to related resources, long-term positive demand drivers (population growth and demographics), and barriers to competition.

Further details of the company and its strategy can be found in their 4Q18 earnings release and Nov 2018 presentation:

http://investors.globalmedicalreit.com/Cache/1500118105.PDF?O=PDF&T=&Y=&D=&FID=1500118105&iid=4677448

http://investors.globalmedicalreit.com/Cache/1500114837.PDF?O=PDF&T=&Y=&D=&FID=1500114837&iid=4677448

Acquisition Strategy

The company is targeting properties and portfolio of properties that are typically smaller in size and in smaller, secondary and tertiary markets at attractive risk-adjusted yields that are 100 basis points to 150 basis points above average. They focus on newer facilities, revenue generating facilities, good locations with attractive submarkets and good healthcare fundamentals. They tend to avoid the larger portfolios that typically attract lots of competing bids and instead focus on the smaller, more niche assets.  Initially, when the company first started operations, there were concerns about how big this company could get because of the niche market they were targeting. However, of the course of the last few years, they have proven that they can source and execute on the acquisitions (as well as dispose of tactically, as we saw in 4Q18) of the kinds of properties that meet the criteria and the strategy of the company.

For the year ended December 31, 2018, the Company completed 14 acquisitions, encompassing an aggregate of 811,707 leasable square feet for a total purchase price of $196.3 million with annualized base rent of $15.8 million at a weighted average cap rate of 8.04%.

During the fourth quarter of 2018, GMRE completed six acquisitions, for aggregate amount of 206,997 leasable square feet, for an aggregate purchase price of $59 million with a weighted average cap rate of 7.6%.  In the period from Jan 1, 2019 to Mar 1, 2019, GMRE completed one purchase for $4.5 million and is under contract for another property worth $16.1 million.

As a result of their growth by acquisition, their AFFO per share for the year ended 12/31/18 grew to $0.76 from $0.54 for the comparable period in 2017. The FFO per share grew to $0.78 compared to $0.41 in the comparable period last year.  In 4Q18, the FFO per share was $0.21, and AFFO was $0.20. The the annualized run-rate dividend is currently $0.80 per share, but I expect that to increase in 2019 as the company deploys its recently 4Q18 equity capital and layers in additional debt.

The recent acquisitions have resulted in the debt-to-equity ratio increasing to about 1.0x as of 12/31/18. The leverage ratio is within a reasonable range, and I expect management to issue an appropriate amount of equity to maintain an optimal leverage ratio over the longer term horizon.

Here’s some recent commentary of the acquisition strategy on the most recent 4Q18 earnings call:

“First, healthcare providers are diversifying their real estate strategies to capture growing patient demand, which is resulting in more settings for care. Second, an aging population has created more outpatient procedures that are driving the need to meet patients demand within their geographic areas, which oftentimes is away from a hospital campus. Third, physicians have also assembled into larger groups that have real estate portfolios located strategically across the suburban communities they serve. We believe these groups are poised to thrive in a value-based, healthcare reimbursement environment, and fourth, we believe technology will continue pushing more healthcare into outpatient settings.

I would like to reiterate our business strategy. We are not just buying real estate. We are underwriting our tenants and why they are strategically valuable to the healthcare delivery network. We strive to turn every stone looking for value, we go the extra mile of that each investment and we close on our deals with conviction in our underwriting.

We look for providers that offer high-quality healthcare in lower cost settings. We look for critically needed providers in suburban communities that lease buildings with solid EBITDAR driven coverage ratios. There is an enormous investment opportunity of these deals and we are uniquely suited to pursue this niche.”

Valuation

GMRE is paying a run-rate dividend of $0.80 per share as of 1Q19 and currently yielding 8%. Among comparable healthcare REITs (MPW, DOC, VTR, HCP), GMRE has one of the most attractive dividend rates. The peers are mostly trading in the 4.75-5.5% yield. As the company scales up over time, we expect the valuation gap to close with the larger peers.

Investment Considerations

1. Significant insider ownership. CEO and his group own about $30 million of common stock.

2. High dividend yield. GMRE is yielding about 8% with the potential for step up in dividends as the company raises capital and deploys it intelligently over time with an optimal capital structure.

3. Solid CEO who understands the smallcap REIT growth playbook.  The current CEO & founder Jeff Busch understands the smallcap REIT playbook. He took over from a prior CEO that didn’t execute well. He has been disciplined both from an acquisition as well as capital raising perspective to grow the business over time to eventually get rewarded by the market with a higher valuation.  When the company’s market cap approached $400 million, GMRE is likely to be included in one or more medical REIT indexes. As the market cap exceeds around $700 million and the trading liquidity increases we expect the company to start getting valuations closer to MPW and DOC, which are trading in the 5-5.5% dividend yield range.

4. External management internalization. The company has disclosed its intention to internalize management eventually when they get to a certain market cap size and trading liquidity. They understand that internalizing management is a prerequisite to garnering a higher valuation over time. The internalization expense is not cheap but within industry norms and will be a one-time cost that will be worthwhile to achieve the higher valuation over time.

Risks

• Increased borrowing costs if interest rates rise, putting pressure on cash flows and slowing down growth by acquisition

• Sudden, unanticipated, negative changes to healthcare regulations, laws and reimbursements could put pressure on tenants and lead to increased vacancies and default. But given the diversified nature of the portfolio, we expect the company to be able to weather such changes.

• Severe economic downturn could impact occupancy and defaults, although the long-term nature of the leases and the fact that healthcare services is much less impacted by the economic cycle mitigates this risk.

Catalyst

Catalysts

• Additional accretive acquisitions

• Dividend increases

• Internalize management