Is Northwest Healthcare Stock Oversold?

Northwest Healthcare stock has plummeted 41% so far this year on concerns over its financial health as interest rates shot higher.

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In the last week, an already battered Northwest Healthcare Properties REIT (TSX:NWH.UN) fell another 17%. This brings its year-to-date decline to 41%. In this article, I will explore what happened to Northwest Healthcare Properties (NWH.un) stock, and whether it is, at this point, oversold.

Back to the beginning

Over the years, Northwest Healthcare Properties has built a strong portfolio of medical buildings across the globe. These buildings are characterized by long-term tenancy, with a weighted average lease expiry of 14 years. They’re also characterized by stability, and they’re often supported by government funding.

That’s the good news. The bad news, however, has come to overshadow this. In a nutshell, Northwest benefitted greatly in the years of low interest rates. In fact, management took advantage of this and embarked on an aggressive growth path, effectively taking on too much debt than they could ultimately handle. Clearly, what worked in a low interest rate environment could not be sustained after the sharp rise in rates in the last year.

A dividend cut announcement sends Northwest Healthcare stock tumbling

As you know, rising debt levels are a concern for any industry that relies on debt for its growth. This includes the real estate investment trust industry, which is typically one that carries high levels of debt.  Last Friday, Northwest Healthcare finally capitulated under this weight and reduced its dividend by more than 50%. This came in conjunction with dispositions and new financing terms, in the goal of gaining financial strength and flexibility.

The first transaction that Northwest implemented is the sale and redemption of its holdings in Australian Unity Funds Management Ltd. Northwest has already received gross proceeds of $82 million, which has been used to repay debt. Further sales and redemptions are expected to result in additional proceeds of $110 to $120 million in Q3 and Q4. So, in total, proceeds of $200 million can be expected.

Secondly, Northwest is selling non-core assets, which is expected to generate approximately $225 million in proceeds in the near term. Beyond these asset sales, Northwest will consider selling other non-core assets.

Finally, we have the distribution cut. This 55% dividend reduction will be effective immediately, and it will result in approximately $100 million per year in savings for Northwest Healthcare.

What’s next for Northwest Healthcare?

Before the changes, Northwest’s balance sheet was carrying debt of over $4 billion. This equates to a debt-to-capital ratio of 54% and an interest coverage ratio of 1.7 times. The announced transactions will make a significant dent in the company’s debt balance. It’s estimated that it will decrease its dividend payments to well under 50% of cash flow from over 130% of cash flow. But the problems remain – the biggest of which is the fact that a large portion of its debt is at floating rates.

Yet, Northwest’s medical properties have actually been quite resilient throughout recent economic turmoil. The occupancy rate of its portfolio is 97%, a rarity among REITs in today’s environment and testament to the defensive nature of Northwest’s business.

The bottom line

Clearly, this latest news is a big blow to Northwest Healthcare Properties (NWH.un) stock. Although not totally unexpected, this demonstrates the balance sheet risk that Northwest has been operating with. It also highlights the risk that remains with this dividend stock.

Yet, Northwest still has a portfolio of properties that continue to be very resilient. This defensive nature of its portfolio remains. With new management stepping in and a resetting of the company’s financial situation, it is likely to be in better shape going forward. The current dividend yield of NWH.UN exceeds 6% and the stock is likely oversold today.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Karen Thomas has no position in any of the stocks mentioned. The Motley Fool recommends NorthWest Healthcare Properties Real Estate Investment Trust. The Motley Fool has a disclosure policy.

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