TPVG - Omega Healthcare Investors: This 8.6% Yielding Trust Is Fairly Valued (Downgrade)

2023-08-18 08:49:56 ET

Summary

• Omega Healthcare Investors has seen stock price strength, but the author has decided to take profits due to fair valuation.
• The company owns a large portfolio of skilled nursing and senior housing facilities, benefiting from the aging population.
• Dividend coverage improved in the second quarter, but the author sees better opportunities in the BDC sector.

I assigned a 'Strong Buy ' rating to Omega Healthcare Investors, Inc. ( OHI ) in February, but I have now decided to take my profits, even though the healthcare real estate investment trust experienced a QoQ improvement in its dividend coverage in the second quarter.

Even though Omega Healthcare Investors seems to be able to pay its $0.67 per share per quarter dividend and profits from favorable, long-term trends in the healthcare market, I think that OHI is now fairly valued which caused me to close my position in the healthcare REIT. I also see better opportunities in the BDC sector that offer higher dividends and better upside potential.

Large SNF-Focused Real Estate Portfolio, Improving Occupancy Trend

Omega Healthcare Investors owns a portfolio of skilled nursing and senior housing facilities that produce recurring cash flow for the healthcare REIT. 74% of all real estate investments relate to skilled nursing facilities, while the remainder, 26%, relates to senior housing properties. In total, the trust’s real estate portfolio included 923 properties at the end of the second quarter, which are leased to 66 operators in 42 U.S. states and the United Kingdom.

A core pillar of the investment thesis for Omega Healthcare Investors has been that the U.S. is faced with the challenge of a rapidly aging population which is driving demand for beds in skilled nursing and senior housing facilities.

As people live longer lives, skilled nursing facility providers like Omega Healthcare Investors are confronted with long-term secular demand drivers that could translate into growing facility utilization as well as long-term FFO growth.

Healthcare trusts like Omega Healthcare Investors were hit hard by the Covid-19 pandemic and multiple operators fell behind making rental payments to the REIT, but the trend is improving. The REIT’s CEO stated in its 2Q-23 earnings press release that it received additional rent payments from restructured operators.

Omega Healthcare Investors’ occupancy trend has also consistently improved in recent quarters, resulting in an average occupancy, as of 30 June 2023, of 78.0%.

Omega Healthcare Investors’ Dividend Coverage Improved in 2Q-23

Omega Healthcare Investors under-earned its dividend with AFFO in the first quarter, but only by a very small margin, and dividend coverage subsequently improved.

The healthcare REIT earned $0.74 per share in AFFO in 1Q-23 while paying out its regular $0.67 per share dividend, which translates into a dividend pay-out ratio of 90%. On a rolling full-year basis, OHI’s dividend pay-out ratio was 92.8%, so the dividend overall has been solidly covered by AFFO and should be sustainable.

Why I Am Selling And Where Am I Putting My Proceeds

I think that Omega Healthcare Investors could earn $3.00-$3.10 per share in AFFO in 2023 which is a slight change from my previous outlook of $3.10-3.20 per share in AFFO, due to ongoing lease restructurings with some of trust’s operators. Thus, I expect Omega Healthcare Investors to produce only low single digit AFFO growth in 2023 (OHI earned $2.99 per share in AFFO in 2022).

With a stock price of $31.14, the trust is valued at 10.2x AFFO. National Health Investors, Inc. ((NHI)) , which has a heavy focus on skilled nursing and senior housing facilities as well, is selling for an 11.9x FFO multiple. National Health Investors recently lowered its FFO 2023 forecast due to recent concessions and incremental asset sales. At more than 10x AFFO, I consider OHI to be fairly valued.

My rating on OHI, following my stock sale, is hold/neutral. I would only rate OHI as a 'Sell' if the Healthcare REIT didn’t cover its dividend with AFFO and if the operator situation wasn’t improving. Because dividend coverage improved and looks good, I think OHI is a hold for passive income investors that look for recurring income.

However, since a re-rating already has taken place since my last article on Omega Healthcare Investors (the trust’s stock was selling at 8.9x AFFO in February), I see better investment opportunities with a higher yield in the BDC sector.

One such opportunity is TriplePoint Venture Growth BDC Corp. ( TPVG ) whose stock sold off after 2Q-23 earnings due to an unexpected rise in bad loans. TPVG presently offers a 14.2% yield that I consider to be a good buy . I am putting my proceeds to work here.

Why Omega Healthcare Investors Might See A Lower Valuation

Omega Healthcare Investors paid a $0.67 per share per quarter dividend even as some operators struggled to survive and experienced significant cash flow pressures during the pandemic that forced the REIT to renegotiate lease terms and, in some cases, place operators on a cash basis or transition facilities to stronger operators.

The Healthcare REIT has come this far without slashing its dividend, and the dividend was covered by AFFO in 2Q-23. If more operators fail moving forward, incremental pressure on Omega Healthcare Investors’ cash flow could build up and trigger a review of the dividend policy.

My Conclusion

Trends in the healthcare industry are positive and supportive of the long-term investment thesis for Omega Healthcare Investors.

Though Omega Healthcare Investors under-earned its dividend with AFFO in the first quarter marginally, OHI recovered in 2Q-23 and managed to earn its dividend with AFFO.

I think Omega Healthcare Investors will be able to maintain its $0.67 per share per quarter dividend pay-out moving forward, but given the expanding valuation multiple since February, I am closing this investment chapter for now.

While I personally sold, I rate OHI as a 'Hold' for passive income investors. I presently see better passive income investment opportunities in select BDC stocks, such as TriplePoint Venture Growth BDC.

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