2023-09-08 05:30:31 ET
Summary
- Omega Healthcare Investors offers a high-dividend yield that is sustainable and has potential for growth in the future.
- The company is a healthcare REIT focused on managing skilled nursing facilities, assisted living facilities, and independent living facilities.
- Omega's financial performance has been impacted by the COVID-19 pandemic, but there are signs of recovery in revenue and occupancy rates.
Omega Healthcare Investors ( OHI ) offers a high-dividend yield that seems to be sustainable and has some potential to grow over the coming years, making it an interesting income investment.
Healthcare REITs are usually good income plays because they operate in an industry with good long-term demand prospects, as the aging demographic in the U.S. and other developed countries support demand for their services for many years.
Despite that, I've previously covered Medical Properties Trust ( MPW ) and decided to avoid it for my personal income portfolio, as the company has too many fundamental issues. In this article, I look at Omega as a potential income play; first, I do a review of the company's business and financial profile, and then discuss its investment case to see if it's a good long-term income investment or not.
Business Overview
Omega is a healthcare REIT focused on managing skilled nursing facilities, assisted living facilities, and independent living facilities, both in the U.S. and the United Kingdom. Omega has been listed on the New York Stock Exchange since 1992 and currently has a market value of about $7.9 billion.
As a REIT, Omega's business model is to acquire and develop healthcare facilities and lease them to healthcare operating companies. All of its leases to operators are long-term leases and mortgage loans, which usually are 'triple-net' leases, typically for periods between five and fifteen years. This means that its tenants bear the vast majority of costs associated with the properties, making the leases quite profitable for Omega.
Regarding mortgage loans, all of its mortgages are secured by first mortgage liens on the underlying real estate and personal property of the operators, making them a low-risk asset for Omega. Beyond that, Omega also provides some loans to its tenants, for working capital or capital expenditures purposes, which it classifies as 'other investments'.
At the end of 2022, its asset portfolio was valued at about $10.3 billion, consisting of more than 900 facilities across the U.S. and the U.K., operated by 67 different tenants. The vast majority of its asset portfolio was based on real estate assets, of which Senior Nursing Facilities are the largest one by far. It has good tenant diversification, with only one tenant representing more than 10% of its investments, and is also well diversified geographically given that Florida represents the largest state, with a weight of 11.5% in total investments.
Facility types (OHI)
Regarding competition, the healthcare industry is highly competitive and Omega faces competition from other REITs and private companies in making new investments, a landscape that is not expected to change much in the foreseeable future. Indeed, due to aging demographics and the increasing demand for healthcare facilities in the future, competition is likely to increase, which makes new investments increasingly challenging.
While historically the healthcare industry was quite resilient and was not much exposed to economic cycles, the industry's profitability has been negatively impacted by the COVID-19 pandemic due to higher labor costs, which is usually the most relevant expense for operators, putting pressure on the profitability level of healthcare operators. While Omega is not directly exposed to this issue because it only owns the real estate, worsening financial conditions from its tenants is a negative trend for rent collection and has an indirect negative impact on the company's financial performance.
Despite that recent setback, the company's strategy is not likely to change much in the near future, growing both organically and through acquisitions, aiming to maintain a sound financial profile and provide solid dividend growth for shareholders over the long term.
Financial Overview
Regarding its financial performance, Omega has a mixed track record given that, over the past few years, its top-line has been somewhat volatile, mainly due to changes in rental income while other revenue lines were more stable.
The vast majority of Omega's revenue comes from rental income, which theoretically should be relatively stable over the long term, but due to COVID-19 and the negative impact on its tenant's financial performance, rental income has been more volatile than expected in recent years, justifying increased volatility both at Omega's top and bottom lines.
Revenue (OHI)
Occupancy rates have dropped compared to the period before the pandemic and have not yet recovered to pre-COVID levels, which is still having a negative impact on its operators' financial performance. While the operating environment has improved in recent quarters, the landscape is still difficult for its tenants due to higher staff costs and other expenses, which is reflected in Omega's rent collection rate of about 85% in the recent past.
Taking into account this backdrop, it's no surprise that Omega's revenues declined by 17% YoY in 2022 to some $878 million. This is a level below its 2019 revenues, which amounted to $928 million, reflecting the challenging operating landscape of its operators due to disruptions in their businesses due to COVID, which are yet to fully recover.
Higher fatality among the elderly and frail populations has led to declining occupancy between 2020 and mid-2021, but since then, occupancy has improved and it's trending better in recent quarters. While some operators have failed to make rent payments to Omega, the company has restructured some lease agreements and mortgage payments and expects higher collection rates in the near future.
Regarding its profitability, it was naturally impacted by lower revenue while, on the other hand, expenses were rather stable, which helped to smooth the impact of a declining top-line. Nevertheless, its free Funds From Operations (FFO) amounted to $460 million, a decline of nearly 30% compared to the previous year.
During the first six months of 2023, Omega's financial performance remained relatively weak, considering that it continues to suffer from financial hardship from some of its tenants. Indeed, some of its largest tenants were allowed to defer rent payments during the first few months of 2023, but since then, LaVie (its largest tenant) has resumed rent payments during Q2, and in the U.K., Healthcare Homes also has resumed rent payments related to May and onwards. This bodes well for revenue growth ahead, an effect that was already visible in the company's Q2 earnings. In the last quarter, Omega's revenue amounted to $250 million, an increase of 2.2% YoY.
At this quarterly run-rate, its annual revenues will be around $1 billion, which is above 2019 levels, showing that operators are recovering, and higher collection rates are expected in the coming quarters and potentially also better occupancy rates. At the end of last June, Omega's occupancy rate was only 75.8%, which is not particularly good and is one of the areas where Omega may have higher potential for improvement in the short term.
In Q2 2023 , its FFO was $155 million, slightly down compared to the same quarter of 2022, and its funds available for distribution were $173 million, or $0.71 per share. Regarding its balance sheet, at the end of Q2, its cash position was $350 million and had $1.4 billion of undrawn cash related to a revolving credit facility, which is more than enough to finance its 2024 bond maturity of $400 million. This means that, from a liquidity perspective, Omega is in an acceptable position and can properly manage the current market downturn without the need to be a forced asset seller.
Regarding its dividend , Omega has a good history of delivering a growing dividend until 2019. However, since then, its dividend has been unchanged at $0.67 per share quarterly, or $2.68 per share annually. At its current share price, Omega offers a dividend yield of about 8.5%, which is quite attractive for income investors.
Moreover, its current dividend is covered by adjusted funds available for distribution, and the company does not need to save cash due to liquidity issues, thus its dividend seems to be sustainable in the short term. However, its payout ratio is quite high, and Omega's ability to raise funds in the credit market is not strong, thus investors should be aware that Omega's dividend can be considered risky even though the company has been able to maintain it in recent years.
Looking at current analysts' estimates , Omega's FFO is expected to gradually increase over the next few years, which seems reasonable considering the improving trends in the healthcare markets over the past few months. Despite that, its dividend is not expected to change over the next three years, which seems to be conservative, and therefore, Omega seems to have room to beat current consensus and grow its dividend in the coming years, something that would be supportive for its share price in the near future.
Conclusion
Omega Healthcare Investors offers a high-dividend yield that is quite attractive to income-oriented investors, and this seems to be sustainable in the short term and has the potential to be increased in the future if operating trends in the healthcare industry continue to improve. Regarding its valuation, Omega is currently trading at about 11x FFO, a discount to the REIT sector, thus Omega seems to be an interesting income play right now.
For further details see:
Should You Buy Omega Healthcare Investors For Its 8.5% Yield?