9.4%-Yielding Omega Healthcare: A Bargain With Upside Potential

It’s easy to write off an investment as being too risky based on yield and near-term price action alone. However, it’s not that simple in reality, as today’s beaten down stocks could be tomorrow’s winners, especially if they are a dominant player in their respective industries.

Such may be the case with Omega Healthcare Investors (NYSE:OHI), which has surely seen its ups and downs over the past 3 years. I last covered OHI here back in March, and while the price has barely budged with a 0.9% increase, the stock has given a 3.4% total return thanks to the power of dividends.

In this article, I discuss OHI’s recent business developments and why now may be a great time to lock in this 9%+ yield.

Why OHI?

Omega Healthcare Investors has been around for 31 years, and is the largest owner of skilled nursing facilities in the U.S., with international exposure in the UK. At present, OHI holds 902 mostly skilled nursing facility properties across the US and UK, covering 66 operators and over 89,000 bends. As shown below, OHI is led by an experienced management team, of whom the top 3 executives have been with the company for 22 years.

OHI recently produced results that were more or less in line with expectations, generating AFFO per share of $0.66 and FAD per share of $0.60. Notably, the $0.67 quarterly dividend was not covered by FAD and the dividend payout ratio was 112%, which is unsustainable for the long-term. However, management expects for the payout ratio to rapidly improve, as one of its top tenants, Agemo, resumed paying quarterly rent and interest of $6.5 million in April.

In another sign of an industry in recovery, the Healthcare Homes operator began paying full contractual rent this month after a four-month rent deferral. Also encouraging, all other assets with troubled operators have been fully transitioned to new ones, and this should provide momentum for FAD growth in the remainder of the year.

Importantly, it appears that the SNF industry is better able to stand on its own legs. This is reflected by core EBITDAR to rent coverage, excluding funds from the CARES Act, improved to 1.09x at the end of 2022 compared to 0.83x at the end of Q3 2022. For reference, operator rent coverage is always reported one quarter in arrears. Plus, OHI is opportunistically consolidating the SNF industry, as it closed $276 million worth of transactions so far this year.

Meanwhile, OHI maintains a strong BBB- rated balance sheet with $1.4 billion in undrawn capacity on its revolving credit facility, and carries a low weighted-average interest rate of 4.2% of its debt. Moreover, 98% of OHI’s debt is fixed rate, thereby mitigating the near-term impact of higher interest rates. It’s also safely levered with a net debt to EBITDA ratio of 5.9x and has a respectable fixed charge coverage ratio of 3.6x.

Looking ahead, stabilization of the SNF industry in the near term bodes well for OHI’s long-term prospects. SNFs remain the lowest cost-of-care setting in the healthcare industry compared to Inpatient Rehabilitation Facilities and Long-term Acute Care Hospitals, with an average cost per day of $462, sitting well under half of that of IRF and LTACH.

Increasing demand for the properties due to an aging population combined with the 86% of states having a moratorium or CON (certificate of need) restrictions should also drive occupancy higher to above 80% over the next few years, above the 77% occupancy rate at present. Plus, as shown below, Medicare and Medicaid patient per day payments have meaningfully picked up over the past year, as shown below.

Admittedly, the SNF segment is higher risk than other healthcare assets due to lower rent coverage ratios. However, that’s the nature of the beast, as operators are not supposed to live richly off government payments, and the industry is adequately compensated for that risk. As shown below SNFs enjoy the highest yields on investment compared to other asset classes.

Lastly, OHI remains in value territory at the current price of $28.48 with a forward P/FFO of 10.4, sitting comfortably below its normal P/FFO of 12.3. Analysts expect FFO/share to grow by 4.6% next year and have a conservative price target of $29.91, implying a potential 14% total return over the next 12 months. Plus, as shown below, SA’s Quant gives a Buy rating with a score of 4.2, with A and B grades for valuation, profitability, momentum, and analyst earnings revisions.

Investor Takeaway

Omega Healthcare is well-positioned to benefit from the recovery of its operators, long-term growth drivers, and limited supply in its industry. While the dividend currently isn't covered, the coverage should improve in the remainder of the year. Meanwhile, OHI carries a strong balance sheet and is growing by consolidating the fragmented industry. Lastly, income investors are well-compensated with a 9.4% yield while participating in the continued turnaround.

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