Omega Healthcare Investors, Inc. (NYSE:OHI) has a healthy balance sheet and pays a hefty dividend. Interest rate increases are of no concern. The company has been growing its book value every year since 2006. Investors have been intimidated by the high payout ratio of 144%, but as I will show in my analysis this payout ratio is inflated as it includes an above average real estate purchase. Consequently, this means that the payout ratio will drop below 100% if the purchase is excluded. The company offers a 7.88% dividend and a potential share appreciation of 22%.
Omega is a real estate investment trust, primarily investing in long-term healthcare facilities in order to create its portfolio. The REIT pays a 7.88% dividend and is about 85% institutionally owned.
Liquidity and balance sheet
The company's long term debt is $4.4 billion as of 3Q16. The debt has almost doubled since 2011 when it stood at $1.6 billion, which represents a 160% increase. Over the same period revenues and net income grew by 200% and 472%, respectively. The ttm revenues are $877 million and the net income is $318 million.
This suggests that the company's management, while highly leveraging the business, is excellent in allocating capital, because they are making more money per dollar of debt. As we reflect on the funds from operations (FFO) we will see that the numbers are even more impressive. First, I'd like to discuss the liquidity and debt maturities. The company has about $1.3 billion in lines of credit at interest rates no higher than 2.33%.
The ttm EBITDA stands at $765 million which represents a 218% increase from 2011 levels. The company does not have any liquidity problems, since the highest note is $700 million. That is, if it chooses to repay the debt instead of refinancing it. To top it off, the company is investing significantly in property, as it should, but it can scale these investments down during rougher times.
It should come as no surprise that the company's book value has grown significantly over the years. While the book value stood at $8.68 in 2011, it now stands at $19.58, which represents an increase of more than a 100%. By now it should be clear that the balance sheet, debt and liquidity numbers are very attractive.
That being said, the payout ratio stands at 144%. There's a caveat to this number though. The ttm dividend cash payout was $460 million, but the company invested a little over $1 billion in properties, which is more than double of what it invested in the previous year ($458 million). This means that the company can actually comfortably manage its payout ratio by scaling down its investments. Investors shouldn't be worried about the payout ratio when looking at it this way.
The interest rate
I believe that interest rate concerns are being over exaggerated. First of all, $3.1 billion of the $4.4 billion debt has fixed rates. Increased interest rates would actually lower the face value of the $3.1 billion of fixed debt. If we assume that all of the $1.3 billion in debt is variable and will rise with the same amount of basis points as the Fed rate increase, their payments would increase by a mere $3 million. Three million dollars is a lot of money, but in context of OHI it is negligible.
Using net income when examining REITs is a little bit deceiving. The reason for this is that depreciation is deducted from net income and this creates an overly conservative number. Real estate properties tend to appreciate over time instead of depreciate. The ttm FFO comes in at $615.9 million which is more than double the ttm net income of $303 million.
Conclusion and valuation
All in all, Omega is a great REIT that is run by smart management. Based on the robust balance sheet, the constant increase in book value and the more than comfortable payout ratio, I definitely think this company is worthy of my portfolio. The 7.88% dividend is a very nice return to have. Historically, the dividend yield on OHI has been 6.5% and the industry average 5.7%. This suggests an additional capital appreciation of 21.75% up ahead for investors if the company begins to trade at its historical dividend yield of 6.5%. I believe that a dividend cut is not likely given the comfortable payout ratio. Lastly, the company trades at 1.57x its book value, which gives it a small margin of safety as I do not believe it will trade below its book value of $19.69.
Margin of safety: $19.69
Target price: $37.50
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in OHI over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.