I have been bearish on Omega Healthcare (OHI) for a couple of years, while the price was rocked by the Orianna bankruptcy. After the dip, OHI came back with a vengeance and is now trading at higher prices despite a 10% drop in FFO and management guiding for another decrease this year.
Clearly, the market believes that all of the shoes have dropped and is very optimistic about OHI's future.
Among healthcare REITs, OHI is the closest to a pure-play on skilled-nursing facilities (SNFs).
Source: OHI Presentation
SNFs are post-acute providers that provide 24-hour skilled nursing care. Most of its patients are people who have been directly discharged from a hospital and still require specialized care.
While SNFs will cater to anyone of any age, its main demographic is the elderly who have more severe health problems and perhaps a more difficult time recovering.
OHI defends its strategy due to the reality that SNF use substantially increases as people age. It argues that while things are tight right now, the large population of Baby Boomers is going to dramatically increase demand as they age. So increased demand means more money for SNF operators and that means OHI can raise rents.
It is a nice theory; we all know that the Baby Boomer generation has a large population spike. But will that population bubble actually translate into improving returns for SNFs and for OHI? OHI's investment thesis might be too simplistic and ignore some very large variable.
Experience So Far
OHI has been using these arguments for years, and the bottom line is that the results to date are not occurring as it predicted. Consider this slide from 2015, which the company is still using.
Source: OHI Presentation
This outlook predicted that with the growing elderly population, occupancy would increase to 91%. In the same presentation, OHI shows us what has actually happened since 2015.
Source: OHI Presentation
Occupancy has trended generally down for the industry. OHI has had a slightly more stable occupancy, but since 2015, it has been flat at best. According to its projections from 2015, it should be climbing towards 91% in 2020 - which is less than seven months away. Instead, occupancy is still at 82% (82.8% in Q1 2019). So are we supposed to believe that in less than a year, occupancy is going to shoot up 900 bps?
Clearly, the prediction from 2015 was dramatically wrong. Not only did SNF occupancy fail to increase at the speed predicted, but it also failed to increase at all.
It is even worse when we look at the number of SNF beds.
Source: OHI Presentation
Since 2015, we have not seen an increase in facilities or beds to absorb all the new demand. In fact, we have seen the number of facilities and beds decline. Occupancy is lower despite supply being lower. If the gross number of patients had remained flat from 2017 to 2018, occupancy would have risen 0.4% due to the decline in beds.
Gross demand is dropping, even though there is an increase in the number of people aged 65+.
Source: OHI Presentation
As another illustration, OHI points to the growing 75+ cohort. Yet this population has been growing since 2010. We are in 2019, almost to 2020. Putting these slides together, since 2010, we have:
- A roughly 20% increase in people aged 75+ (nearly 4 million people)
- No net new supply of facilities or beds (a 16k decrease in bed count)
So with an increase in the target demographic and a slight decrease in supply, shouldn't that lead to higher occupancy? Instead, occupancy declined from 84% to 82% for OHI and from 83% to 80% for the industry.
If the last 4 million increase in the 75+ age group failed to increase occupancy, what is going to be so different about the next 10 million?
OHI's own presentation shows that the assumption that an aging population is going to directly translate into higher occupancy is too simplistic and should not be taken at face value.
Investors in OHI should always keep an eye on the Skilled Nursing Data Report provided quarterly by the NIC. This report helps keep your fingers on the pulse of what is occurring in SNFs. The most recent report has some good news and some bad news.
The good headline for OHI is that occupancy climbed in Q1. This is the second consecutive quarter of occupancy increases, breaking a trend of occupancy bumps that only lasted for a few months. While still very low compared to a decade ago, some might see it as an indication that the trend is finally turning around.
Typically, Q1 experiences a bump in occupancy due to flu season, but the occupancy increase seems to be stronger than can be explained by the flu. This is a spark in an industry that has been nothing but down for almost four years. The report notes:
Overall occupancy increased 77 basis points from the fourth quarter of 2018 to 83.7% in the first quarter of 2019, the highest rate since the first quarter of 2018. An increase in occupancy is typically expected from the fourth to the first quarter, given the flu season and higher admissions in the winter months. However, as occupancy has shown strength over the past several months, it suggests that seasonality is not the only factor in the recent uptrend in occupancy. In fact, year-over-year occupancy was also positive as it increased 28 basis points from March of 2018.
Then there is the bad news.
While occupancy has increased, the payment sources continue to change. SNFs make the highest amount of money from Medicare, at $520 per patient day. Medicare has dropped from 17% to 18% of patient days to only 12%.
Meanwhile, Medicaid patient days, the lowest paying at only $210/day, have increased from 60-62% to pushing against 66%. "Managed Medicare" pays about 17% less than traditional Medicare. Managed Medicare has increasingly been putting pressure on SNFs. Even as Managed Medicare has become a more significant payer, the amount it pays has been in steady decline, dropping from $446/day in Q1 of 2018 to $432/day in 2019.
This has put significant pressure on the profit margins of SNFs as they experience rising labor costs while receiving less revenue per patient day due to a volume shift towards lower-paying patients.
OHI has a perplexing chart in its presentation:
Source: OHI "Silver Tsunami" Presentation
OHI shows how SNF profit margins took a dive from 2014 to 2016. With conditions failing to have improved, it is likely that profit margins have remained very compressed. Given this, should any of us be surprised that its tenants are struggling with paying rent?
The bottom line is that SNF operators have seen declining occupancy, along with declining revenue per day as the mix has heavily trended towards the lower-paying Medicaid and Managed Medicare.
Occupancy has slightly improved, but is very far from the rosy scenario envisioned several years ago. The mix continues to get worse with no end in sight. So while operators had a slight reprieve early in the year, it is likely that the pressure is going to continue to increase.
The "Patient Driven Payment Model" is a significant shift in how the government calculates reimbursement for SNFs. While public commentary from OHI has been bullish, it is important to remember that the new model is revenue neutral. This means that for every SNF which receives more revenue, another SNF is receiving less.
Source: Skilled Nursing News
Skilled Nursing News conducted a poll, summarizing the results:
Multiple optimistic prognosticators have positioned PDPM as a revenue booster for skilled nursing facilities. But because it's revenue-neutral, CMS won't be increasing or decreasing spending on nursing care - so every operator that comes out ahead will do so at the expense of another that will suffer reimbursement declines. Respondents to SNN's survey were split pretty evenly about where they thought their companies' revenues would fall next year, indicating that leaders could have a more realistic view than the public calls for optimism.
With so many moving parts, even industry experts cannot perfectly predict the impact that PDPM will have on the industry. More importantly for OHI, it is impossible to determine whether the changes will be beneficial for its tenants.
Currently, OHI has two top-10 tenants - Signature and Daybreak - which were unable to pay their full rent and have struck deals with OHI to defer a portion of their rent.
Source: OHI Supplement
Genesis (GEN) is now its second largest tenant and is a company which has had its own substantial problems. While it is currently paying rent, the company is far from healthy. GEN has breached several covenants with landlords. From the 2019 Q1 10-Q:
We have two master lease agreements with Cindat Best Years Welltower JV LLC involving 28 of our facilities. We did not meet certain financial covenants contained in one of the master lease agreements involving nine of our facilities at March 31, 2019. We received a waiver for these covenant breaches.
At March 31, 2019, we did not meet certain financial covenants contained in four leases related to 12 of our facilities, which are not included in the Restructuring Transactions. We are and expect to continue to be current in the timely payment of our obligations under such leases. These leases do not have cross default provisions, nor do they trigger cross default provisions in any of our other loan or lease agreements. We will continue to work with the related credit parties to amend such leases and the related financial covenants. We do not believe the breach of such financial covenants has a material adverse impact on us at March 31, 2019.
OHI is currently trading at a price/AFFO multiple over 12x - that is at the high end of its historic range.
Source: Company Filings, Chart Authors
OHI has not been trading this high since 2015, before its tenants' average profit margins were sliced in half, when occupancy rates were in the mid-80s and Medicaid accounted for less than 62% of patient days.
While there is some positive movement in occupancy, the fundamentals remain much weaker today, and the industry is clearly still facing headwinds as Medicaid becomes an increasingly large use of resources.
The "Silver Tsunami" has failed to show up as aggressively as was predicted back in 2015. Instead of steadily climbing occupancy, it has been declining and has only now started to bump up slightly.
In 2018, we saw a decline in the number of certified beds from 1.662 million to 1.654 million. That decline alone explains an upward shift of approximately 0.4% in occupancy with an equal number of patients. It is possible that much, if not all, of the increase in occupancy is due to facilities going out of business. When an SNF shuts down, their patients have to go somewhere.
The increase in patient days that are reimbursed by the lower-paying Medicaid and Managed Medicare continue to be headwinds for the industry. There is a lot of hope that PDPM is going to change things for the better.
As a revenue neutral change, any net gains from one provider will come out of the pocket of another. There is some chance that it could reduce expenses involved in processing the paperwork, but that isn't something I would care to bet on. There is simply no way to predict whether it will be a net positive or negative for OHI's tenants. Make no mistake, the government's interest is not in making sure that SNF landlords have pockets full of cash. The government is trying to get higher-quality care without having to spend additional money.
Specifically for OHI's tenants, we know that three of its top-10 tenants have huge problems. Two are behind in their rent, and GEN is a publicly-traded company, so we can see the problems for ourselves.
Despite these issues, OHI is trading like all of its problems are in the past and it has clear skies ahead. I continue to urge investors to proceed with caution, the coast is not clear, and there is no evidence that the "Silver Tsunami" is rushing in to save the day.
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Disclosure: I am/we are short OHI. 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.
Additional disclosure: Beyond Saving is short OHI. HDO neither has nor endorses any position in OHI.