Omega Healthcare Investors: Wait For A Drop

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About: Omega Healthcare Investors, Inc. (OHI)
by: Achilles Research
Summary

Omega Healthcare Investors reported better-than-expected Q2-2019 results on August 6, 2019.

Omega Healthcare Investors is poised to benefit from an aging U.S. population and an associated increase in healthcare expenditures.

The healthcare REIT outearned its dividend with AFFO in Q2-2019.

However, Omega Healthcare Investors downgraded its outlook for 2019.

An investment in OHI yields 6.9 percent.

Omega Healthcare Investors, Inc. (OHI) reported results for its second fiscal quarter on Tuesday that came in slightly better than expected. The healthcare REIT also once again outearned its dividend with adjusted funds from operations, but issued a weak guidance for the remainder of the year. In my estimation, Omega Healthcare Investors' shares are now slightly overvalued and investors may want to wait for a drop towards the low $30s before gobbling up some shares. An investment in OHI at today's price point yields 6.9 percent.

Omega Healthcare Investors - Portfolio And Growth Opportunity

Omega Healthcare Investors is a U.S. healthcare real estate investment trust with an SNF-focus, meaning the company invests largely in senior-focused skilled nursing facilities. At the end of the June quarter, the REIT's portfolio consisted of 949 properties valued at $9.2 billion. The majority of Omega Healthcare REIT's properties related to skilled nursing/transitional care facilities (86 percent of properties) while the remainder of the real estate portfolio is made up of senior housing properties.

Here's a portfolio breakdown by asset type.

Source: Omega Healthcare Investors Earnings Supplement

Omega Healthcare Investors faces a multi-decade growth opportunity in the healthcare industry: The U.S. population is aging rapidly and older age cohorts are projected to make up a larger share of U.S. society going forward. Projections indicate that the 80-84 and 85+ age cohorts will be the fastest-growing elderly demographics over the next two decades, pointing to significant demand growth for healthcare REITs that cater to the healthcare needs of senior citizens.

Source: Omega Healthcare Investors

Texas is the most important state for Omega Healthcare Investors because of its large and fast-growing elderly population. The U.S. state accounts for ~14 percent of all properties and ~12 percent of the REIT's total investments.

Here's an investment breakdown by U.S. state.

Source: Omega Healthcare Investors

How Is Omega Healthcare Investors Growing?

Omega Healthcare Investors is growing primarily through acquisitions, but the company also spends a significant amount of capital on renovations and construction-in-progress projects in order to upgrade its healthcare facilities. Omega Healthcare Investors regularly invests hundreds of millions of dollars each year into its property portfolio. Year-to-date, OHI has spent $726 million on its real estate portfolio.

Here's an acquisition breakdown since 2014.

Source: Omega Healthcare Investors

Omega Healthcare Investors also occasionally buys entire companies to integrate into its real estate platform and grow FFO. In Q2-2019, for example, Omega Healthcare Investors completed the acquisition of MedEquities Realty Trust, Inc. OHI agreed to buy the REIT earlier this year in a transaction valued at $600 million. The acquisition is expected to be accretive to FFO and AFFO by $0.05/share and increases Omega Healthcare Investors' operator diversification profile.

Source: Omega Healthcare Investors

Distribution Coverage

Omega Healthcare Investors froze its dividend in Q1-2018 on the back of operator troubles and a lowered AFFO outlook. To this day, OHI pays shareholders a $0.66/share quarterly dividend which has been solidly covered by the REIT's adjusted funds from operations. Q2-2019 AFFO was $0.77/share which compared favorably to a consensus AFFO estimate of $0.76/share.

Omega Healthcare Investors earned an average of $0.76/share in AFFO in the last six quarters, implying an 87 percent adjusted FFO payout ratio. The dividend is not at risk over the short haul.

Source: Achilles Research

Valuation

Omega Healthcare Investors last week guided for $3.03-$3.07/share in adjusted funds from operations for 2019, which is lower than the previous guidance of $3.00-$3.12/share. The guidance was revised downwards due to "the pending sale of ten Diversicare assets, continuing [operator] Daybreak on a cash basis at approximately $3 to $5 million per quarter and to a lesser extent, shares issued under our equity programs".

Based on the new guidance, shares currently change hands for ~12.5x 2019e adjusted funds from operations. I continue to see Omega Healthcare Investors' fair value somewhere between $33-$36/share, which would imply an 11-12x AFFO-multiple, meaning OHI is probably slightly overvalued today. As a result, I don't believe shares currently represent a healthy risk/reward for high-yield investors.

Risks

Omega Healthcare Investors faces several risk factors that all could have a dramatic impact on the distribution. For one, Omega Healthcare Investors could run into more problems with operators that work in the competitive SNF business. Operators that struggle to make lease payments on time have the potential to destabilize the healthcare REIT and have a negative effect on cash flow and guidance. Further, increasing competition in the SNF market could put pressure on Omega Healthcare Investors' cash flow, and, ultimately, the distribution. Lastly, if OHI issues equity in order to shore up its balance sheet and/or raise cash for acquisitions, investors face dilution risks.

Your Takeaway

Omega Healthcare Investors had a decent, yet boring second quarter. The company continues to outearn its dividend with AFFO and the REIT could afford to raise its payout. However, management's priority is not dividend growth right now, but "buying growth" through acquisitions. I like the healthcare REIT, but the valuation is just not too compelling for me to get back in yet. Wait for a drop towards $33 in order to improve the risk/reward setup and entry yield.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.