Monty Rakusen
Healthcare REIT Omega Healthcare Investors (NYSE:OHI) may potentially be primed for a dividend cut in the near future if its funds from operations trajectory doesn't improve. The REIT did report in Q3'23 that a number of operators have fallen behind making payments -- whose rent shortfall was applied against posted security deposits -- so new payer problems in the fourth quarter could potentially endanger the REIT's dividend. Omega Healthcare's facility occupancy did improve in the last two years, however, but I don't believe the dividend is as safe as some investors may think it is. Given an increase in the FAD-based payout ratio in the last year, there is a very real risk that the healthcare REIT will under-earn its dividend in the near term.
Focus on skilled nursing portfolio
Healthcare REITs have a number of options to invest in real estate assets that benefit from growing healthcare spending, including hospitals, senior housing, medical offices or skilled nursing properties. The core trend for all of these different styles of healthcare investments is the aging of the global population. The 65+ population, based on Aetna projections, is set to grow from 7% in 2000 to 16% by 2050 which creates fundamental long-term demand growth for healthcare REITs.
Aetna
Omega Healthcare Investors is a mixed healthcare REIT with a primary focus on skilled nursing/transitional care operations and a secondary focus on senior housing. As per the latest supplement, Omega Healthcare's portfolio included 899 healthcare properties, 688 of which fell into the primary category and 211 into the secondary category, while another 14 assets were considered assets to be sold.
Omega Healthcare
Omega Healthcare is mostly focused on the U.S. market, but has about 111 properties in the U.K. From a diversification perspective, I like the exposure to a non-U.S. market.
Omega Healthcare
The average size of an Omega Healthcare facility represents approximately 100 beds and operators tend to chiefly receive payments from either Medicare or Medicaid. There is a small percentage of private-pay beds included in Omega Healthcare's portfolio, but the operators running the REIT's facilities mostly depend on government-funded disbursements to achieve income. As a result, these operators generally face predictable cash flow and income patterns.
Omega Healthcare
The payment mix has been consistent over time with about 15-16% of operator revenues coming from private-pay patients while the overwhelming majority of income comes from Medicaid (54%) and Medicare (30%).
Omega Healthcare
The occupancy rate fluctuates wildly across facilities. The occupancy rate on a portfolio basis was ~79% as of the September quarter and has been increasing. The portfolio has seen a recovery in occupancy in the last two years, especially as the SNF market recovered from the COVID-19 pandemic. At the end of FY 2021, the REIT's portfolio occupancy rate was 74% and in the following year 76%, so occupancy rates have improved approximately 2 PP annually during this time.
Omega Healthcare
Operator rent payment delays and asset sales translate into shrinking FFO, growing dividend risks
Omega Healthcare did not provide guidance for FY 2023 in terms of FFO or AFFO and this is related to the REIT reporting that some operators have not kept up with their rent payment schedules, creating uncertainty around cash flow projections.
Based on the November update, Omega Healthcare sold seven facilities in the third-quarter that were leased to LaVie for $84.4 million. LaVie is the third-largest tenant generating about 7.8% of the REIT's rent/interest. Omega Healthcare sold another 29 facilities leased to LaVie after Q3 quarter-end which may be an indication that payment problems have gotten worse during Q4'23.
The REIT also disclosed that Maplewood Senior Living -- the fourth-largest tenant with a 7.1% rent/interest share -- short-paid its rent by $1M per month and that Guardian Healthcare failed to make its contractual rent payments in August and September as well.
These and other payer issues have resulted in a 6% decline in its FFO in the first nine months of 2023 to $462M and chances are that Q4'23 may also see a decline in the REIT's funds from operations, especially if new payer problems emerged. New payer issues in Q4'23, given Omega Healthcare's rising payout ratio, could foreshadow a dividend cut in the near future, in my opinion, and make the 9% yield more risky than investors may want to admit.
Omega Healthcare
The FAD-based dividend payout ratio (column on the very right in the table below) shows that the ratio exceeded 100% in Q1'23, but remained quite close to 100% in the two succeeding quarters as well, leaving only a very narrow margin of error for Q4'23. FAD stands for funds available for distribution and is a core metric for healthcare REITs that make dividend payments to their investors.
If Omega Healthcare discloses new payment problems for Q4'23, which is not entirely unlikely, there is a good chance that the payout ratio will ratio above 100% again, potentially necessitating a dividend cut. As a result, as the Q4'23 earnings date approaches, I believe investors face material dividend risk.
AFFO/share | Dividend | Payout Ratio | FAD | Payout Ratio | |
Q4'22 | $0.7271 | $0.67 | 92.15% | $0.7040 | 95.17% |
Q1'23 | $0.6571 | $0.67 | 101.96% | $0.6046 | 110.82% |
Q2'23 | $0.7445 | $0.67 | 89.99% | $0.7023 | 95.40% |
Q3'23 | $0.7118 | $0.67 | 94.13% | $0.6784 | 98.76% |
(Source: Author)
We have no FY 2023 guidance for FFO or AFFO, so we could approximate Omega Healthcare's likely cash flow potential by annualizing Q3'23 AFFO... which was $0.71 per share. This calculates to an annualized $2.84 per share in AFFO, a 5% decline relative to FY 2022. Based on annualized AFFO, shares of Omega Healthcare are valued at 10.5X projected forward AFFO. This valuation implies a 9.5% AFFO yield.
Is Omega Healthcare's 9% yield expensive?
It depends. Omega Healthcare pays a 9.0% yield and, at least so far, the dividend is covered by AFFO. However, if OHI were to under-earn its dividend with AFFO in the near term, investors may see a dividend cut and then shares all of a sudden are more expensive. Omega Healthcare's shares traded between 9-12X AFFO in the last year, so historically speaking, OHI is trading at about its average valuation of the last year. Given the risks to the dividend, however, I would say shares are likely leaning a bit on the expensive side. Given the risk to the dividend, I would not pay more than ~9X AFFO for Omega Healthcare at this time, implying a fair value of ~$26.
Risks with Omega Healthcare
A short-term risk is the disclosure of incremental payer problems in Q4'23 which may cause not only a series of stock downgrades but also a further deterioration in the payout ratio. The trend is already not good. New payer issues would greatly increase the chance of a dividend cut which I consider to be the biggest risk for investors. For those reasons, investors who really rely on dividend income from their investments may want to avoid OHI.
Final thoughts
Given the trend in Omega Healthcare's FAD payout ratio, there is a risk that incremental payer problems will result in an unsustainable dividend payout. The dividend is already not growing, and the risks to the dividend have clearly increased. Although occupancy trends have improved in the last two years, Omega Healthcare is likely primed for a dividend cut. Given the high risk of a dividend cut at this point, I would caution against buying Omega Healthcare's 9.0% dividend yield.
