Omega Healthcare Investors: Sometimes Short-Term Bad Can Be Long-Term Good

This article is about Omega Healthcare Investors (NYSE:OHI), a REIT, and why it’s a buy for the income investor long term, even when OHI has a short-term problem with one of its operators. I believe that the management of OHI is good and has already outlined the steps to be taken to get the Orianna properties to new operators with reduced rents.

Omega Healthcare is one of the largest operators of skilled nursing care properties and assisted living properties. OHI is a full position at 6.0% in The Good Business Portfolio. OHI’s position will be left to grow over time and added to whenever a dip like this happens. The company has at many times been under pressure and gotten down to $28 range, and each time it has bounced back, so this is another chance to buy into a good company with a very high yield.

When I scanned the five-year chart, Omega Healthcare Investors has a poor chart going up and to the right for 2013-2014, then down slowly for three years ending behind the market. In 2013, OHI had a good year when the market was up 27%; the company came in at a 30% increase.

Chart

OHI data by YCharts

Fundamentals of Omega Healthcare Investors will be reviewed in the following topics below:

  • The Good Business Portfolio Guidelines
  • Total Return And Yearly Dividend
  • Last Quarter’s Earnings
  • Company Business
  • Takeaways
  • Recent Portfolio Changes

I use a set of guidelines that I codified over the last few years to review the companies in The Good Business Portfolio (my portfolio) and other companies that I am taking a look at. For a complete set of the guidelines, please see my article “The Good Business Portfolio: Update To Guidelines And July 2016 Performance Review“. These guidelines provide me with a balanced portfolio of income, defensive, total return and growing companies that hopefully keeps me ahead of the Dow average.

Good Business Portfolio Guidelines

Omega Healthcare Investors passes 9 of 11 Good Business Portfolio Guideline, a fair score (a good score is 10 or 11). These guidelines are only used to filter companies to be considered in the portfolio. Some of the points brought out by the guidelines are shown below:

  1. Omega Healthcare Investors does meet my dividend guideline of having increased dividends for seven of the last ten years and having a minimum of 1% yield, with 10 years of increasing dividends and a 9.3% yield. Omega Healthcare Investors is therefore a good choice for the dividend income investor. The average five-year payout ratio is high at 82% because of its REIT designation. After paying the dividend, this leaves cash remaining for investment in expanding the business by buying bolt-on properties to the 1,000 it already owns or leases.
  2. I have a capitalization guideline where the capitalization must be greater than $7 billion. OHI fails this guideline by a small amount. OHI is a mid-cap company with a capitalization of $6.2 billion. Omega Healthcare Investors’ 2017 projected total yearly AFFO flow at $646 million is good, allowing the company to have the means for growth and increase dividends.
  3. I also require the CAGR going forward to be able to cover my yearly expenses. My dividends provide 3.2% of the portfolio as income, and I need 1.9% more for a yearly distribution of 5.1%. The one-year forward CAGR of 7.0% meets my guideline requirement. This good future growth for Omega Healthcare Investors can continue its uptrend benefiting from the continued growth of the senior citizen population.
  4. My total return guideline is that total return must be greater than the Dow’s total return over my test period. OHI fails this guideline since the total return is 64.33%, less than the Dow’s total return of 78.53%. Looking back, $10,000 invested five years ago would now be worth over $18,700 today. The total return in the good year of 2013 was 29.6% compared to the Dow gain of 27%, a small beat. This makes Omega Healthcare Investors a fair investment for the total return investor that has future growth as the senior citizen sector continues to grow. As an added plus we have President Trump cutting corporate taxes (both domestic and foreign) which will increase earnings slightly.
  5. One of my guidelines is that the S&P rating must be three stars or better. OHI’s S&P CFRA rating is three stars or hold with a recent calculated target price to $35.4, passing the guideline. OHI’s price is presently 25% below the target. It is under the target price at present and has a low price to AFFO of 10.8, making it a good buy at this entry point if you are a long-term investor that wants income with an above-average dividend yield.
  6. One of my guidelines is would I buy the whole company if I could. The answer is yes. The total return is weak, but an above-average yield makes OHI a good business to own for income with moderate growth long term. The Good Business Portfolio likes to embrace all kinds of investment styles but concentrates on buying businesses that can be understood, makes a fair profit, invests profits back into the business, and also generates a fair income stream. Most of all what makes OHI interesting is the potential long-term growth, as more skilled nursing care facilities are required and the income for the income investors is great.

Total Return And Yearly Dividend

The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. Omega Healthcare Investors misses the Dow baseline in my 56.0-month test compared to the Dow average. I chose the 56.0-month test period (starting January 1, 2013, and ending to date) because it includes the great year of 2013, and other years that had fair and bad performance. The fair total return of 64.23% makes Omega Healthcare Investors a fair investment for the total return investor who also wants a steady increasing income. OHI has an above-average dividend yield of 9.3% and has had increases for the past 21 quarters, making OHI also a good choice for the dividend growth investor. The dividend has recently been increased to $0.65/Qtr., from $0.64 or a 1.6% increase for the quarter.

Dow’s 56.0-month total return baseline is 78.53%.

Company Name

56.0-month total return

Difference from Dow baseline

Yearly dividend percentage

Omega Healthcare Investors

+64.23%

-14.3%

9.3%

Last Quarter’s Earnings

For the last quarter, on October 30, 2017, Omega Healthcare Investors reported AFFO of $0.79 that missed expectations by $0.06 and compared to last year at $0.82. Total revenue was higher at $194 million, up 4.4% year over year and missed expectations by $44 million. This was a poor report with the bottom line missing expectations and the top line increasing. The next earnings report will be out in late January 2018 and AFFO is expected to be $0.82 compared to last year at $0.82. The company guided AFFO for the year to $3.27-3.38, but this assumes it will be able to fix the problem with one of its operators. Earnings will most likely be very volatile over the next six months.

Business Overview

Omega Healthcare Investors is one of the largest skilled nursing care and assisted living facilities REITs in the United States.

As per Reuters:

“Omega Healthcare Investors is a self-administered real estate investment trust (REIT). The Company maintains a portfolio of long-term healthcare facilities and mortgages on healthcare facilities located in the United States and the United Kingdom. It operates through the segment, which consists of investments in healthcare-related real estate properties. It provides lease or mortgage financing to qualified operators of skilled nursing facilities (SNFs) and assisted living facilities (ALFs), independent living facilities, rehabilitation and acute care facilities. Its portfolio consists of long-term leases and mortgage agreements. As of December 31, 2016, its portfolio of investments included 996 healthcare facilities located in 42 states and the United Kingdom and operated by 79 third-party operators. As of December 31, 2016, the Company’s portfolio consisted of 809 SNFs, 101 ALFs, 16 specialty facilities, one medical office building, fixed rate mortgages on 44 SNFs and two ALFs.”

The graphic below shows the type of facilities required today. With seniors remaining active into their 80s, 90s and beyond, skilled nursing facilities continue to evolve to meet the higher expectations new generations of seniors and their families want with regards to amenities, décor and care.

Source: Omega Healthcare Investors Web Site

Overall, Omega Healthcare Investors is a good business with a 7% CAGR projected growth as more skilled nursing care facilities are needed going forward. The good AFFO provides OHI the capability to continue its growth by increasing revenue as it buys bolt-on properties and increases dividends.

Also as a tailwind, we have President Trump wanting to lower corporate taxes on income. As the corporate tax rate is lowered, earnings of OHI should increase slightly.

The economy is showing moderate growth right now (about 2.9%), and the Fed has raised rates in June 2017, with future rate increases dependent on the United States economy and inflation. The Fed projects for one more increase in 2017. I feel the Fed is going slowly; it doesn’t want to trigger a slowdown in the economy.

From October 30, 2017, earnings call, Taylor Pickett (Chief Executive Officer) said:

Adjusted FFO for the third quarter is $0.79 per share. Funds available for distribution, FAD for the quarter is $0.73 per share. The reduction in adjusted FFO and FAD is primarily related to converting the Orianna portfolio to cash basis accounting with no adjusted FFO or FAD recognized for Orianna in the third quarter.

During the third quarter, we cooperatively completed the transition of Orianna’s Texas facilities to another Omega operator, and we completed the sale of the Northwest facilities to two buyers. Unfortunately, the remaining portfolio continues to underperform and Orianna continues to apply free cash flow to pay down past due vendors and other obligations.

We are in active discussions with Orianna’s owners and consultants regarding the potential transition and/or sale of certain assets versus a federal or state court restructure. We are hopeful, we can develop an out-of-court plan, which if successful, would likely result in cash rents of $32 million to $38 million per year, as compared to the current annual contractual rent of $46 million.

“We remain confident in our ability to pay our dividend, increasing our quarterly common dividend by $0.01 to $0.65 per share. We’ve now increased the dividend 21 consecutive quarters. Our dividend payout ratio remains conservative at 82% of adjusted FFO and 89% of FAD, and we expect these percentages will improve as the Orianna facilities return to paying rent. Our revised 2017 guidance reflects the impact of Orianna’s cash accounting and our anticipation that no cash were received for the balance of the year. “

This shows the feelings of the top management for continued growth of the business and shareholder returns and the action being taken to fix the problem with Orianna.

From October 30, 2017, earnings call Daniel Booth (Chief Operating Officer), said:

“Turning to new investments. During the third quarter of 2017, Omega completed two new investments totaling $202 million, plus an additional $36 million of capital expenditures. Specifically, Omega completed $190 million purchase lease transaction for 15 skilled nursing facilities in Indiana and as part of that same transaction simultaneously completed a $9.4 million loan for the purchase of the leasehold interest in one skilled nursing facility with an existing Omega operator.”

This shows that OHI is still growing even with an operator in trouble.

Takeaways

Omega Healthcare Investors is a great investment choice for the long-term income investor with its high yield and a fair choice for the total return investor. I take this downturn as a long-term opportunity to get a great income stream at a bargain price. Omega Healthcare Investors is 6.0% of The Good Business Portfolio and will be held as we watch it grow over time. If you want a growing income, OHI may be the right investment for you, but it will be volatile for the next six months and you should be a long-term investor.

Recent Portfolio Changes

  • Increased the position of Omega Healthcare Investors to 6.0% of the portfolio. I wanted a little more income and to take advantage of the recent dip in price.
  • Recently, on October, 16 trimmed Boeing (BA) from 11.3% of the portfolio to 11.0%. A great company, but you have to be diversified. The Paris Air Show was great for Boeing, and it easily beat Airbus (OTCPK:EADSY) in orders by a mile.
  • Wrote some L Brands (LB) November 17 strike 42.5 calls on the part of the holding. If the calls remain in the money near exercise time, they will be moved up and out.
  • Increased the position of L Brands to 3.2% of the portfolio; I believe the downturn in LB is well overdone.
  • Increased position of GE (NYSE:GE) to 4% of the portfolio, a full position. GE has now become a value and income play.
  • Sold the Harley-Davidson (HOG) position from the portfolio and will watch it see if President Trump cuts corporate taxes or brings foreign profits back at a low tax rate. This sell gets rid of an underperformer and makes room for a company with more present growth.
  • Added a starter position of 3M (MMM) at 0.5% of the portfolio. It has a good steady dividend history, a dividend king with 58 years of increasing dividends, and great total return. Please see my article “3M: Dividend King With Great Total Return“.

The Good Business Portfolio generally trims a position when it gets above 8% of the portfolio. The four top positions in The Good Business Portfolio: Johnson & Johnson (JNJ) 8.8% of the portfolio, Altria Group (MO) 6.8%, Home Depot (HD) 8.6%, and Boeing 11.0% of the portfolio; therefore, BA, JNJ, and Home Depot are now in trim position with Altria getting close.

Boeing is going to be pressed to 11% of the portfolio because of it being cash positive on 787 deferred plane costs at $316 million in the first quarter, an increase from the fourth quarter. The second quarter saw deferred costs on the 787 go down $530 million, a big jump from the first quarter. The second-quarter earnings were fantastic with Boeing beating the estimate by $0.25 at $2.55. The third-quarter earnings were $2.72, beating expectations by $0.06 with revenue increasing 1.7% year over year, another good report. Recently S&P Capital IQ raised its one-year target to $272.

JNJ will be pressed to 9% of the portfolio because it’s so defensive in this post-Brexit world. Earnings in the last quarter beat on the top and bottom line, and Mr. Market did like the growth going forward. JNJ is not a trading stock but a hold forever; it is now a strong buy as the healthcare sector remains under pressure.

For the total Good Business Portfolio, please see my article on The Good Business Portfolio: 2017 2nd Quarter Earnings And Performance Review for the complete portfolio list and performance. Become a real-time follower, and you will get each quarter’s performance after the earnings season is over.

I have written individual articles on JNJ, EOS, GE, IR, MO, BA, PEP, AMT, PM, LB, OHI, DLR and HD that are in The Good Business Portfolio and other companies being evaluated by the portfolio. If you have an interest, please look for them in my list of previous articles.

Of course, this is not a recommendation to buy or sell, and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account, and the opinions on the companies are my own.

Disclosure: I am/we are long BA, JNJ, HD, OHI, MO, IR, DLR, GE, PM, LB, MMM.

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.