Omega Healthcare: Healthy Returns from Skilled Nursing Facilities

09/11/2018 5:00 am EST

Focus: REITS

Ben Reynolds

CEO, Sure Dividend

Omega Healthcare Investors (OHI) is the largest publicly traded real estate investment trust (REIT) in the U.S. dedicated to owning and  operating skilled nursing facilities (SNFs), notes Ben Reynolds, editor of Sure Dividend.

Approximately 83% of its portfolio consists of skilled-nursing, with the remaining 17% from senior housing. Its portfolio consisted of 963 operating facilities, spread over 41 U.S. states and the United Kingdom.

Last year was difficult for Omega, as the company recorded $198.2 million in impairment charges due to problems related to two tenants, most notably Orianna Health Systems. Omega announced on March 7th, that certain affiliates of Orianna will pursue Chapter 11 bankruptcy. This is concerning, but Omega does not believe the bankruptcy materially affects the value of the facilities in question.

In early August, Omega reported (8/3/18) second-quarter earnings. Revenue of $219.2 million beat expectations. Funds from Operation (FFO) increased 2.7% from the same quarter a year ago and beat expectations by $0.02 per share.

Omega is not entirely out of the woods; 2018 is expected to be a difficult year as well. Omega expects adjusted FFO-per-share in a range of $3.03 to $3.06, compared with $3.30 in 2017. That said, we expect the company to return to growth over the long-term. It continues to reshape its property portfolio, as Omega sold 47 assets in the second quarter, and transitioned 14 Orianna facilities to existing operators.

Despite Omega’s portfolio issues, the company should deliver satisfactory growth over the long run. Growth will be driven by industry tailwinds, specifically the aging U.S. population. The population of 85-year-old people in the United States is expected to grow by ~50% in the next 15 years.

According to Omega, skilled nursing facilities are expected to enjoy rising demand, with limited supply. Occupancy rates are rising at such a strong pace that by 2025 Omega’s occupancy will exceed 100%.

Omega continues to cover its distribution with sufficient cash flow.

We expect Omega will generate FFO-per-share of $3.04 in 2018. The company currently pays an annual distribution of $2.64 per share. Even when including the potential FFO decline for 2018, the forward distribution payout ratio is approximately 87%.

Omega Healthcare Investors’ average distribution yield over the past 10 years is 6.8%. The current distribution yield is 8.4%, which indicates the high level of negative sentiment. In addition, shares of Omega trade for a price-to-FFO ratio of 10.3, a valuation that we believe is too low.

Our fair value estimate is a price-to-FFO ratio of 12.4, which means an expanding valuation could add 3.8% to annual shareholder returns if mean reversion occurred over a 5-year time horizon.

In addition, we expect Omega to generate FFO growth of 4.5% per year. Valuation changes, expected FFO growth, and the 8.4% distribution yield result in 16.7% expected returns for Omega each year.

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