This most recent purchase wasn’t really planned, as it’s a stock that’s not on my watch list for this month. However, I always remain interested in opportunistically buying stocks on dips when the value seems to be notable enough to veer off track. Just like I might go to the grocery store with a list of food to buy, I’m also not going to pass up an incredible deal on dinner – even if it wasn’t a planned purchase – when it’s right in front of me. Might leave less capital on the table for other opportunities, but that’s the nature of the beast. Sometimes you take what the market gives you.
Now, dips in price are not necessarily indicative of a good buy – price and value aren’t usually one and the same. However, this stock seemed compelling both in terms of quality and value after a slow and steady drop in price of about 18% over the last three months. And so I pounced!
I purchased shares of Omega Healthcare Investors Inc (NYSE:OHI).
Omega Healthcare Investors is a self-administered real estate investment trust that provides capital and financing to the long-term healthcare industry, with a particular focus on skilled nursing facilities in the US.
After a recent merger with Aviv Reit Inc., the combined company has a portfolio of over 900 properties across 41 different states, operated by 81 different third-party operators. They are now by far the largest player in the SNF space, with more than two times the number of properties as that of their closest competitor.
They were founded in 1992.
Omega might not be a household name, but they sport excellent fundamentals across the board.
First, we’ll take a look at growth over the last decade. It’s important to note that REITs, due to their structure, routinely issue shares to fund growth, so it’s important to take a look at growth on a per-share basis so as to determine the most relevant growth rate.
Revenue in absolute terms has increased from $105.8 million to $504.8 million from fiscal year 2005 to fiscal year 2014. That’s a compound annual growth rate of 18.96%. However, OHI’s share count increased from 52.1 million to 127.3 million, so revenue actually grew at a CAGR of 7.74%, which is still incredibly solid.
Now, earnings per share isn’t an accurate or meaningful way to determine profitability for a REIT because depreciation is usually a large non-cash charge for REITs, but real estate generally doesn’t depreciate over long periods of time. It instead usually appreciates. As such, it’s better to look at funds from operations when analyzing a REITs profitability, since FFO adds back in depreciation and amortization to earnings. You can read more about that here.
OHI’s FFO per share has increased from $0.78 to $2.71 over this period, which is a CAGR of 14.84%. That’s about as good as you’ll find in the REIT space in terms of long-term growth. That’s actually quite impressive in any industry.
I love investing in companies that are growing at this kind of double-digit clip, as it’s just not all that often you’ll find a high-quality company growing that fast. But OHI has managed to post great numbers fairly consistently over the last decade.
But it’s one thing to grow, and quite another to share that growing profit pie with shareholders in the form of an increasing dividend. In this regard, OHI definitely doesn’t leave shareholders hungry.
They’ve increased their dividend for the past 13 consecutive years.
Over the last decade, they’ve grown that dividend at an annual rate of 10.9%.
So the dividend has grown at a healthy rate, but conservatively in the sense that it’s below what the company can support and sustain – FFO per share has grown even faster. That’s led to a fairly healthy payout ratio of just 76.1%. As such, the company can easily continue to pay and grow its dividend.
What’s perhaps best of all is the yield, which is currently 6.1%. I’ve mentioned this before with other stocks that exhibit similar numbers, but a yield of over 6% and dividend growth in the high single digits or low double digits generally will generally lead to outstanding total returns over a long period of time – OHI’s total return from 2004 to 2014 is 586%.
I will quickly note here that OHI recently declared a prorated dividend due to the timing of the AVIV acquisition and the issuance of equity. All in all, the announcement still added up to a 1.9% increase over the payout in the previous quarter – the prorated dividend added up to $0.54, an increase of $0.01 over the prior quarter’s payout of $0.53. However, that $0.54 was paid out in two payments of $0.18 and $0.36 per share. That increase, by the way, is the 11th consecutive quarter in which OHI increased its dividend.
This prorated dividend seems to have confused some investors who assumed the dividend was cut, which is a good example as to why it’s important to double check with a company’s press releases whenever confusion arises.
OHI’s balance sheet is fairly conservative, which I also like. Total liabilities are $2.5 billion against $1.4 billion in shareholders’ equity as of the end of FY 2014. Debt/market cap is 30.5% after the acquisition of AVIV. Senior unsecured debt remains investment grade: BBB-/Baa3, with Moody’s just upgrading OHI. Furthermore, most of their debt is due between 2020 and 2025.
The company remains aggressive in terms of new investments, even outside the AVIV acquisition. In 2014, they closed on approximately $566 million in new investments. From 2004 to 2014, the company logged $2.7 billion in new investments to grow the company.
OHI specializes in long-term, triple-net leases with built-in rent escalations. Triple net means that the tenants pay all property related expenses, including real estate taxes, net building insurance, and common area maintenance. It limits the responsibility at the owners’s level, which is what I really like about these kinds of leases.
In addition, the weighted average lease maturity is 13 years. So those are very long-term leases which gives the company significant rental revenue visibility looking out over the next decade or so.
OHI basically provides the financing and specialization from a high level, while allowing the third-party operators to run the day-to-day operations at the facility level. This allows OHI to concentrate on financing and ownership, while collecting healthy rent in the process. So this is your classic landlord business model.
What’s truly wonderful is that the long-term demographics and economics are on OHI’s side. According to the US Census Bureau, the percentage of the domestic population that will be 85 years and above will more than double in percentage terms by 2050, from approximately 2% in 2010 to 5% of the total population in 2050. We all know that old age can bring about mental and physical challenges, increasing the odds that one will need long-term medical assistance. And with skilled nursing facilities having a major cost advantage over impatient rehabilitation hospitals and long-term acute care, the foreseeable future bodes well for OHI and their focus in the SNF arena.
Notably, OHI’s occupancy rate for certified beds was 84.3% in 2014, which is well above the industry average of 82.3% for last year.
The acquisition of AVIV adds a lot to like here. There’s only one overlapping top-ten operator across both portfolios (Diversicare). Meanwhile, AVIV adds 33 new operator relationships in total. And the acquisition reduces the concentration of top-ten operators from 69% to 52%. This combined entity is absolutely the 800-pound gorilla in this industry, which should allow their scale, expertise, and access to financing to assist in continuing to grow at an attractive rate.
Meanwhile, there’s still a lot of growth potential. OHI notes that the industry is $100 billion in size and heavily fragmented, with 87% of SNFs privately owned. So that’s a lot of potential meals for a very hungry OHI.
I find it unlikely that OHI’s skill and expertise becomes any less valuable in the future. It would seem that the demographics and long-term trends are absolutely indicating that the demand for the services of SNFs will only increase over time.
I see the major risks for OHI revolving around the very industry they operate in. A significant portion of their operators’ revenue is derived from government reimbursement, primarily through Medicare and Medicaid. Any major fundamental change there could impact the operators’ ability to pay OHI.
While OHI’s credit ratings are investment grade, they are lower on that scale. Any downgrade could cause their cost of capital to rise substantially. In addition, any rise in interest rates could negatively affect their cost of capital, though this is true for any business that relies on borrowing for growth.
Lastly, there is integration risk with the recent AVIV acquisition. This acquisition is incredibly large, so it remains to be seen how well the two entities work together in terms of synergies and growth. As it stands, OHI anticipates that the transaction will be immediately and significantly accretive to FFO.
OHI’s P/FFO ratio is 12.46 after the recent slide, which I find incredibly attractive. The P/FFO ratio is comparable to the P/E ratio that one would use for C corporations. I will note, however, that the five-year average yield is 6.5%. But I think that just indicates the stock has gone from extremely cheap to less cheap. This stock was available for absolutely ridiculous prices with sky-high yields for a while coming out of the financial crisis. I regret not jumping on this stock earlier, with the initiation of my position occurring in January 2014.
I valued shares using a dividend discount model analysis with an 8% discount rate and a 4% long-term dividend growth rate. That growth rate is quite conservative as it’s less than half that of OHI’s long-term dividend growth track record, but I’m modeling in the fact that REITs require the heavy use of leverage and equity issuance to fund growth. The DDM analysis gives me a fair value of $56.16.
That price would put its P/FFO ratio closer to 19, which, when converted to a P/E ratio, is comparable to a number of companies growing at similar or slower rates on a per-share basis. As such, I think there’s real value here. Furthermore, OHI is currently guiding for $2.98 to $3.04 in adjusted funds from operations per diluted share in FY 2015, so the stock looks even cheaper on a forward-looking basis.
There’s just a lot to like here. Plenty of historical growth, an exciting acquisition, long-term demographic trends that bode well for demand, a low valuation, a juicy yield, and an experienced management team that has lived up to its promises. I’ve been a very happy shareholder since initiating my position early last year, seeing dividend increases in every quarter since I’ve owned it.
I don’t know if dividend increases will continue to be announced in sequential quarters like that, but I think this REIT is in an excellent position to grow its dividend at an attractive rate looking forward, based on the historical track record, growth opportunities looking forward, accretive acquisition, and moderate payout ratio.
This was a rather small transaction for me. I already had transferred capital over to my new TradeKing account prior to this purchase, and that capital was earmarked for another stock. So this was basically just a situation where I saw the opportunity and quickly transferred over capital to my Scottrade account where I had some free trades there waiting to be used. Looking back on it, I wish I would have transferred over a little more capital and picked up an additional five or ten shares, but I’m already being quite aggressive this month in terms of capital deployment as it stands. As always, opportunities outstrip capital. So many stocks, so little capital.