Omega Healthcare Investors Inc (NYSE:OHI) 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 and the United Kingdom, operated by 84 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.
Averaging Down After A Stellar Quarter
OHI is down almost 10% over the last month, which strikes me as a pretty incredible opportunity.
It was just over a month ago that the company reported its fiscal year 2015 Q2 results. And the results were rather stellar across the board.
Revenue came in at $197.7 million, which is 62.3% higher than Q2 2014. Even factoring out the dilution from the Aviv acquisition, revenue was 6.3% higher year-over-year.
Funds from operations was hit by acquisition costs, but adjusted FFO/share (which factors out the acquisition costs) was up 11.6% YOY, coming in at $0.77.
Meanwhile, Omega announced multiple investments, including $112 million of real estate in Manhattan for the development of a senior housing community. They also completed $178 million of new United Kingdom investments.
And they continue to take care of shareholders in the form of a large and growing dividend. And not just a growing dividend, but one that continues to increase quarterly. They’ve increased their dividend three times this year, for a cumulative increase of 7.8% YOY. That dividend growth is obviously very attractive when you consider the stock yields 6.66% here.
I added to my position in this wonderful REIT back in May for $35.39 per share. So I was ecstatic to see it drop down to $33 per share. Even after this transaction, I still have room in the portfolio for a larger slice of Omega, so I’m hoping that the stock drops even more from here. As long as I’m acquiring shares, I look forward to cheaper prices so that my capital goes further, buying an even higher yield which puts me that much closer to my long-term goals.
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 13.11. And that’s factoring in Q2’s acquisition costs, which were somewhat substantial. Factoring those costs out, the P/FFO ratio is closer to 11.97. Either way, the stock appears to be quite cheap to me. The P/FFO ratio is comparable to the P/E ratio that one would use for C corporations. The yield is currently higher than the five-year average, even while that average includes a rather lengthy period of time where the stock was half its current price. So, in my view, the stock has gone from ridiculously cheap to less cheap. Not surprising with the way the market has advanced over the last five years. Still a lot of value here, though, from what I can see.
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 $57.20.
Omega has been an incredible performer over the last decade, generating an annualized total return of just over 17% for shareholders (even after recent volatility). Combine a yield over 6.5% and dividend growth in the low double digits, and that’s what you tend to get. Chronic undervaluation over many years helped as well. Looking at more recent dividend growth (and a yield that’s still very high), one can see how this stock should continue to do very well for shareholders in terms of both aggregate dividend income provided and total return going forward.
The stock is now down more than 17% YTD, which appears to be due to a combination of broader market volatility and fears of rising interest rates. Rising rates or not (which will affect all businesses), skilled nursing facilities aren’t going to see their demand materially change. Elderly citizens who require specialized care aren’t going to up and leave in droves because rates rise by 0.5% or 1%. So keep that in mind.
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