Omega Healthcare at 9% yield is too good to pass up
It’s not hard these days to find high-quality REITs that yield more than 3%, because the era of TINA (there is no alternative) is now over. Indeed, income asset classes such as REITs, BDCs, and MLPs have a lot of competition for investment dollars, especially the 10-year Treasury note now yielding slightly above 4%.
Some investors, especially retirees, may be looking for a higher initial yield, as this can help meet RMD requirements on retirement accounts without them having to sell their holdings. Plus, higher yielding stocks simply provide more financial flexibility to fund day-to-day expenses and dividend reinvestment opportunities.
This brings me to Omega Healthcare Investors (NYSE: IHO), which is a favorite income for many. With the stock now back to a 9% yield, I’m highlighting why it’s time to revisit this position, so let’s get started.
Omega Healthcare Investors is the largest publicly traded owner of skilled nursing facilities. It has been listed on the stock exchange for 30 years and currently has 921 properties spread across the US and UK, comprising 63 operators and 92,000 beds. It is also geographically diverse with exposure to almost every region of the United States, and its top 3 states are Florida, Texas, and Indiana.
Starting with the negatives, it is no secret that the skilled nursing segment is a low-margin business as it depends on government programs for its funding. This industry is notorious for having low rent coverage, and labor shortages and wage inflation have only exacerbated these issues over the past year, putting pressure on operators.
While these are legitimate concerns, we should not ignore the fact that SNFs are mission critical and offer a much lower cost of care than acute care hospitals. Management noted that while the increased post-COVID cost structure may be permanent, a number of states have announced significant Medicaid rate increases to help offset higher costs.
It appears, however, that the industry is beginning to turn the page, as management has completed its restructuring work related to its Gulf Coast operator, and is well on its way to restructuring with Agemo, which accounts for 6% of the contractual rent, none of which was recognized during the second quarter. Notably, management noted that its other cash-strapped tenants have generally agreed to pay contractual rent as they work through various asset sales or transitions to new operators.
Importantly for income investors, OHI’s quarterly dividend of $0.67 remains covered by AFFO per share of $0.76 and funds available for distribution of $0.71, at distribution rates of 88% and 94%, respectively. Given OHI’s restructuring progress with Agemo, I expect OHI’s payout ratios to improve in the third quarter and beyond.
Meanwhile, it looks like OHI has prepared for this kind of adversity, as it has a strong BBB-rated balance sheet with a safe net debt to EBITDA ratio of 5.3x and a strong fixed charge coverage ratio of 4. ,2x. Additionally, 98% of OHI’s debt is fixed rate, making it less vulnerable to rising rates. This also means that it will take a number of years for OHI to realize a higher cost of debt, as not all of its debts mature at the same time, and this assumes a bad scenario in which interest rates interest and inflation will remain high for years to come.
In the long term, I believe OHI remains well positioned as the largest owner of skilled nursing facilities. This takes into account the growing elderly population over the next decade and the fact that 86% of states have a moratorium on new beds or CON (certificate of need) restrictions on new construction.
I find that the recent drop in the IHO price from near $34 to $30 offers another opportunity to layer on top of this high yield. He currently carries a forward P/FFO of just 10.2, well below his normal P/FFO of 12.5.
Thanks to OHI’s chronic undervaluation and high dividend yield, OHI has actually easily beaten the S&P 500 (SPY) on a total return basis over the past decade, as shown below.
Key takeaway for investors
Omega Healthcare appears to be turning the page, as occupancy rates rise and states increase Medicaid funding to offset wage inflation in the skilled nursing segment. The dividend remains covered and I expect the payout ratio to improve for the remainder of the year as management works through restructuring activities. The recent drop in OHI’s share price has boosted its dividend yield by nearly 9%, making it an attractive option for income investors.