Omega Healthcare (OHI): A High-Yield Healthcare REIT

Omega Healthcare Investors (OHI) is a real estate investment trust (REIT) with a high dividend yield over 6%.

The company operates in the healthcare sector, which is generally one of the best stock sectors for dividend income because of its essential products and services.

However, a high dividend yield can be a signal that a company’s dividend payment will not be sustainable.

We will only invest in safe dividend stocks for our Conservative Retirees dividend portfolio, so let’s see if Omega can make the cut.

Business Overview

Omega is a healthcare REIT that provides financing and capital primarily to skilled nursing facilities (SNFs), which account for about 90% of the company’s facilities. The remaining 10% of Omega’s facilities are used for senior housing.

Patients discharged from hospitals are sent to SNFs when they still require care or rehab before they can be sent home. Compared to hospitals, SNFs can provide short-term care on a much more affordable basis to save healthcare costs.

Omega’s tenants receive revenues through Medicare and Medicaid reimbursements as well as private pay for their services. Omega receives fixed rent payments from its tenants with annual escalators and uses triple net lease agreements, which are generally thought to be lower risk deals because they require the tenant to pay property taxes, insurance, and maintenance expenses.

Overall, Omega has more than 930 properties located across over 40 states and operated by more than 80 different operators. The company owns about 84% of its assets with mortgages (9%) and direct financing leases (7%) accounting for the remainder.

Business Analysis

Omega is the largest skilled nursing facilities REIT with more than twice as many properties as its next largest competitor and is playing the role of consolidator in this large and fragmented market.

The company boosted its property count by nearly 50% with its $3.9 billion acquisition of Aviv on April 1, 2015, which helped Omega gain operating, growth and cost of capital efficiencies.

Importantly, the deal also increased Omega’s diversification by state and operator. Unlike HCP, another healthcare REIT that we analyzed earlier, Omega’s largest tenant accounts for less than 7% of rent, and no state accounts for more than 11% of its total rent.

This diversification prevents the company from being overly exposed to unexpected headwinds that could emerge at any given tenant or in any particular state as it relates to issues such as Medicaid reimbursement.

While the skilled nursing industry certainly has its share of risks (more on that later), there are several elements of it that attract us.

Most notably, we continue to believe that the industry’s supply and demand fundamentals remain attractive.

From a demand standpoint, Omega’s occupancy rate has consistently remained in excess of 80% thanks to the non-discretionary nature of its operators’ services, and demand should rise as the senior population continues growing.

SNFs also seem likely to remain the go-to sites for post-acute care. Simply put, SNFs remain the most cost-effective environment for rehab services in most cases due to their relatively smaller footprints and lower staff counts.

As seen below, SNFs have about 50% market share of patients sent to post-acute care.

Omega OHI Dividend Omega Healthcare
Omega Healthcare

Source: Omega Investor Presentation

Looking at industry supply, we can see below that the supply of facilities and beds to meet increasing future demand has been limited due to Certificate of Need (CON) restrictions, which are aimed at restraining health care facility costs and have helped industry occupancy rates:

Omega OHI Dividend Omega Healthcare
Omega Healthcare

Source: Omega Investor Presentation

Overall, we expect Omega’s operators to enjoy higher volumes thanks to expanding Medicare coverage and a growing senior population.

We think the company will continue to have plenty of opportunities for acquisitive growth as well. As seen below, Omega has done an outstanding job finding reinvestment opportunities over the last decade (double-digit sales growth in nine of the last 10 years), and tougher reimbursement from Medicare and Medicaid should continue encouraging consolidation.

Omega OHI DividendSource: Simply Safe Dividends

Omega’s Key Risks

Omega’s biggest risks are arguably all outside of the company’s control.

Skilled nursing generally has higher reimbursement risk than other areas of healthcare such as senior housing because SNFs more on Medicare and Medicaid reimbursements from the government.

As a result, changes in federal policies and increased scrutiny over billing practices of SNF operators have potential to materially impact the ability of Omega’s tenants to meet their lease obligations.

While Omega has enjoyed rising Medicare and Medicaid rates over time (see below), lengths of stay are declining under alternative payment models such as bundling and managed care.

Omega OHI Dividend Omega Healthcare
Omega Healthcare

Source: Omega Investor Presentation

Despite shifts in rates and the length of patient stays, SNF Medicare patient days are still projected to grow due to increasing enrollment.

Omega OHI Dividend Omega Healthcare
Omega Healthcare

Source: Omega Investor Presentation

Let’s take a closer look at some of these risks as it relates to dividend safety.

Dividend Analysis: Omega

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Omega’s long-term dividend and fundamental data charts can all be seen by clicking here.

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

Omega’s Dividend Safety Score of 65 suggests that its current dividend payment is somewhat safer than the average dividend stock.

However, one of the first things income investors point to when reviewing Omega is the company’s dividend cut in 2000.

As seen below, the company reduced its total dividends paid from $2.80 per share in 1999 to $1.00 per share in 2000 before completely eliminating the dividend in 2001 and 2002.

Omega OHI Dividend Omega Healthcare
Omega Healthcare

Source: Simply Safe Dividends

Since restarting its dividend in 2003, Omega’s annual dividends have increased every year. However, conservative income investors have every right to question whether Omega’s current dividend payment is really reliable. After all, a company that cuts its dividend once certainly seems more likely to cut it again.

Why was Omega forced to cut its dividend in 2000, and could that same risk reemerge in the future?

The answer comes from Omega’s 2001 annual report. The Balanced Budget Act of 1997 introduced a new payment system for the reimbursement of Medicare patients in SNFs.

A major shift took place in which a cost-based reimbursement system that was historically used was essentially abandoned in favor of a reimbursement system that capped payments per service at a fixed amount. This was done by the government to save money and attempt to balance the federal budget by 2002.

While some of these payments changes were reversed by

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