Omega Healthcare (OHI): Mr. Market Liked 2024 Guidance As The 8.55% Yield Remains Intact

Over the previous year, shares of Omega Healthcare Investors (NYSE:OHI) reached $34.77 in October before retracing roughly -19.5% to the $28 level going into Q4 2023 earnings. While the past decade has been full of ups and downs as shares traded above $40 and under $25, they have ultimately declined by -1.94%. The market seemed to have liked OHI’s Q4 earnings and the 2024 guidance, as shares have appreciated by 10.67% since February 7^th, going from 28.07 to $31.12. OHI is a triple net lease (NNN) REIT that specializes in skilled nursing facilities and long-term care facilities. These industries are still recovering from the pandemic, and OHI is still trading at a discount to their pre-pandemic level of around $42. Individuals allocate capital toward many different types of investments, and while big tech has monopolized the narrative, I feel there are still opportunities in other segments of the market. OHI managed its way through an unprecedented environment, and it seems as if the market is responding well to its 2024 guidance. It may take several years, but I believe that the combination of a lower rate environment and OHI’s operators getting back to pre-pandemic levels of operating will make OHI an attractive candidate for capital appreciation while paying a high-single-digit yield on its dividend.

Following up on my previous article about OHI

In December, I wrote an article on OHI (can be read here), and since then, shares of OHI have appreciated by 1.7% compared to the S&P 500, rising 6.93%. When OHI’s dividend is factored in, its total return over this period is 4.06%. In this article, I had discussed Q3 earnings and how OHI delivered a top and bottom line beat, but shares retraced on funds available for distribution [FAD] worries. Now that the 2023 fiscal year is in the books, I wanted to follow up with a new article, discuss the Q4 results, and 2024 guidance, and provide an update on my original investment in OHI.

Risks to investing in OHI

The latest CPI print showed CPI declining to 3.1% MoM, but this was actually a hot print as the consensus estimate was 2.9%. Core CPI also was above the consensus estimate of 3.7%, as the print was 3.9%. Rent inflation is still over 6%, and CME Group is now getting back in the higher for longer camp, as they are only factoring in a 4% chance that the Fed cuts rates in March. There is a chance that the Fed will come out hawkish, as they have continuously indicated they will rely on the data to determine when the appropriate time to start cutting rates is. At the last Fed press conference, Fed Chair Powell was clear that they would be data-dependent but felt an easing cycle would start in 2024 with an estimated 3 cuts of 25 bps. If the economy continues to run hot and CPI prints come in ahead of the consensus numbers, the Fed may revert to a higher for longer stance and rethink when the easing cycle will start. If this occurs, it will impact the economy, especially the REIT sector, as reprieve from high-interest debt will be pushed out further. This could negatively impact OHI and its operators, which would be negative for the investment thesis.

The market is reacting positively to the 2024 guidance and I think OHI is emerging from the difficulties of the pandemic

Shares are up, and things are looking better for OHI. In Q4, OHI delivered a revenue beat of $32.74 million as they generated $239.32 million in revenue during Q4. OHI also produced $0.68 in funds from operations [FFO] in Q4, which a $0.01 ahead of the consensus estimates. Substantial progress is being made, as OHI generated $57 million in net income in Q4 and generated $173 million in adjusted FFO. OHI made $249 million in new investments throughout the quarter, which broke out to $167 million in real estate loans, $51 million in acquisitions, and $31 million in capital renovation and construction. OHI sold 32 facilities and generated $324 million in cash and debt repayments while repaying $227 million on 25 HUD mortgage loans. Management had previously indicated that FAD would be light in Q4, and it did trail the quarterly dividend as OHI generated $0.64 per share of FAD compared to the $0.67 quarterly dividend.

In the 2023 fiscal year, OHI operated at a 102% payout ratio on the dividend as they only produced $2.62 of FAD compared to the annualized dividend per share of $2.68. This has led to skeptics making a bear case for the dividend and insinuating that a future dividend cut is imminent. While operating at over a 100% payout ratio isn’t optimal, keep in mind that the REIT structure requires REITs to pay at least 90% of their taxable income out to shareholders through a dividend or distribution. REITs will always operate at a high payout ratio, and in situations where the FAD supersedes the dividend, it is important to look through the numbers to determine if the REIT can afford to maintain the current dividend level and if FAD is projected to normalize in the future.

While the Q4 FAD of $0.64 wasn’t optimal, OHI controlled the narrative and highlighted its operational progress. Throughout the pandemic, some of OHI’s operators fell on hard times, and it’s been an ongoing process to rectify the situation. OHI ended up selling 30 facilities that were leased to LaVie Care Centers for $317.9 million in Q4, which consisted of cash and loan repayments. In Q4, LaVie paid $5.3 million in rent, and throughout January, LaVie paid OHI roughly $1.45 million in rent obligations. Maplewood paid OHI $11.6 million in Q4, and in January, Maplewood paid OHI $3.8 million in rent. Guardian Healthcare didn’t pay OHI its contracted rent in Q4, but OHI was able to post $4.4 million of revenue due to the security deposit. Guardian isn’t in the best situation as OHI had to draw down the remaining $100,000 from the security deposit, but OHI is looking to sell or release the 6 facilities to another operator.

While the situation is improving, OHI completed $249 million in new investments. The $167 million in real estate loans have a weighted average interest rate of 10.5%, while its new acquisitions have a weighted average annual yield of 9%. This is one of the reasons I am bullish on OHI because there are 2.5% annual price escalators built into the contracts. In 2023, OHI sold 69 facilities for $485 million, and it finished the year with 862 facilities across its portfolio. OHI’s balance sheet was strengthened due to the portfolio progress, as 25 HUD mortgages totaling $227 million were repaid. OHI ended 2023 with over $440 million of cash on its balance sheet and roughly $1.4 billion in its credit facility borrowing capacity. OHI is in a position of strength when it comes to its debt maturities, as 99% of its debt is fixed, and OHI will have no issues making the upcoming $400 million bond payment in April. From a coverage perspective, OHI’s net funded debt to its adjusted normalized EBITDA was 4.96x.

If you have time on your side, income investing can do well through the powers of compounding

To some, investing in income-producing assets isn’t exciting, but that doesn’t mean it can’t lead to positive outcomes. Here is a real-life example of how my initial investment in OHI unfolded. I do own more OHI than these shares, but I kept these in a separate account to make tracking its progress easier. I made 2 investments that occurred at the end of 2017 and the beginning of 2018. I ended up purchasing 163 shares for $4,875.37. My price per share is $29.91, and today, shares are trading at $31.12, which is a 4.04% return.

The real story is how the investment changed due to reinvesting the dividends. I made my 2^nd purchase after the first dividend was declared; that’s why the chart below spiked in Q1 2018. I have collected $3,617.39 in dividends, which is 74.2% of my original investment. In this account, my share base has increased by 69.86% as I have been able to add 113.87 shares. Instead of having a 4.04% return, my actual return is 76.74%, as the investment is now worth $8,616.26. In total, I have collected 26 dividends, and if I omit the first dividend from the 2^nd dividend to the 26^th dividend collected, the quarterly dividend will increase by $72.38 or 66.3%. My forward dividend income has also increased from $423.80 on the initial 163 shares to $742.02, which is an increase of 75.09%.

While I invest in big-tech, growth companies, and index funds, I also have an income-producing portfolio that continues to expand by reinvesting the dividends. I have been able to sit back and let OHI’s dividend do the work, and while shareholders haven’t gotten a dividend increase since 2020, my quarterly dividend continues to grow at an average rate of 2.14%. I need to generate another 49.13 shares to double my initial share base from the dividend, which will take roughly another 2 years. The day-to-day or month-to-month price fluctuations don’t bother me as this is an investment that continues to pay for itself, and eventually, I will start taking the cash to pay for expenses when I retire. I am providing this data to show that sometimes a boring dividend company that only has a 4.04% return on invested capital from an appreciation standpoint can actually work out much better than people think. Currently, OHI has an average annualized rate of return of 11.8% for me since my original investment.

Conclusion

2024 will mark the first time since the pandemic when OHI provides full year Adjusted FFO guidance, projected to be $2.70 – $2.80. This excludes new investments or sales that OHI may conduct throughout the current fiscal year. Based on OHI’s forecast, the dividend would be covered on a run-rate basis. I think things are getting better and that OHI is well-positioned for the future. There is still work to be done, but it’s not the dire situation it was in back in 2020. OHI has been able to navigate the waters and continue paying large dividends. As we enter a rate cutting environment, I think REITs will become stronger, and OHI will significantly benefit. I am long OHI and feel it’s still a good investment for long-term income generation and capital appreciation.