Omega Healthcare Investors Inc (NYSE:OHI) generates quite a great deal of controversy nowadays. Many folks love OHI stock for its 7.7% dividend yield. Judging from retail investor interest, Omega Healthcare is one of the most popular healthcare real estate investment trusts out there.
However, the stock has plenty of detractors. In fact, bears have plowed into the company, shorting 22% of the company’s total shares. That’s a massive short position. Usually bears try to avoid shorting things yielding almost 8%.
Why are they so confident?
Contrary to some investors’ expectations, President Trump hasn’t been able to resolve the healthcare debate. Far from it, in fact. And some trends within Omega Healthcare’s industry have turned more negative. That said, OHI stock has sold off lately, and that yield certainly is quite high. Is there enough to justify buying the stock here, or are the skeptical arguments too strong?
Let’s dive in.
OHI Stock Cons
Skilled Nursing Struggling: Not all nursing homes are the same. Omega Healthcare focuses its land ownership in skilled nursing facilities. And this sector has struggled since Obamacare came along and hurt profits.
HCR ManorCare, a major operator in the space, went bust earlier this year. So far its primary landlord, Quality Care Properties Inc (NYSE:QCP) hasn’t suffered too badly. But you never want your major tenant to go bust if you’re a landlord. Another player in the space, Genesis Healthcare Inc (NYSE:GEN), has declined more than 75% since 2015. Between Obamacare issues and declining attractiveness and affordability to seniors, skilled nursing as a sector has hit a rough patch.
Healthcare Uncertainty: OHI relies heavily on the federal government for reimbursements. It is almost certain that the Trump administration will eventually manage to overhaul the Medicare and Medicaid systems which contribute so much to Omega’s bottom line. Yes, Trump and the republicans have so far failed to get anything concrete enacted. But sooner or later the politicians will make an agreement. And given the lack of clarity so far, changes could hit Omega Healthcare hard. It’s hard to quantify risk at this point.
Growth Through Share Dilution: REITs are known for expanding their share counts. To access new capital, a REIT generally has to sell new stock, or take on debt. This is because taxation law requires REITs to pay out 90% of taxable income annually as dividends. This leaves very little room for the firms to grow organically.
That said, some REITs issue modest amounts of new shares, while others simply deluge the market in a torrent of paper. OHI, unfortunately, is among the latter group. In 2002, it had 34 million shares of stock outstanding. Today, that figure has exploded to 197 million shares. Omega Healthcare’s share count has soared more than 400% in just 15 years. That means, in practical terms, that had you bought OHI stock in 2002, your ownership position has been diluted by more than 80%!
Looking at it another way, since 2002, OHI’s revenues have octupled. Yet revenue per share has grown by less than 50%. The company continues to grow by acquisition and selling new stock shares. It looks like things are booming on the top line. However, very little of this makes it to shareholders after the impact of endless share dilution. As a result, you get the stagnant share price and slowing dividend growth that you see now.
OHI Stock Pros
Demographic Wave: It’s no secret that America is getting older. The country faces a major group of folks about to retire over the next decade. Not that long afterward, purely based on the aging of the population, we should expect companies such as Omega Healthcare to see increasing demand for its services.
To put a number on it, today, as of the previous census, around 40 million Americans were over the age of 65. By 2050, this figure is expected to more than double to around 90 million retirement-aged folks. Now bears will argue that OHI’s skilled nursing facilities are falling out of favor with older folks. And they may be right. But with the over-65 crowd set to double in size, the demographic surge could power big gains for all classes of senior living facilities regardless.
Well-Covered Dividend: I’m skeptical that OHI stock will produce much capital gains in the face of the unrelenting share dilution. However, if you’re mainly interested in the stock for the 7.7% dividend, things look pretty good on that front.
The company’s debt is rated BBB-, which is alright. It’s the last tier of investment grade, which is a passing score, and is ahead of some of its peers. Also, Omega Healthcare’s payout ratio as portion of adjusted funds from operations “AFFO” has declined from the low 80s to the low 70s over the last few years. This indicates that the company’s operations are increasingly capable of covering the current dividend, and may allow the company to boost the dividend growth rate slightly going forward.
Insider Buying: As OHI stock has fallen from its peak in the low 40s, insiders have started to buy. Most notably, director Bernard Korman stepped up big late last year, adding 100,000 shares at $29/share. That’s an almost $3 million addition to his existing stake in Omega Healthcare.
Omega’s CEO also found the $29/share level an opportunistic point. He picked up 21,000 shares last November at that price, increasing his overall holdings in the firm by 10%. Most recently, director Craig Callen picked up 15,000 shares in June at $31 a pop. Now, to be fair, the COO and CFO have sold some OHI stock recently. However, on balance, the insiders here are buying the stock in the $30 range, giving support for the idea of copying them and doing the same.
Bottom Line on Omega Healthcare
Yield-centered investors can choose OHI stock with good reason. As a pure dividend play, it’s one of the safer choices out there today in the 8% range. That said, I doubt this stock will produce total gains (dividend + share price appreciation) as large as many other companies over the long-term.
It generally doesn’t pay to make this sort of name a huge position. If a dividend cut does come along, the share price would get splattered as all the yield-holders would bail. It’s generally better to be quite diversified in high-yield names rather than betting it all on one company, as investors in Kinder Morgan Inc (NYSE:KMI) learned the hard way when that formerly popular dividend vehicle chopped its payment by 75% in late 2015. Your income is too important to put it all in one basket.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.