Omega Healthcare Investors Inc: This 7.3% Yield Keeps Growing
February 25, 2019
Is This Payout Safe?
If you want to make a lot of money over the next few years, you need to understand a specific number.
Each day, 10,000 baby boomers turn 65. An older population means more demand for everything from doctor offices and prescription drugs to senior housing and retirement communities.
Omega Healthcare Investors Inc (NYSE:OHI) has profited handsomely from this boom. The partnership invests in skilled nursing and assisted living facilities, with over 900 locations across the country. And with a yield approaching 7.3%, income investors have taken notice.
Savvy readers, however, will want to answer one important question before pulling the trigger on Omega Healthcare units: “Can such a high payout possibly be safe?”
Let’s dig into the financials.
Omega is a cash flow machine, to begin with. The company doesn’t actually manage the facilities it owns. Instead, executives lease out the properties to operators, which do the actual work of taking care of patients.
These deals get done on a “triple net” basis. This means the operators, not Omega Healthcare Investors Inc, have to pay for most of the operational expenses of running the property (insurance, taxes, renovations, etc.). As a result, almost every dollar the company collects in rent flows straight to the bottom line.
Next year, analysts project that Omega will generate $3.12 in adjusted fund flows from operations. From this total, executives expect to pay out $2.64 in distributions. That comes out to a payout ratio of 85%, well within my comfort zone for a recession-proof business like senior housing.
That conservatism extends to the partnership’s balance sheet as well. Omega has only $5.00 in debt for every $1.00 generated in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). That represents only a modest amount of leverage for the real estate industry.
More importantly, management has locked in nearly 80% of this debt at a fixed interest rate, and most of these liabilities don’t mature for another decade or more. So even if rates keep rising, the company won’t have to fork over more cash to creditors.
(Source: “Cash Flow,” Omega Healthcare Investors Inc, last accessed February 25, 2019.)
The big risk here? Tenants.
Running a senior care facility is a low-margin business. From time to time, operators miss or skip rent. We saw this happen last quarter, when Omega Healthcare announced that one of its tenants, Daybreak Venture, LLC, would defer $5.0 million in payments.
This doesn’t present a big problem for income investors though. Omega Healthcare Investors Inc still generates more than enough cash flow to fund its distribution and reinvest in its business. But with wages rising across the country, investors need to keep an eye on the operators.
In the meantime, the distribution from OHI stock looks safe.
