Recent Purchase and Analysis of Omega Healthcare Investors (OHI)
I wasn’t expecting to make another purchase in April, but I couldn’t resist the downward price movement in the REIT sector, so I initiated a position in Omega Healthcare Investors (OHI). OHI provides financing and capital to the long-term health care industry with a prominent focus on skilled nursing facilities located in the United States. After suspending dividends in 2001 to meet debt obligations, this REIT has been on fire over the last decade and growing at a very attractive pace. With an increasing senior citizen population and need for cost efficient healthcare, the future looks bright for this company.
This is a new position for me and my portfolio now holds 24 businesses. On Wednesday, April 29th I bought 38 shares for $36.76 each and a $6.95 commission for a total transaction of $1,403.83 in my Sharebuilder ROTH IRA. My 5.85% yield will provide $82.08 in annual income for a new 12 month total of $1,816.81. I’m aiming to achieve impressive income and capital growth with this company and this post will cover OHI’s operations, fundamentals and valuation.
The number of people aged 85 and older is growing quickly at 1.5% of our current population, and it’s estimated to swell to over 5% by 2050. With old age comes physical and mental challenges and an ever increasing need of assisted living and medical care. Omega Healthcare is the major player in the skilled nursing facilities (SNF) industry. It’s an expanding market worth over $100 billion with 87% of SNF being privately owned and ripe for the picking. OHI recently combined with Chicago based Aviv REIT to become the largest public U.S. owner of high quality skilled nursing facilities. They’ve significantly enhanced their national and operator diversification by adding 312 new facilities and established a presence in four new states. They now have over twice the number of SNF properties as the next public competitor which makes OHI the largest pure-play SNF REIT, with plenty of room to keep growing.
OHI’s total 10 year return through the end of 2014 was an astonishing 586% which is the second highest among ALL publicly traded equity REITs. Here are other attractive compounded annual growth rates from the same time period:
- Real Estate Investments: 15.8%
- Operating Revenue: 17.2%
- Adjusted FFO per Share: 11.8%
- OHI Share Price: 13.1%
- Dividends: 11%
Those are some solid and rare numbers. It’s not often businesses are able to provide such high dividend and capital growth rates. OHI also has strong portfolio rent coverage with no upcoming material lease expirations. Revenue streams are very diverse with no single property contributing over 12% of the investment portfolio.
The balance sheet remains strong with no long-term debt maturities until 2020:
OHI’s use of cash flow is consistent, stable and conservative. This is particularly impressive considering the large shareholder payouts they’re required by law to make:
OHI has a specific vision for future success stating they plan to:
- Leverage the unique consolidation strategy, management knowledge, expertise, and operator relationships to continue owning, acquiring and developing SNFs.
- Leverage a disciplined approach and cost of capital advantage to fund accretive transactions.
- Continue to strengthen the credit quality of tenant relationships.
- Continue to improve the overall properties and investment portfolio.
- Continue to maintain a strong balance sheet with minimal maturity and interest rate risk.
- Continue to deliver meaningful dividend growth and total shareholder returns.
One major risk to OHI is a possible future change in medicare policy. Also being so heavily concentrated on SNFs lacks a certain diversity, but that could also be viewed as a strength and I’m personally attracted to that pure-play factor.
The best way to value a REIT is with free cash flow and we clearly see a growing slope upwards of that metric and for dividends:
I recently read Chuck Carnvale’s precise return strategy and was motivated to use it for future purchase posts. It’s not enough to buy a business simply because it looks like it’ll keep growing. None of us can predict stock prices and movements; but deeply understanding those businesses and having expectations for dividend growth and total return from current prices can lead to much better conclusions on valuation. In my purchase summary I mentioned my objective of a hybrid investment to provide high income and capital growth. Let’s run a few quick fast graph calculations to help estimate whether this investment might be on the right track in the coming years.
- Analyst Estimates: This calculation uses S&P Capital IQ data to help us predict a reasonable return:
With growth capitalized at a reasonable P/FFO ratio of 15, we witness an enviable 23.41% total annual rate of return in 2016. That’s a $11.46 gain in price and $3.76 gain in potential prorated dividend income. Here’s how often OHI has met analyst expectations:
- Historical Compounded Annual Growth Rate (No Analysts): Here I use the lowest annual growth rate from the last decade which is a 7 year annual return of just 10.9%:
We witness an annual rate of return of 21.89% from here through 2018.
- Conservative Expected Growth: Here I use the decades lowest historic cash flow growth rate of 10.9% combined with the lowest historical normal P/FFO ratio of 12.3:
We see a much lower and conservative annual rate of return through 2018 of just 7.85%.
- Most optimistic Case: This calculation is based on its premium normal 10 year P/FFO ratio of 13.7:
We see an annual rate of return of 17.39% into the year 2016.
- Most Pessimistic Case: This calculation is based on the lowest normal P/FFO multiple of 12.3 over the last 10 years:
We see an annual rate of return of 10.66% into the year 2016.
- Dividend Expectations: A historic 10 year look at dividends compared to the S&P 500:
The total dividend income of a $10,000 investment in OHI after 10 years trumps the S&P 500 producing over $24,000 verses just $3,000 with dividends reinvested. If that’s not enough we also see that the total annualized rate of return was 20% compared to just 7.8% of the S&P 500.
What a beautifully run and fundamentally strong business for my stated high yield and growth objective. I’m much more comfortable investing after digging in and calculating so many return possibilities on such different metrics and I believe the stock is current fairly valued. It’s no surprise that I’m mainly impressed with OHI’s commitment to dividend growth, and while I expect it to slow down in 2015, I trust management will have the opportunity for plenty of increases in the future. I hope to take advantage of short-term market noise and double down on this position at an even more advantageous price later in the year. Since I’ve wanted to own this business for a long time, I gladly started a small position at today’s prices.
What do you think about Omega Healthcare Investors?