Is Omega Healthcare Stock’s Big Dividend Safe? (NYSE:OHI)

Omega Healthcare Investors, Inc. (NYSE:OHI) is known for its mouthwatering 9%+ dividend yield that it has managed to sustain and even grow for decades, including through the Great Financial Crisis and the COVID-19 crash.

That said, the sky-high dividend yield, issues with some of its tenants, and tight AFFO payout ratio imply that the dividend’s safety is not a guarantee. We will take a look at it in more depth in this article and offer our take on whether investors can rely on this dividend through thick and thin as they have in the past.

Tight Payout Ratio

In 2021, OHI actually had a pretty reasonable AFFO payout ratio of 85.4%. However, this year analysts expect the payout ratio to tighten considerably to 97.5% with no dividend per share growth factored in and management stated on the call that in Q1 its dividend payout ratio was 103% of funds available for distribution, implying that competing targets for its cash flow were consuming too much for OHI to fully cover its dividend without digging into its liquidity.

While this course is obviously not sustainable, next year it should improve some as AFFO per share is expected to improve by 4.2%. That should provide some leeway to investors.

Balance Sheet & Property Portfolio

In addition, it is important to remember that OHI is investment grade rated (albeit barely, with a BBB- rating), has significant liquidity, and its cash flows are generally quite stable thanks to the fact that 97% of its revenues are tied to long-term triple net master leases with 2.3% weighted average fixed escalators.

It has over $1 billion on total available liquidity as of the end of Q1, with no material maturities this year. It also has a 4.1x adjusted fixed charge ratio, leaving it in solid financial shape for now. One item of concern is its rather elevated debt to adjusted EBITDA ratio of 5.3x, which is above their target range of 4.5x-5.0x. However, it still has a Stable outlook from S&P on its investment grade credit rating, so it should be fine at this level for a while. It has more than enough liquidity to handle the maturing debt in 2023 and 2024 in the event that it is unable to refinance these notes on reasonably attractive terms.

Meanwhile, its leases have a 9.4-year average lease term remaining, with 98% of its portfolio expirations taking place after 2024 and 93% of them taking place in 2027 or later.

Industry Trends

There are some headwinds facing the business right now, including increasingly tight tenant EBITDARM and EBITDAR coverage ratios (1.48x and 1.14x, respectively) due to lower Medicare reimbursement rates, lower occupancy rates due to demographics, and increased wage pressures.

That said, the demographic trends in the next few years should sharply reverse this trend and create occupancy growth momentum for OHI. The 65+ pool is projected to grow from 56.1 million in 2020 to 65.2 million by 2025 and soar to 73.1 million by 2030, thanks to the Baby Boomer generation aging. This leads some analysts to expect skilled nursing facility (“SNF”) demand to outstrip supply by 2030, with utilization rates improving from 76% in 2021 to 101% by 2030 and 116% by 2040. This means that OHI should have opportunities to grow its portfolio profitably over the next two decades.

While it waits for this turnaround to take full effect over the next few years, OHI benefits from significant diversification, with 938 properties and 64 operators spread across 43 states and the United Kingdom. It also benefits from the fact that hardly any of its leases will be expiring until after this demographic shift is expected to take effect, so it should not suffer from idling properties over that span unless any of its tenants go bankrupt.

Operator Issues

This brings us to the final major risk facing the business right now: the fact that operators representing 15% of OHI’s contractual rent and mortgage payments stopped paying as of March 2022. However, operators representing ~91% of OHI’s Q2 contractual rent and mortgage payments came through with rent payments in April 2022. Management said that as a result, they expect funds available for distribution in Q2 to increase by ~7%. While this points to a positive trend, management had this to say on its June Investor Presentation:

We continue to work diligently to resolve our outstanding operator issues. However, until we reach agreements with these operators, the ultimate resolution of these operator issues is unknown. Furthermore, with many operators continuing to struggle with the impact of COVID-19 on both occupancy and staffing, there remains an elevated risk that additional operators may be unable to pay in accordance with their contractual terms.

They also had this to say on their Q1 earnings call:

I think in terms of calling the bottom [in terms of cash flow paid to us by our operators], it’s fair to call the bottom as it relates to the operators we are talking about, but we still need to be wary of the next couple of quarters. And I would point out…the revenue side of the equation for our operators. And when the — if the health emergency isn’t extended beyond July, that will create some additional pressure.

So, we feel good about the resiliency of the portfolio and the workouts that the team has been able to work through. But I am still — I would still stress that we are not through this, but in terms of these operators, I think, we are in pretty good shape…

There are some smaller operators that are struggling that we have had discussions with. There are no operators of any real scale that we are having issues with from a payment perspective. So, it’s hard to predict out in the future, as we have said, there are still challenges out there and a number of things on the horizon including the comeback in occupancy, the labor costs, all the things that we discussed that still remain challenges for our sector and we have to sort of navigate the next few quarters going forward. But to predict what percentage that is, that would be throwing darts.

Investor Takeaway

With its sky-high dividend yield and implied cap rate, OHI is clearly trading at a compelling value. With a well-diversified portfolio and a proven management team that has delivered outstanding long-term total returns and dividend growth to shareholders, OHI looks like a slam-dunk purchase here.

That said, its dividend coverage ratio is razor thin at the moment due to poor occupancy rates and operator solvency issues. If management can manage to navigate the next year without having to cut its dividend, it should be in decent shape as occupancy rates rebound due to a continued decline in COVID-19 headwinds and the increasingly favorable demographic trends.

Given its over-$1 billion in liquidity, well-laddered debt maturity profile, recession resistant business model, lack of meaningful floating interest rate exposure, few-to-no lease maturities for several years, and additional liquidity from its asset sales, OHI looks like it has a greater than 50% chance to make it to the other side of the current headwinds without having to cut its dividend.

That said, this is far from a “sleep well at night” SWAN investment here. Investors who are looking for a conservative income play should look elsewhere, while more aggressive investors who are willing to hold in the event of a dividend cut for the recovery on the other side should find considerable value here. We rate shares a speculative Strong Buy.