Recent Sell: Omega Healthcare Investors (OHI)

Omega Healthcare Investors, Inc (“OHI”) is a Real Estate Investment Trust (“REIT”) that invests in income-producing healthcare facilities, including long-term care facilities located in the United States and United Kingdom. Its portfolio focuses on long-term healthcare facilities with contractual rent escalations under long-term leases, along with fixed-rate mortgage loans.

I built my position throughout 2015 and held on to the position mainly for the following reasons:

  • The firm is facing long-term tail winds due to an aging baby boomer population that should see demand growth for skilled nursing facilities
  • Operator reliance on Medicare & Medicaid reimbursements provide rent support and a barrier to entry to new competition
  • The dividend yielded over 6%, was growing on a quarterly basis, and was covered by FFO

My thesis was that a combination of the bullet points above should create strong compounding potential and long-term share growth. The company’s main growth strategy focuses on M&A and OHI has grown its asset base from $850 million to $8.6 billion since 2004. During that same time frame the firm was able to increase its Funds From Operations (“FFO”) from $36.8 million to $575 million. This translated to an FFO/Share annual growth rate of 14%. Management had been raising the dividend on a quarterly basis, the dividend yield was greater than 6% and the payout was fully covered by FFO. Dividend growth has been 9.3%, 8.4% and 7.9% over the past 10 years, 5 years, and 3 years, respectively. I believed that the financials were directly indicative of a competent management team taking advantage of industry tailwinds and making value-add investment decisions. However, over the past year cracks have started to appear in Omega’s financials. Though management has continued to raise the dividend throughout 2018, as of Q3 and Q4 FFO no longer covers the dividend. There are negative pressures on FFO due to a couple major tenants that have been struggling to make their rent payments.

In 2013 OHI closed a $529 million purchase/leaseback transaction in connection with the Ark Holding Company, acquiring 55 skilled nursing facilities operating under the name “Orianna.” OHI has not been recognizing any direct financing lease income from Orianna since July 2017 as they continue to not satisfy their rent payments. In Q4 OHI further wrote down their investment in Orianna by $27 million. Though I do believe that OHI can restructure their agreement with Orianna and navigate through this situation without significant detriment to their financials, management is no longer including Orianna’s rental income given their bankruptcy status (See note 3 in figure below).  I was afraid that this was not a one-off event, but rather a sign of a broader market that is struggling and that Orianna was the first sign of trouble.

Sure enough, on the latest earnings call, the management team mentioned troubles forming on another top 10 tenant, Daybreak. Daybreak represents 3.8% of OHI’s portfolio and 57 total properties. During the last quarter OHI received approximately $4MM in underpayments from Daybreak and is expecting reduced payments moving forward. Management has made comments that leads me to believe that more operator troubles are on the horizon. In the latest earnings call they mentioned potentially issuing equity to de-leverage, and, though possibly a prudent move, this would be dilutive to shareholders. Furthermore, management “currently anticipates maintaining our current quarterly dividend level for the next several quarters with the goal of increasing the dividend in the relatively near future.” Given that many investors hold this stock for the dividend, I am afraid that a dividend freeze, and in a worst-case scenario – a dividend cut, would have investors selling the stock thus putting negative pressure on the stock price. Also, I tried to analyze the financials for the top-10 operators to get a better idea of their relative health, but given that most of these companies are private, I found it difficult to compile any meaningful information. I decided I would rather not hold my shares and hope for the best.

OHI was 2.8% of my satellite equity portfolio and generating 6.6% of the portfolio income. In light of the recent updates, I decided to do another deep dive into the financials to get a better understanding of the risks I was exposed to. I realized, rather humbly, that the business model and industry sit outside my circle of competence. I did not feel that my due diligence and understanding of the company was thorough enough and, as a result, I determined that I did not feel comfortable holding the position through tougher times. I do believe that the long-term thesis may still be in play, however I decided to exit the position so that I can reallocate the capital to opportunities that I understand with better clarity and can get comfortable with the risk exposure. Since initiating my position in 2015 my total return from OHI was 24% or about 8.4% annualized.

-Hedgehog

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