There's no way to sugarcoat the issue: Nursing homes bring vulnerable older adults into the exact group setting in which the coronavirus spreads most easily. In the early days of the COVID-19 pandemic, that led to steep declines in occupancy that have only just started to meaningfully reverse. That's one reason why Wall Street is worried that Omega Healthcare Investors (OHI 1.18%) could cut its dividend. But given the trends the company is seeing, that's a risk that might be worth taking.
A very big dividend yield
Real estate investment trust (REIT) Omega Healthcare sports a dividend yield of 9.3%. That's huge when you compare it to the S&P 500's yield of roughly 1.4% and the 2.2% average yield for REITs, using the Vanguard Real Estate Index ETF as a proxy. In fact, even if Omega cut its dividend in half, the yield would still be more than twice that of the average REIT and three times the dividend yield of the S&P 500. The truth is, there is a real risk of a cut, though management has been very clear that the dividend isn't likely to be trimmed unless the board sees a long-term change in the company's prospects.
Based on the fact that the dividend hasn't been cut even after two years of pandemic issues, it appears that the board hasn't seen anything about the future that has it worried. That said, the adjusted funds from operations (FFO) payout ratio is high at around 90.5%. And the REIT is working with a number of troubled tenants to help them muddle through the pandemic hit, staff shortages, and the inflationary cost environment. That's all bad news, but what about the good news?
Slow recovery
First and foremost, occupancy levels at Omega's properties are trending higher again after a long string of declines. It appears that the bottom was hit in mid-2021 at a quarterly average of roughly 94.2%. At the end of the first quarter, that number inched up to an average of 94.5%. Management has highlighted 80% as the pivotal figure to look for. During Omega's Q1 2022 earnings conference call, it noted that occupancy in mid-April was up to 77.9%. In other words, this figure looks set to trend higher in a very positive way.
Working with troubled tenants, meanwhile, has included things like rent concessions and, in worst-case scenarios, selling assets. However, there's a silver lining for each. Rent concessions put tenants on sounder footing and keep some rent flowing. When the worst is past, those rents will likely head higher again. Selling assets, while not ideal, improves near-term cash flow, which supports the dividend. That's important because the long-term story here is all about the aging of the baby boomer generation, which is expected to increase the number of adults age 80 and over in the United States by nearly 24 million people by 2040. The pandemic hasn't changed that trajectory in a material way, and it should lead to increased long-term demand.
Meanwhile, Omega's balance sheet remains investment-grade, so it has advantaged access to debt financing. It's even buying back shares, given the stock's low price and what appears to be a pretty solid financial condition. That reduces the total dividend payments the company needs to make, supporting the dividend in a different way. And the REIT is still buying properties when it believes it can get a good deal, supporting long-term business growth.
Yes, Omega is dealing with headwinds. But the actions it is taking do not appear to suggest it is in financial trouble. As noted above, should it cut the dividend by 50%, the yield would still be high compared to other options. The business's long-term prospects would remain solid regardless of such a move. In fact, it wouldn't be shocking to see the REIT's stock rise on the news of a dividend cut as that bad news looks at least partly baked into the stock price.
A calculated risk
Omega Healthcare is not an appropriate investment for the risk averse. However, looking at the risks (a dividend cut), the recovering business (occupancy starting to rebound), and the long-term opportunity (aging baby boomers), more aggressive types might want to take a closer look at this high-yield name. Even what seems like the worst-case outcome here -- a big dividend cut -- would still leave investors with a generous passive income stream and a business that's slowly getting back to normal.
