In my recent article on Omega Healthcare Investors (NYSE: OHI ) , I referred to operational risks associated with the Medicare Payment Advisory Commission's (MedPAC) Congressional recommendation to "freeze payments to Skilled Nursing Facilities beginning in 2010." As promised, further research yielded the nitty-gritty on this topic.
While MedPAC's choice of phrasing invites a frightful scenario in which the government severs the artery on all reimbursements, the "freeze" refers to the annual cost-of-living adjustment, not base payments. And currently, the recommendation is just that. Moreover, such a policy, if adopted, seems reason enough for only the briefest pause.
Great news, checkup complete, yes? Not quite.
With narrow operating margins, skilled nursing facilities (SNFs, for short) are the Costco (NYSE: COST ) of the health-care industry. According to the Alliance for Quality Nursing Home Care, "overall operating margins for America's nursing homes hover close to 3%." In part, this is due to the outsized labor component in the sector's cost structure. Beyond that, state Medicaid payments, the Alliance reports, have consistently undershot cost of care, offsetting the margins on Medicare and private payments.
Depending on an individual facility's revenue mix, a year or two of stagnant Medicare rates could squeeze already razor-thin operating margins dangerously close to zero. Under these conditions, SNFs could choose to deny admittance to Medicare-covered patients in favor of the privately insured, but one has to wonder whether such a tactic would come at the expense of overall occupancy.
So, was my generally positive investment thesis on Omega misguided? I don't think so.
First of all, MedPAC took a similar stance toward 2009 payments, but ultimately, Medicare payments to SNFs were increased 3.4%. Second, if a freeze does become policy, the worst I foresee is that Omega may have to give its facility operators a pass on annual lease hikes. Finally, Medicare policy would be able to turn a blind eye toward inflation for only so long before the entire nursing home system threatened a collapse. Congressional support for such policies would quickly become political suicide.
At the end of the day, Omega should be able to maintain its healthy cash dividend, despite possible short-term policy contortions. Health care REITs with high debt-to-EBITDA ratios (above 5), such as Nationwide Health Properties (NYSE: NHP ) and Ventas (NYSE: VTR ) , may be more prone to financial ailments.
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