Saturday, January 14, 2017

Omega Healthcare (OHI)

Omega Announces Eighteenth Consecutive Increase in Its Quarterly Common Stock Dividend "As of September 30, 2016, Omega has a portfolio of investments that includes approximately 1,000 properties located in 42 states and the United Kingdom and operated by 81 different operators.")

Omega increased its quarterly dividend to $.62 per share from $.61. 

I first bought OHI shares in December 2013 and described some of my reservations about this REIT in that post:  Item # 2: Bought 100 OHI at $29.85 

I sold that lot at $37.52 on 9/6/16. I reinvested only one quarterly dividend: 

2016 OHI 101+ Shares +$887.91 (sold 9/16/16)
I also sold my highest cost lots into an OHI stock rally last year. The first snapshot was the highest cost then existing in my Schwab account which was sold at $37.27+. I kept the lowest cost 50 share lot purchased at $32.68 total cost per share  (11/16/15).  

2016 50 Shares +$117.6 (Sold 8/12/16)
2016 Roth IRA 50 Shares +$73.05 (Sold 8/10/16) 
The last snapshot above involved the disposition of my then existing highest cost lot:  1. Sold Highest Cost OHI Lot at $37.15-Update For Portfolio Positioning And Management As Of 8/21/16 - South Gent | Seeking Alpha

2016 OHI Trading Profit = $1,078.56

With OHI, my strategy is to harvest the generous dividend payments, sell the rips and buy slowly into the dips for the reasons discussed below.  

After selling my highest cost lot in my Schwab account, I bought several small lots using commission free trades, as the price fell late last year: 

Current OHI Position Schwab Taxable Account

When and if the OHI price pops again, then I would consider selling the 50 share lots bought at $32.68 and $32.9 while keeping the shares purchased with dividends and at lower open market prices.  The consider to sell range starts at $35. The last dispositions occurred with the spice spiked to over $37.   
Interest Rate Risk: Contrary to the arguments made by the REIT industry association, Brad Thomas and many others, REIT stocks will react negatively to a rise in intermediate term interest rates. 

There have been periods in the past where short term interest rates were rising in response to a federal reserve tightening cycle (e.g. 2004-2006), and REIT stocks rose in price. 

In that 2004-2006 period, intermediate term interest rates declined after the FED started to raise the FF rate and thereafter remained stable as the FED tapped down on inflation and inflation expectations through increases in the federal funds rate. 

REIT borrowing costs generally have weighted average debt maturity in the 4 to 6 year range. Most REIT mortgages have terms close to 5 years. If one or more matured during that 2004-2006 period, the refinancing cost would not materially impact FFO. Given that intermediate term rates were materially higher in 2000-2002: 

Ten Year Treasury 2000-2007

10-Year Treasury Constant Maturity Rate | FRED | St. Louis Fed

The seven year treasury was around 4.3% when the FED started that tightening cycle and fell to less than 4% later in 2004 and moved below 4% several times in 2005: 7-Year Treasury Constant Maturity Rate-St. Louis Fed The five year treasury was at 3.55% in mid-June 2004 and fell to below 3.3% in October 2004.  5-Year Treasury Constant Maturity Rate-St. Louis Fed

While borrowing costs remained relatively stable, CPI rose 2.7%, 3.4%, and 3.2% in 2004, 2005 and 2006 respectively. Consumer Price Index, 1913- | Federal Reserve Bank of Minneapolis

In short, rents tied to CPI were rising while borrowing costs remained stable or declined in many cases. 

The reason for paring OHI during the 2016 summer was due to what I call a directional change in intermediate term interest rates. 

Starting in July 2016, the ten year treasury moved from a 1.37% yield (7/5) to 2.6% (12/15): Daily Treasury Yield Curve Rates A 2.6% ten year treasury is abnormally low by historical standards, so that move was just from an historically low yield to one less abnormally low.  

The REIT ETF VNQ closed at $89.68 on 7/5/16 and at $81.41 on 12/15/16, a 8.27% decline in about five months. 

REIT stocks will generally respond negatively to persistent increases in in intermediate term rates, particularly when the percentage increase in rates is significantly higher than the percentage increases in inflation and inflation expectations. 

That happened between May 2013 and December 2013 when the ten year went from 1.66% to 3.04% while inflation and inflation expectations remained steady. That particular spike in intermediate rates is sometimes called the "taper tantrum".  

I refer to that spike in intermediate term interest rates simply as the market's effort to normalize rates based on traditional spreads to actual anticipated inflation rather than abnormally low rates set by central planning. Short term interest rates did not move due to ZIRP. 

The Federal Reserve manipulated interest rates to abnormally low levels after WWII and that effort help to ignite a long term secular bear market in bonds when the FED allowed the market to set interest rates once again based primarily on an adequate real rate of return. There is no dispute that the FED successfully manipulated interest rates to abnormally low levels after WWII given the inflation numbers from that period (see Before the Accord: U.S. Monetary-Financial Policy, 1945-51)

The 32 year long term bond bear market started in 1950 and is reflected in this chart published by

I would also note that the FTSE REIT index produced a 7.05% return in 2001 and a negative 2.15% in 2002. Returns had been erratic starting in 1998 and 1999 when the index experienced two consecutive down years falling 18.82% and 6.48% respectively.

REIT price performance does not occur in a vacuum where interest rates are the only variable. The potentially worse mix is a long period of rising prices resulting in historically higher P/FFO ratios when intermediate terms start to rise due in significant part to interest rate normalization rather than to a material rise in inflation. That was the case in May 2013. That was not the case in 2004-2006.  

See page 3 Lazard US Real Estate Indicators Report.pdf for aggregate P/FFO and Price/Net Asset Value information. 

Interest Rate Movements and REIT Stocks: Update For REIT Basket Strategy As Of 8/11/15/Interest Rate Cycles And REIT Stock Prices - South Gent | Seeking Alpha

Skilled Nursing Home Operators: Reimbursement and Leverage:

The other concerns about OHI involve skilled nursing home properties and their operators in general.    

I disagree with Brad Thomas who characterized OHI as a Blue Chip REIT here:

Quote from Comment Made on 9/24/14: 

"The operators of nursing homes are generally highly leveraged and a meaningful change in government reimbursement policies may tip some of them over into bankruptcy.
Back in 1999, there was a significant and unexpected cut in Medicare reimbursement rates that led to the bankruptcy of some operators including GenesisHealth Systems, now known as Genesis HealthCare. That company emerged from BK and is now a major tenant of OHI.
There was something like 1600 bankrupt nursing home facilities in 2000. The main operators filing for BK included Sun Health Care, Vencor, Genesis, Mariner, and IHS.
The government denied that it played any role and blamed the operators.

Based on OHI's price action, institutional investors do not share the same favorable opinion about OHI as individual investors. 

I would view the government's action similar to kicking the SNF's hard in the rear when they were already leaning too far forward.

When an investor reads an OHI transcript, there will frequently be questions about the financial health of the operators, particularly Genesis. An investor in a REIT that leases to SNF operators needs to monitor the government's reimbursement policies and to read the earnings call transcripts and pay attention to the OHI news.
I would not agree with Brad that OHI is a blue chip REIT. Maybe I would put it on the borderline, and would take it down some notches when and if there is a significant change in reimbursement rates. In that connection, I would note that the federal government has not exactly planned too far ahead to fund programs like Medicare for the baby boom generation and the government's debt accumulation has been rapidly rising since passing the $1 trillion mark around 1980."

End of 2014  Comment Quote

What is the likelihood that the GOP will reduce reimbursement rates to SNFs during Trump's first term.

It is a risk. 

We already know that virtually all GOP House members voted for a voucher plan for Medicare that would have increased premiums by about $6K per year in the first year over traditional medicare premiums in a cost saving move. The fact that this increase would bankrupt most middle class households after a few years was not a matter worthy of any consideration.  

Kaiser Foundation Page 3 Figure 1.pdf

Those numbers were calculated by the CBO. A question worth of consideration is whether SNF reimbursement rates will be an easier target in the coming years compared to increasing out-of-pocket insurance rates by $12K per year for a retired couple.  

I previously discussed earnings reports and other matters relating to OHI in several SA Instablogs, including the following: 

Item # 2. Added 50 OHI at $32.5 Roth IRAUpdate For Equity REIT Basket Strategy As Of 11/16/15 - South Gent | Seeking Alpha

I still own that lot held in my Vanguard Roth IRA.

I also own Omega Healthcare senior unsecured bonds as part of my intermediate term bond ladder strategy:

Item # 5. Bought in Roth IRA 2 Omega Healthcare 4.375% Senior Unsecured Bonds Maturing on 8/1/2023 at 100.995 (101.195 with commission):Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of 7/19/16 - South Gent | Seeking Alpha

Prospectus 2023 Bond Sold Last July 

2. Bought 2 Omega Healthcare 4.5% Senior Unsecured Bonds Maturing on 1/15/2025Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of 6/24/16

I do not like the fact that OHI does not calculate AFFO in accordance with industry standards as I have pointed out several times. AFFO is defined to exclude non-cash revenues recognized by the accounting  concept known as straight line rents. Glossary of REIT Terms |

Instead OHI includes non-cash revenues in its AFFO calculation, which is supposed to be a real cash flow number rather than a pretend one and then takes out non-cash revenues in a straight line rent adjustment to arrive at funds available for distribution ("FAD"), which is at least closer to cash flow.

SEC Filed Press Release Earnings Report Q/E 9/30/16

The problem with OHI's FAD number is that it still includes actual expenses that are classified as extraordinary expenditures even though they reoccur such as acquisition expenses. Those expenses do fluctuate from quarter-to-quarter, year-to-year, sometimes by large amounts, but an annual average number needs to be deducted IMO before arriving at FAD.

I mention the foregoing-again, since institutional investors probably drill down to the real cash flow numbers whereas individual investors probably focus on FFO which is much higher than FAD or FAD as adjusted for "routine" extraordinary cash expenses.
Omega Healthcare SEC Filings

2015 Annual Report

In February 2015, 9.5M OHI shares were sold to the public at $42 per share.

The stock is currently trading below 200 day SMA line using a one year YF chart: OHI Interactive Stock Chart The 100 day line is at $32.45. The stock pierced the 50 day SMA line to the upside in last December. That SMA line now stands at $30.51.
Closing Price 1/13/16: OHI $32.46 -0.07 -0.22%

A five year YF chart highlights the difficulty in staying over $38 for long. Starting in March 2013, most of the trades have been in a channel between $28 and $36 per share. Until proven otherwise, I am assuming that a $37+ will be another lighten up point.  

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