Omega Healthcare: A Dividend Cut Is More Likely Than It Seems (NYSE:OHI)
Ever since the Covid-19 pandemic swept across the globe three years ago, Omega Healthcare (NYSE:OHI) found itself under pressure, which to the disappointment of shareholders continues weighing on their share price. This now leaves their dividend yield at a high near-9%, which is obviously very desirable if maintained with the key word being “if” because as any experienced investor would know, there is seldom a low-risk double-digit yield. Whilst I can see many bulls making their cases for why their dividends are likely to be maintained, I would like to provide a countercase for why a dividend cut is more likely than it seems on the surface. Read my previous coverage on OHI here.
Cash Versus Accrual-Based Accounting
When it comes to dividend investing, there are various ways that investors like to assess the coverage and thus by extension, the safety of their cherished dividends. The preferred metric tends to vary between different sectors and listed structures with REITs often utilizing their funds available for distribution, hereon referred to as FAD. On the surface, this sounds like a straightforward and very useful metric for income investors to quickly compare against their dividends, although like many non-GAAP accrual-based metrics, it does not necessarily paint the same picture as their GAAP financial statements, in particular, their cash flow statements.
This does not mean nor imply that management is intentionally doing anything underhanded but objectively speaking, there was a noticeable difference that emerged ever since 2017 whereby their FAD is always noticeably above their operating cash flow. I feel this runs contrary to logic because how could an REIT have more ‘funds’ available for distribution than cash that was actually generated within that given period of time? As a side note, if anyone wishes to check for themselves, this data is readily available within their quarterly supplement reports.
Since this situation was the case for the last six consecutive years, this is not merely a case of cherry-picking data on my behalf. Nor is it a case of lumpy working capital movements skewing their operating cash flow and so forth, as after more than half a decade, anything of this nature should have neutralized and thus netted out. Interestingly, if looking back prior to 2017, the years of 2013-2016 largely netted out with 2013, 2014 and 2016 all seeing more operating cash flow than FAD, thereby negating 2015 that saw more FAD than operating cash flow. When combining all of the years across the last decade, their FAD is a collective $301.4m higher than their operating cash flow, which is a sizeable difference.
If zooming into 2022 and merely looking at their FAD, it shows they had $677.6m but only returned $632.9m via dividend payments. So, if leaving an analysis right here, it would seem like an easy open and shut case whereby they returned less ‘funds’ than possible and thus in turn, it appears to bode positively for their dividend safety on the surface. Although as the above graph shows, their operating cash flow was only $625.8m and thus in reality, apart from being noticeably lower than FAD, there was also a shortfall versus their dividend payments, which obviously bodes negatively for their dividend safety. Therefore, I feel their often touted FAD paints a better picture of their dividend safety than is necessarily the case, starting ever since 2017.
The Likely Dividend Cut
To take a look at the year ahead, we obviously do not know exactly where their operating cash flow will land but thus far, the picture is not too bright as they deal with restructurings, as other authors have discussed throughout their articles. In fact, they even expect their FAD to see a shortfall in covering their dividend payments during the first quarter of 2023 before hopefully recovering thereafter, as per the commentary from management included below.
…we believe our first quarter 2023 FAD will be less than our current dividend of $0.67 per share.”
“We believe as these current restructurings are resolved and already completed restructurings, principally Agemo begin paying restructured rent, we will again return to a FAD run rate in excess of our current dividend.”
– Omega Healthcare Q4 2022 Conference Call.
The extent of the shortfall during the first quarter of 2023 remains to be seen and likewise, the extent of their recovery during the subsequent quarters. That said, unless their cash generation suddenly improves, it seems as though 2023 will be weaker year-on-year versus 2022. Since their operating cash flow is normally lower than their FAD, I therefore expect another year whereby their dividend payments exceed their operating cash flow. In light of the tight monetary policy that is draining liquidity from capital markets, this significantly increases the likelihood of a dividend cut in 2023 or if not, during 2024, especially if the recent banking turmoil spreads deeper into the financial system.
Please do not get me wrong, I know accrual-based metrics can be very useful for removing noise to aid with year-on-year financial performance comparisons. Although, it is my opinion that when it comes to dividends and their safety, cash is always king. Why? Well, largely because when a shareholder receives a dividend payment in their bank account, it was obviously paid with cash and not any accrual-based metric. Likewise, when debt comes due or interest needs to be paid, their lenders obviously want cash and therefore, it does not matter if they are an REIT, they still require cash just like every other company.
Admittedly yes, management continues to indicate they will maintain their dividends but at the same time, this is not an ironclad guarantee and as such, they can change their tune quickly, especially if potential future turbulent market conditions provide a reason. Even as a rule of thumb, I have noticed that dividend growth often stalls in the lead-up to a cut, which is clearly evident in this situation. In my opinion, multiple consecutive years of stalled dividend growth is a red flag for severe stress and poor safety, especially when it occurs after years of what was strong growth in previous years. Whilst yes, the Covid-19 pandemic threw a curve ball, at the end of the day, the cause does not necessarily change the outcome because that is entirely dependent upon their financial performance, which itself is concerning.
To be clear, unlike their GAAP financial statements contained within their SEC filings, management essentially enjoys free rein when it comes to their non-GAAP metrics, such as FAD. As such, I am not alleging nor implying anything illegal is occurring despite this noticeable difference because they are allowed to represent their non-GAAP results however they feel is optimal for their REIT. Although at the same time, I nevertheless wish to highlight how their GAAP financial statements paint a different picture of their dividend safety that in my eyes, bodes negatively.
Understandably, most investors focus on their FAD when assessing dividend coverage and thus by extension, when forming their views on the likelihood of a cut. Although when digging into their SEC filings, their GAAP financial statements seldom paint the same picture. In fact, ever since 2017 their FAD was noticeably above their operating cash flow every year, which I feel means a dividend cut is more likely than it seems on the surface. I suspect such a move should not be far away, as 2022 was a tough year with a shortfall between operating cash flow and dividend payments, which I suspect is likely to continue into 2023 given their commentary thus far. This increases their reliance upon external capital at the same time as tight monetary policy is draining liquidity. When combined, I feel this makes a dividend cut during 2023 or early 2024 likely and I believe that a sell rating is appropriate since such a move would continue weighing upon their share price.