Via SeekingAlpha.com

Careful investors can add both potential steady growth, and income between about 6.0% and 7.5%, to their portfolios with these two complementary REITs.

Financial statement numbers in this article are taken from data provided by Seeking Alpha, the companies’ websites, and the author’s calculations.

Background

The post-war baby-boom generation, those born from 1946 to about 1964, are about to retire. The leading edge of that demographic is turning 74 this year, putting them four years past the beginning of mandatory distributions from IRAs (RMDs), and four years past the last chance to increase their Social Security benefits by not retiring. Almost all those in the leading edge of the baby boom demographic who can retire (i.e., those already over 70, who can live on their Social Security, RMDs, and income from non-IRA investments) probably have retired, unless they just want to keep working. About 25 million more will retire in the next 15 years.

In 2018, there were about 50 million people in the US aged 65 and over, and by 2035, the number will grow to 78 million (Census). There will also be about 76 million people under 18 in 2035.

Both the US Bureau of the Census and sources such as GeriatricNursing say not only are the ranks of baby-boomers pressing the capacity of hospitals because there are so many of them, it is likely they will live longer than their parents did. In 1900 the life expectancy for a 65 year old was about 10 or 11 years. Today a 65 year old has a life expectancy of about 19 or 20 years. Baby-boomers already stress the healthcare system: 90% of nursing home care, 26% of doctor visits, and 34% of prescriptions go to baby boomers. As an ancillary problem, the population of nurses, already about 10% under the current demand for their services, is also aging, with the bulk of registered nurses already in their fifties.

Beyond the effect on hospitals and direct healthcare providers, GeriatricNursing reports baby-boomers also need places to live that offer help with nutrition, prescription medicine control and management, social contact, and physical safety. Many baby boomers do not have family available to help out, and though they may wish to live on their own, as people age they see independent living as less desirable. A large portion of the demographic are on their own, with 20% childless (no one to check on them, no one to move in with) and another 20% do not have a spouse or partner, and their grown children live more than 500 miles distant. That means some 40% of today’s 50 million (and 40% of 2025’s expected 78 million) are candidates for some kind of assisted living.

MPW

Medical Properties Trust, Inc. (MPW), taxed as an REIT, acquires and develops hospital facilities. MPW acts as an intermediary between medical facilities/hospitals and investors, allowing medical facilities’ managers to sell or refinance, and lease back, real property, freeing up cash for healthcare operations and other uses for the healthcare facilities. MPW then uses the cash flows thus created to service debt, fund new acquisitions, and provide substantial dividend income to MPW investors. With over 380 healthcare facilities, and over 40 thousand beds, MPW is one of the world’s largest owners of hospitals. Excluding a $673 million gain on sale of assets in 2018, MPW has averaged 30.5% return on sales over the last five years (47.0% with the gain.) MPW grew revenue at a 17.5% average rate over the last five years.

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Based on annual high and low stock prices, MPW’s average high P/FFO ratio is usually around 14.5 times FFO, and the low average P/FFO ratio is around 11.4 times FFO per diluted share. Over the last five years, MPW FFO has grown at an average annual growth rate of 26.8%, to about $535.8 million through 2019. A simple straight-line trend (least squares method) indicates total FFO for MPW of about $1,091.6 million for 2025. MPW issues stock almost every year, to raise capital and use in acquisitions. The forecast for 2025 weighted average diluted shares outstanding is about 721.5 million shares. Thus, the 2025 expected FFO per diluted share is about $1.51, and using the average high and low price to FFO ratios, expected prices for MPW stock for 2025 range between a low of about $17 per share, and an expected high of perhaps $22 per share. MPW is currently at about $19.25 per share

MPW dividends appear to have been maintained in the face of the Corona virus, with the most recent quarterly declaration at $.27 per share, an implied rate of $1.08 per year. The dividend has a nearly perfect correlation with FFO, on a per share basis, with the coefficient of correlation at .998, with a .996 coefficient of determination. The average dividend payout ratio was 81.4% of FFO, over the last five years. If the payout ratio holds (which the coefficient of correlation suggests it will) at 81.4% of FFO, then the dividend expected in 2025 should be about $1.23 per share. If the stock trades between $17 and $22, the dividend yield will range between 5.6% and 7.2%. Over the last five years the yield has averaged between 6.0% and 7.6%.

OHI

Omega Healthcare Investors, Inc. (OHI) is another REIT that invests in healthcare related properties, and finances healthcare related real estate. Although they do own some hospitals, their primary focus, which distinguishes OHI from MPW, is on assisted living facilities and skilled nursing facilities, generally deployed as triple net lease assets operated by 70 varied healthcare companies. They operate primarily in the US and the UK. Over the last five years OHI net income has averaged 24.7% return on sales, and their revenue growth rate for the last five years averaged 5.5%.

OHI shares traded in a range of P/FFO ratios, over the last five years, from a low average of 11.3 times, to a high of 14.6 times FFO per share. OHI FFO has grown at about 10.9% average annual rate over the last five years. The straight-line trend for OHI FFO indicates expected OHI FFO for 2025 of about $794.6 million. Given OHI’s expected weighted average diluted shares for 2025 or about 272.1 million shares, 2025 FFO should be about $2.92 per share. Thus, OHI stock should trade in a range from about $33 per share to about $43 per share in 2025. OHI trades at about $29.56 today.

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OHI has paid a dividend for each of the last five years, and has increased the dividend each year. Using their payout ratio of 87.7% of FFO, the expected FFO for 2025 of $2.92 per share should produce a dividend of about $2.56 per share, for a yield from 6.0% to about 7.8%.

Analysis

There are many numbers describing MPW and OHI, recited above. To those who deal in such calculations on a daily basis, the numbers speak for themselves. For the rest of us, some analysis and explanation may be useful.

FFO is funds from operations. FFO is a non-GAAP measure of the cash flow produced from operations by real estate investment trusts. It is a standard measure defined by the National Association of Real Estate Investment Trusts (NAREIT), and though it is close to cash flow from operating activities in a GAAP statement of cash flows, the two are not exactly the same. As it is a standard for REITs, many analysts use FFO instead of GAAP net income and/or GAAP cash flow from operating activities, and many use the Price to FFO ratio (P/FFO) in lieu of the usual price earnings ratio (P/E).

Price earnings ratios allow investors to compare companies of different sizes, because they tell us how much one must pay for $1 of earnings. The same idea holds for P/FFO, as a means for comparing companies. Other useful points of comparison between MPW and OHI include (A) overall size as measured by total FFO, (B) historic growth rates in FFO, (C) dividend payout ratios, and (D) dividend yields. The table below shows the data points for these points of comparison for MPW and OHI.

MPW

OHI

Average high annual P/FFO ratio

14.5

14.6

Average low annual P/FFO ratio

11.4

11.3

Total FFO, 2019 ($ mil)

535.8

640.0

5-Year average annual growth rate-FFO (%)

26.8

10.9

Dividend payout ratio (% of FFO)

81.4

87.7

Range of average dividend yields (%)

6.0-7.6

6.0-7.8

Although these two firms are different in many ways, based on their price-to-FFO ratios, the market gives them essentially the same value per $1 of FFO, in good times and bad. By total FFO, as a measure of overall scale, they are also about the same. The two have different growth rates, with MPW at 26.8% per year on average, and OHI growing FFO only at about 10.9% per year on average. OHI typically pays out a bit more of FFO than MPW, but again, they are close to the same on this measure. Also, note that REITs are required to pay dividends of at least 90% of taxable income. Taxable income is not the same as GAAP income, and it is not the same as FFO. Finally, these two firms are priced by the market to yield almost exactly the same dividend return.

These are big companies, with large numbers, and statistically, large numbers are slower to change than smaller numbers. Both have maintained their respective measures of growth, profitability, P/FFO ratios, and payout percentages for a long time, so we expect these numbers and measures to stay about the same in the future. Because of these factors of stability, it is appropriate to forecast with simple techniques, such as projecting straight-line trends. FFO is projected into the future, five years out, and the P/FFO ratios are applied to determine the range of prices within which MPW and OHI should trade in 2025. By application of the dividend payout percentages to projected FFO, future dividend and yields, based on the predicted prices, are projected.

Risks

There are inherent risks in any forecast. There are many more factors that will affect future prices and yields that can be included in any model, and results predicted could be completely wrong. Death rates may change for the worse, or for the better. The economy could crash. The medical payments system could collapse, and healthcare providers could become unable to pay their contracted rents. Regulatory changes in the healthcare system could change the economics of the public/private insurance and hospital systems in the US, to the detriment of REITs like MPW and OHI. MPW and/or OHI could suffer mishaps, such as the financial collapse of 2008, that prevent them from raising new capital, or refinancing existing debt. These companies could change their modes of operation in ways that have a deleterious effect on their financial results, and they could have difficulty identifying the causes of the changes in results, or how to correct them. These are all the kinds of risks that investors face from day to day, and in a general sense, they are priced in to the P/FFO ratios accorded to stocks by the securities markets.

Conclusion

The markets served by these two well-managed REITs appear poised for continued growth for the next fifteen to twenty years, as the post-war baby boom generation continues to shape the economic panorama of the US. Although MPW and OHI are very similar, they cover different yet complimentary segments of the healthcare markets, though with some overlap. Both are expected to continue to grow, although perhaps at different rates. Both are profitable, both are expected to produce capital gains, and both provide yields from about 6.0% to about 7.5% cash dividends. Investors seeking long-term growth at reasonable prices and consistent dividend income should consider owning both of these stocks.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in OHI & MPW over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.