Will the Upcoming “Silver Tsunami” create a “$4.8 trillion torrent of wealth?” (The Wealth Advisory)

Sniffing out the "market-beating income plays" from Brian Hicks

By Travis Johnson, Stock Gumshoe, November 27, 2012

The Wealth Advisory is one of those “entry level” newsletters that pretty much all publishers put out — it costs less than a hundred bucks a year, and it gets you used to paying for financial analysis without feeling too much pain … sort of a gateway drug before you get pitched on the “hard stuff” like the special trading services, deep value letters, or niche advisories on mining stocks or energy or biotech or options that cost hundreds or thousands of dollars a year.

As a publishing strategy, it clearly works well — even though my readers often write in with anger about how frustrated they are when they pay for an analyst’s advice in one of these less expensive letters and still get teased about the better, more expensive advice or recommendations that analyst is providing for a more “elite” group of subscribers.

This newsletter is currently edited by the publisher, Brian Hicks, and he’s teasing us about a “silver tsunami” that will bring massive wealth — so what is it?

Well, thankfully, it’s not about actual silver. We’ve seen plenty of silver pitches and teases in recent months, and I know plenty of folks love the shiny stuff, but one does run out of things to say about it. This is more of a silver fox story — all about the aging baby boomers and the massive healthcare spending that will follow them into retirement.

And as a big theme it is certainly worth revisiting — though we all obsess about the fiscal cliff, government insolvency around the world, the growth of the Chinese economy, the value of gold, the profit margins of Intel or Procter and Gamble … really, when it comes to actual foreseeable economic impact, the retirement and extended lives of the baby boomers will probably be the most significant economic event of the next 20 years. Not just because the generation now hitting retirement age is carrying a huge load of wealth into retirement relative to prior generations, and not just because their retirement is going to force an overhaul of Social Security, Medicare and Medicaid, but also because, as Brian Hicks teases, they’re going to expect long, active lives in retirement … and that means heavy spending on the upkeep of their bodies.

So Hicks is saying that we’ll see a $4.8 trillion “healthcare superboom”, and he’s teasing three companies that he thinks will benefit.

Which is when we get to the power of the Mighty, Mighty Thinkolator: What are these companies? Can we find out without subscribing?

I thought you’d never ask!

Here are the hints:

“Health Care Superboom Opportunity #1:

“Steady, Huge Payouts that Have Gone Up for 14 Years Straight!

“The increased demand for drugs that the aging of America is igniting will create an unstoppable profit wave for the world’s biggest drugmakers, which happen to be some of the best income-producing stocks in the S&P 500…

“That’s why I’m recommending that you add this booming $189 billion health care giant to your portfolio.

“It markets more than 18 drugs totaling $28 billion in sales per year.

“In the last 14 years, it has bought back nearly $14 billion worth of its shares (always a sign of strength) and has paid out more than $12.6 BILLION in dividends to shareholders.

“And the payments to shareholders have gone up every year for the past 14 years. In fact, this company has raised its dividend 65% since 2008!

“On top of that, management plans to increase its already hefty dividend — and is targeting a 40% payout ratio by 2013.

“It has recently shed some of its non-core businesses and plans to focus exclusively on the growth of its core pharmaceutical business and the development of new drugs, where its expertise puts it head and shoulders above the competition….

“In June 2012 the FDA approved a widening of the use of one of its blockbuster drugs to include treating pain from spinal cord injuries.”

So … we toss all that into the Thinkolator and learn that this is, no surprise, Pfizer (PFE), one of the mega-pharma companies that would surely come to your mind if you were forced to name a large drug company. They do indeed have a market cap around $180 billion, they did just get approval for one of their major drugs, Lyrica, to be used in treating spinal cord injury pain, they pay a large and growing dividend and aim for a larger one … all fairly typical of the largest global drugmakers.

Pfizer was in a funk for about ten years, despite the huge success of Lipitor that first drove their sales to incredible heights in the late 1990s and early 2000s — and arguably some of that funk was because of Lipitor, since the overwhelming worry for Pfizer for the last five or six years has been, “how will they replace that revenue when Lipitor goes generic?”

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Well, it’s generic now and has been off patent for about a year — and their revenue will probably be down a bit next year, but they still make an awful lot of money on that and other drugs, with a dozen or so big name-brand drugs including Lyrica, Celebrex and Viagra (which itself goes off patent around now, I think). They’ve also been part of the mega-merger trend in pharma over the years, acquiring Warner-Lambert, Pharmacia and Wyeth over the last decade or so, and it would probably take another big merger or acquisition to spur really dramatic revenue growth for Pfizer going forward — absent a surprise breakthrough in the fight against some major disease. Right now analysts are expecting that Pfizer will grow earnings by just one or two percent a year for the next several years, which is decent considering that revenue has dropped and will probably continue to drop by at least a little bit as some major drugs lose patent protection.

If you add that kind of stable performance expectation to a decent and growing dividend that still has room to grow a bit over at least the next year or two, that’s apparently enough to make investors reasonably happy with Pfizer — not least, ironically enough, because those same baby boomers who are going to be forcing such high spending on pharmaceuticals are themselves looking for dividend income. That’s led to a year of substantial outperformance for PFE shares, they’re up about 50% this year and have handily beaten the S&P 500 — heck, they’ve even beaten the pharma average, as represented by the S&P Pharmaceutical Index ETF, though they’ve stuck pretty close to that benchmark.

From my perspective, as someone who has not read all of Pfizer’s filings or studied their drug pipeline, they look awfully similar to the other big drug stocks that get teased from time to time — stocks like Eli Lilly (LLY), Merck (MRCK) and Bristol Myers Squibb (BMY) that also generally have discount valuations (forward PE of 10-12 or so), strong yields (most of those are a little higher than Pfizer’s, at over 4% versus PFE’s 3.5%) and low growth expectations. I personally don’t own any of these, my only pharma stock holding is in Teva (TEVA), which is more of a “cheap growth” play with a small dividend as I think we’ll continue to see higher generic drug sales and an appreciation for Teva’s phenomenal manufacturing efficiency, but that pick has certainly done far worse than most of the big pharma ones since I’ve owned it so you can take my opinions with a grain of salt (or perhaps even a few teaspoons). Pretty much all the big pharma names are being bought as income producers, and it’s hard to argue with a stable and growing 4% yield in a world when government bonds are losing money after inflation, and there is at least a general tailwind from both our aging population and from the increasing health care spending of other nations (though none of them, I expect, will catch up with us on the spending front).

Even if dividend taxes go up in January, as they probably will (though the consensus seems to be that they’ll be in the 20-25% range, depending on your income level), a growing 4% yield from a stock with a high level of perceived safety sounds pretty good. And unless you’re going to develop a high level of expertise in this sector, it’s hard to say that any of them carry particular risks or benefits beyond the few major “patent cliff” problems that they’re all working through now — they mostly move together when it comes to things like political risk (“Obamacare” or pressure over drug costs in general), and the other company-specific risks (like failed drugs or lawsuits) are, at least for me, impossible to predict, so if I were going to go into buying some big pharma stocks in search for dividend yield and slow dividend growth I’d choose at least two or three of them and spread my investment around a little bit. Others that you might add to that “mega pharma, 3-5% dividend” list include Novartis (NVS), GlaxoSmithKline (GSK), Johnson & Johnson (JNJ) and Abbott Labs (ABT) — generally, the lower-yield plays like ABT also have somewhat stronger growth expectations.

Next? This second one is not a drug stock, it’s a different way to get “medical income” …

“Health Care Superboom Opportunity #2: A Gov’t-Mandated “Cash Machine” that Pumps Out Huge Dividends like Clockwork

“There’s a tiny group of government-regulated companies that own almost every medical facility in the United States…

“From Baylor Medical Pavilion in Dallas, Texas, to Sarasota Medical Center in Florida to the St. Thomas Heart Institute in Nashville, Tennessee, to name just a few….

“… hospitals and medical facilities have lots of money.

“And they don’t sign yearly leases like you or I… they sign five- to twenty-year leases with “rent escalators” that guarantee rents will increase 2%-4% annually.

“So they’re contractually guaranteed to receive a steady stream of income worth millions from some of the richest companies in America.

“And thanks to the government, they also get to rake in this rent income tax-free.”

So that’s quite clearly a teaser for the subsector of REITs that own medical office buildings and other healthcare facilities, from hospitals to nursing homes — but which one is he teasing? A few more hints for us:

“I’ve identified a cash-rich medical facility owner poised to pay out the biggest, safest dividends over the next 12 months and beyond…

“This company owns an impressive portfolio of investments, including 432 health care and medical facilities in 35 states.

“It currently pays a hearty 7% dividend, and in a past five-year period, this company has paid out 258% in dividends.”

This is not just a healthcare REIT, it’s the highest-yielding healthcare REIT: Omega Healthcare Investors (OHI)

Omega has an unusually high yield for the sector at almost 8% now, and they’ve recently been steady dividend-raisers — though they don’t have the steady dividend growth history of some of the more established firms in their space like Health Care REIT (HCN) or HCP (HCP). And the reason they have a generally higher yield than most healthcare REITs (which on average have yields of more like 5%, though there are only a half dozen or so companies in this space) is that Omega is smaller and less diversified when it comes to political risk — most of the REITs own a variety of nursing homes, medical office facilities and surgical centers, but OHI concentrates on skilled nursing facilities … which means their customers are very much reliant on Medicare payments. So when Medicare reimbursement rates for nursing homes are under threat, folks worry a bit more about OHI. At least, that’s the way it seems to me.

Is that fair? Well, maybe on a big picture level — but OHI is just the building owner, they have nothing to do with operations and they have a huge number of operating partners (47 different operators, I think, for their 432 facilities) so it’s not just one company that might run afoul of Medicare or plan poorly for rate changes. And these are, as is typical of the healthcare REITs, triple net leases with some inflation protection built in in the form of annual rent increases, so there aren’t huge risks for maintenance or property taxes or the like. Certainly if Medicare reimbursement rates for skilled nursing facilities fall then their tenants might be in trouble, but we are on the cusp of a dramatic shortage in nursing facility beds — once the baby boomers hit their 70s and 80s, there’s not going to be anywhere near enough capacity to meet their nursing home needs if they require nursing services at the rate that’s expected. And while skilled nursing facilities are expensive, they’re a lot less expensive than some of the other options for the elderly, injured and infirm — rehab centers and acute care facilities are far more expensive, so there will probably be new categories invented as we try to develop services for our largest generation of senior citizens ever … but for now, there seems to be at least a good argument that OHI is likely to benefit form the supply/demand picture for skilled nursing beds.

Omega also carries a substantial amount of debt — not surprising or unique for a REIT … but they also, like most of the other healthcare REITs, pay out more than they earn — like master limited partnerships, a portion of their dividend has lately been “return of capital”, meaning it’s not taxable as income (though it lowers your cost basis, so increases capital gains taxes when you sell). The income portion of the dividend is taxed as regular income, as with pretty much all REITs (they don’t pay corporate tax, they pass through the tax liability to shareholders like you), so they don’t worry much about the discounted dividend tax rate for “qualified” dividends because their dividends are not qualified in the first place. Their dividend payments have generally tracked right along with “operating cash flow”, though — they pay out in dividends just about what they pull in as “cash earnings” before they deduct the big ticket non-cash charges of amortization and depreciation — so it’s not as though they’re doing anything crazy, they’re just paying out as much cash as they possibly can. They add debt and sell new stock with some frequency, and most of that cash effectively goes back into acquisitions and debt payments on those acquisitions as far as I can tell — so the operating cash flow, broadly speaking, gets sent to shareholders. Free cash flow (operating cash flow minus capital expenditures) does not quite cover the dividend, but it comes close. So as long as they keep growing their portfolio, and as long as they keep the occupancy rate up, I don’t know of any red flags that would make me want to avoid the stock.

There is clearly risk in the broad health care/government spending debate, since their tenants are all dependent on government spending, but my guess is that the shares are already pricing in quite a bit of that risk — a growing 7.8% yield is pretty shocking in any REIT right now, so I think I’ll be making some time to take a closer look at Omega Healthcare Investors at some point in the next few weeks to see if I can find something scarier than I’ve seen so far.

That’s our first two “Healthcare Superboom Opportunity” solutions — I’ll see if I can get to the third one in a future installment. So what do you think? Ready for some pharma or skilled nursing facility income in your portfolio, or do you have better ways to pull in a 4-8% yield? Different favorites in these sectors than those stocks we’ve seen teased (or that I’ve mentioned) above? Let us know with a comment below.


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