Description
OPI debt was recently written up by Rosie918. Rosie is an excellent analyst, and I agree with his report and conclusion.
I am recommending OPI equity which has considerably more long-term upside potential from the same underlying assets. The equity offers the opportunity to earn a 20+% annualized return through late 2025, versus the debt’s 9% yield through May 2024.
RMR-related assets are generally stigmatized and trade at lower valuations than comparables, however, the current pessimism about the company and its asset base seems overdone.
OPI equity currently trades at 3x FFO and has a 15% dividend yield. Just a year ago, with the same management team and assets, the same RMR overhang, the same work-from-home trends, the same dividend, and the same payout ratio, the stock traded in the $23-27 range with an 8.5-9.5% dividend yield.
As shown below, OPI has the lowest FFO multiple and highest yield in the office sector.
The company’s implied capitalization rate (based on the MRQ EBITDAre of 80.0) is 10.4%. The company generated 367M of TTM NOI on an enterprise value of 3.081B (2.394B of debt, 14M of cash, and 701M market cap).
Management recently said “we remain very comfortable with our dividend” and noted their constant payout ratio since 2019 which I expect to continue. TTM FFO is $4.92 for an FFO payout ratio of 50%. The company expects “normalized FFO” to be $4.71-4.73 per share in 2022, which takes into account pending dispositions. TTM CAD is $3.30 for a CAD payout ratio of 66.7%.
The company has a conservative capital structure with $2.4B of debt, a weighted average interest rate of less than 4%, and a weighted average maturity of over 5 years. EBITDA covers interest expense by over 3x. Currently, the company is rated Ba1 by Moodys and BBB- by S&P. 97% of the debt is unsecured – leaving considerable capacity to put mortgages in place – and 94% of it is fixed. Only 50M of mortgage debt comes due in mid-2023 and no senior notes mature until May 2024. The revolver has 615M of availability and has been extended through mid 2023 with an option to extend through January 2024.
Via asset sales, the company plans to deleverage modestly from 7x debt/EBITDA (using TTM EBITDA) to 6-6.5x EBITDA and intends to remain investment grade rated. Now is not the time to sell assets, but this is their mid-term plan.
The upcoming lease renewal exposure appears to be manageable. In the recent earnings call, the CFO noted that of the upcoming 14% of lease expiries, “nearly 4%” has already signed renewals subsequent to quarter-end or are in advanced stages of lease negotiations, 1% of the expiries are in contracted dispositions, and most of the remaining expiries occur in Q3-Q4 2023 so there is time to find new tenants.
By 2024, the company will have finished renovating two major assets in Seattle & DC with a total cost of $377M and an expected return of 10%. This will provide a $38M lift to NOI which will offset any deterioration between now and then.
We maybe heading into a recession. For the sake of conservatism, let’s assume FFO declines in 2023-2024 to a run rate of 146M, down 32% from current run rate. (Morgan Stanley expects $212M in 2023 FFO). With a 50% payout ratio, 146M in FFO would result in a $1.50 dividend. Let’s assume the dividend is cut in mid-2023, so we have 2 more quarters of the current $0.55 quarterly dividends and $0.375 for the following 10 quarters of our anticipated 3-year hold period.
As for the exit price, let’s assume that OPI trades at an 8% yield in 2024, or $18.75 based on the $1.50 annual dividend. Based on this, the IRR is 20% and the return on invested capital is 63%.
If the new redeveloped properties generate the 10% ROI that management is forecasting, this will add another 34M of FFO, which would bring the dividend back to $1.90. If the market trades this $1.90 dividend to an 8% yield, the stock trades to $23.75. Inclusive of the dividends received between now and then, with a $23.75 exit price, the IRR will exceed 25%.
Part of the OPI wager is a macroeconomic bet. The extreme stimulus in 2020-2021 led to the extreme tightening we have encountered in 2022. This will lead to another overcorrection by central banks to extremely low rates again, probably in 2024-2025. In this low interest rate climate, investors will again be seeking yield wherever they can get it.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
High dividend yield sustained into a low interest rate environment