Orion Office REIT: 3 Reasons We Are Moving To A Strong Sell

seekingalpha10-09

Orion Office REIT's occupancy has dropped from 92% in 2021 to around 80% in Q2-2024.The company's Funds From Operations (FFO) continues to decline.Orion's debt levels are concerning, with net debt to ...

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PM ImagesIt is fair to say that we have been on the correct side of the trend for Orion Office REIT (NYSE:ONL). We never \"bought into\" the much hyped spin-off. We never gave it a single buy rating.   Seeking AlphaWe always thought the leverage was too high while others claimed they were being conservative. The stock has performed about in line with our expectations, though we did expect 2024 to be a bit worse for the company than it has actually been. Data by YChartsSince our last article, the stock is actually up and has delivered a good result.   Seeking AlphaWe examined the facts and decided it was time for a rating change. This was not in the direction bulls might have expected. 1) Occupancy Looks Catastrophically Bad In Q2-2024, Orion reported having 69 operating properties with an occupancy rate which we could round to about 80%.   Orion Q2-2024 ResultsIf you examine the history of REITs, this level is where things really break. REITs are not designed to operate with 80% occupancy levels as they carry far too much leverage for that. The bigger problem here is that Orion has gotten here after selling, selling and more selling. Over the last 3 odds years, the company has sold 23 vacant (or soon to be vacant) properties. All with one goal to keep occupancy looking somewhat normal. At the end of 2021, it had 92 properties with a 92% occupancy rate. As of December 31, 2021, the Company had a real estate portfolio comprised of 92 properties, and a 20% ownership interest in a joint venture comprising six properties. The Company’s portfolio occupancy rate was 91.9%, approximately 67.7% of the Company’s annualized base rent as of December 31, 2021 was from tenants with an investment grade credit rating, and the weighted average remaining lease term was 4.1 years. Source: Orion Q4-2021 Results So this remains one of the fastest and easily the most predictable deteriorations we have seen. Occupancy levels improved from Q1-2024, but that was the result of selling 6 properties.   Orion Q1-2024 Results 2) Funds From Operations (FFO) for 2025 Will Shock You The bulls have hung around from its start price of around $25, simply because it was \"cheap\". It is only (insert silly low multiple here) X FFO. We freely admit here that the stock price has declined a bit faster than the FFO. The former is down 84% while the latter is only down about 40%. This is recruiting a new generation of future tax-loss sellers. Our rationale here is that you just open your eyes and read what management is telling you.   Orion Q2-2024 ResultsNo, not the Core FFO for 2024. The expected Core FFO for the last two quarters of 2024. That is a simple subtraction.   Orion Q2-2024 ResultsThe company expects 37 cents of Core FFO for the back half of 2024. Based on our estimates, we think this will break up along the lines of 21 cents and 16 cents. We also see no chance of FFO stabilizing at Q4-2024 levels. But even if you believed that, the stock is now back over 6X FFO when you annualized Q4-2024. That is not cheap for a single tenant office REIT. 3) Debt Is Fairly Large In Relation To The Cash Flow We will put this picture in here again. You can see below the artistically circled Core FFO is the net debt to adjusted EBITDA.   Orion Q2-2024 Results Granted the newbies are not going to get scared with a 6.4X number. After all, it is a REIT. 6.4X is enough to wipe out a single tenant office REIT in fairly short order once deterioration hits. Check out the history of Office Properties Income Trust (OPI) for a quick primer. We will be nowhere near 6.4X by 2025. You can see the rate at which the adjusted EBITDA is dropping in the picture below. Interest coverage ratio has almost halved from year back.   Orion Q2-2024 ResultsDespite asset sales and retention of cash, net debt is moving down far slower than EBITDA.   Orion Q2-2024 ResultsWe expect this (debt to EBITDA) to reach 8.0X by the end of 2025. Realistically, single tenant office buildings are worth an EBITDA multiple close to the number of years on the lease. So with a weighted average of 4.2 years, you can see how even the current 6.4X is likely to be enough to push the equity under. Verdict There are two other considerations here. The first being that the majority of the debt is earmarked against specific properties.   10-QThis has been the crux of the bull case. From our perspective, it is hard to know exactly how much cash flow is coming from these properties. There is further language here that suggests that simply walking away is not exactly a fix that they can deploy.  In connection with the CMBS Loan Agreement, the Company (as the guarantor) delivered a customary non-recourse carveout guaranty to the Lender (the “Guaranty”), under which the Company guaranteed the obligations and liabilities of the Mortgage Borrowers to the Lender with respect to certain non-recourse carveout events and the circumstances under which the CMBS Loan will be fully recourse to the Mortgage Borrowers, and which includes requirements for the Company to maintain a net worth of no less than $355.0 million and liquid assets of no less than $10.0 million, in each case, exclusive of the values of the collateral for the CMBS Loan. As of June 30, 2024, the Company was in compliance with these financial covenants. The CMBS Loan Agreement includes customary representations, warranties and covenants of the Mortgage Borrowers and the Company. The CMBS Loan Agreement also includes customary events of default, the occurrence of which, following any applicable grace period, would permit the Lender to, among other things, declare the principal, accrued interest and other obligations of the Mortgage Borrowers to be immediately due and payable and foreclose on the Mortgaged Properties.  Source: 10-Q One final point we want to make is that the Core FFO terribly overstates the earnings power of the company. Funds available for distribution or FAD is a better metric. FAD subtracts out the huge capex costs to retain tenants. At present FAD is running at an annualized 56 cents per share rate.   Orion Q2-2024 ResultsWe see this metric falling to under 40 cents by Q4-2024 or Q1-2025.   Seeking Alpha We wouldn't be getting too comfortable with that 10.64% dividend yield.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2474286668"}