OPINL - Office Properties Income Trust: Look Towards Debt To Get Income

Summary

• Office Properties Income Trust has been working its way out of the pandemic.
• The company is becoming more reliant on its revolving line of credit and asset sales to support its dividend.
• Office Properties Trust debt provides good yields and there is a baby bond for income investors.

Last week, Office Properties Income Trust ( OPI ) reported its full year financial results. The stock rallied 7% on the week, but the bonds remained fairly similar to levels where they were when I last wrote about the company in December. Based on the latest financial data, I believe the dividend is in danger of being reduced, but the 10.5% yielding 2026 bonds are a good alternative for income investors.

For retail investors who wish not to purchase bonds in $1,000 increments, there is another solution. Office Properties offers a baby bond ( OPINL ) which currently trades at $20.46. The bond trades just like a stock with quarterly interest distributions totaling $1.59375 per share per year. At its current price, the baby bond is trading at 8% yield to maturity. While the yield is lower than the traditional bonds, the coupon yield is much higher, near 7.8%. The baby bond is also callable in June of 2025, which if done then, would yield investors a return of 17%.

Office Properties’ 2022 results featured no major highs or lows. The company reduced the number of properties under ownership by 10%. Total occupancy of the remaining properties increased by 110 basis points to 90.6%. From an income and profit standpoint, the company saw lower revenues year over year, due to owning fewer properties. Office Properties’ expenses declined due to lower real estate taxes, but not enough to preserve net operating income, which fell by $14 million. At $359 million, the company is still generating enough income to cover its interest expenses, which fell to $103 million last year.

Office Properties’ balance sheet shows some changes in the company’s capital structure during the year. The company reduced its debt by approximately $100 million, but it required drawing $195 million under its revolving credit facility to pay down its unsecured notes and mortgage debt. The company’s cash balance also drew down by $70 million to $12 million.

Office Properties’ cash flow is helpful in determining its dividend sustainability and the ability to reduce debt. Over the last three fiscal years, Office Properties’ operating cash flow has declined sequentially year over year, with $193 million generated in 2022. What’s most alarming is the company’s free cash flow was slightly negative after $204 million in capital expenditures, more than double the amount of the last two years. Office Properties’ $106 million dividend obligation and debt reduction were both fueled by $203 million in proceeds from the sale of assets. Asset sales to fund dividends is not a good position for the company to be in.

Investors should recognize that supporting the current dividend came at the cost of liquidity in 2022. The company started the year with $830 million in liquidity (cash plus revolver capacity) and ended the year with under $570 million in liquidity. Two more years of this pace will reduce Office Properties liquidity capacity to zero without raising new capital.

The situation is further stressed by management’s comments that they are planning $250 million in new capital expenditures in 2023. Furthermore, the company expects to fund these investments through the sales of assets, termed capital recycling. It's important to note that dollar for dollar asset sales aren’t going to be able to fund dividends in total as the company will also have to manage the reduction of leverage by paying down debt. Reducing the dividend would aid in this endeavor.

In addition to funding its planned capital expenditures, Office Properties also needs to deal with upcoming lease expirations. Over the next two years, more than a quarter of the company’s square feet will have their leases expire. This includes just under 1.9 million square feet in 2023. It’s important to note that Office Properties seems to be prepared to handle these negotiations with over 2.5 million square feet in leases negotiated in 2022.

Looking further out, Office Properties debt maturities are manageable over the next two years, but the company does face a $650 million maturity in 2025. A combination of dividend reduction and free cash flow consistent with historical capital expenditure levels would make refinancing this debt much easier. Office Properties should have enough liquidity in its revolver to get through 2024 should refinancing not be a viable option.

Overall, I am more concerned about Office Properties’ dividend sustainability than I was a quarter ago. I do believe the capital recycling plan is needed to shed underperforming properties, but asset sales can only fund dividends for so long. Consequently, I do not believe the company is headed towards bankruptcy and has sufficient liquidity to navigate through the 2026 bonds, yielding those investors over 10% per year in returns.

CUSIP: 67623CAD1

Price: 78.50

Coupon: 2.65%

Yield to Maturity: 10.496%

Maturity Date: 6/15/2026

Credit Rating (Moody's/S&P): Ba1/BBB-

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