ONL - Orion Office Is Dirt Cheap With Upside Potential

Summary

• Orion Office has a strong, mostly investment-grade rated tenant base in recession-resilient industries.
• It carries low leverage and the dividend is very well protected by a low payout ratio.
• The stock is priced far below that of its peers, setting it up for potentially strong returns.

Orion Office REIT ( ONL ) hasn't done very well from a share price perspective since being spun-off from Realty Income Corp. ( O ) fourteen months ago. Understandably, the market is rather weary around office properties, especially considering the takeoff of remote work since 2020.

However, I don't believe this asset class is permanently impaired, as what the market seems to believe. In this article, highlight why ONL may be a solid long-term buy at this time with plenty of headwinds already baked into the stock price, so let's get started.

Why ONL?

Orion Office is an internally-managed REIT that owns a diversified portfolio of mission-critical and headquarters office buildings. Its properties are located in high quality suburban markets across the U.S., and are primarily leased to single, credit-worthy tenants on a net lease basis, resulting in simplicity of operations compared to multi-tenant properties.

At present, ONL's portfolio is comprised of 87 wholly-owned properties plus an additional 6 properties through unconsolidated joint ventures. It has high investment grade tenancy, which comprise 70% of its annual base rent. As shown below, the portfolio is well diversified by geography, and has over 30% exposure to the growing Sunbelt markets.

ONL's top 10 tenants include well recognized names such as the U.S. Government's General Services Administration, Bank of America ( BAC ), Cigna ( CI ), Walgreens ( WBA ), T-Mobile ( TMUS ) and Novartis ( NVS ). As shown below, the tenant base is comprised primarily of defensive industries like healthcare, government, and insurance, that are recession resilient.

Meanwhile, the overall portfolio is on solid footing with an 88% occupancy rate, and management seeks to create value through sale of non-core properties with redeployment of proceeds into assets that meet its targeted investment criteria. While ONL does have some high lease expirations next year, lease expirations are well staggered thereafter.

Moreover, it has an additional growth source through its Arch Street Joint Venture, which was formed in 2020 by VEREIT (pre-merger with Realty Income) and Arch Street Capital Partners. This portfolio has a safe portfolio loan-to-value ratio of 60%. Plus, Arch Street is a leading advisor to international investors with 17 years of experience, advising on $8.5 billion of transactions since inception.

Nonetheless, ONL still has plenty of work to do in stabilizing its portfolio with an optimal portfolio mix. This has been complicated by higher interest rates and general economic uncertainty, and may take longer than expected. However, it has plenty of liquidity to weather current challenges as highlighted by management during the last conference call :

While it remains our goal to reach stabilization and enhance our portfolio's weighted average lease term by addressing the portfolio's vacancies and significant lease rollover in the next several years, we now believe it could take somewhat longer than initially anticipated given the changing economic environment.

Notwithstanding the headwinds, our portfolio continues to have positive net cash flow and our available capital to execute on our business plan continues to grow with over $418 million in total liquidity. That liquidity, coupled with our experience, expertise and the underlying strength of many of the properties we own in the portfolio will continue to serve as a strong core platform.

Given the macroeconomic environment, we remain highly disciplined and strategic when it comes to adding new properties to our core portfolio. Longer term, we remain excited about Orion's growth prospects and opportunity set.

Meanwhile, ONL maintains a strong balance sheet, with it reducing debt by 11% or $69 million since its spin-off, and it carries $418 million in total liquidity. It also carries a low net debt to gross assets ratio of 32% and a low net debt to EBITDA ratio of 4.4x, sitting below management's targeted range of 4.7x to 5.0x. Plus, 95% of ONL's debt is fixed rate, making it less vulnerable to rising interest rates.

Importantly, ONL's dividend is very well protected by a 24% payout ratio as a percentage of FFO and 27% payout as a percentage of Funds Available For Distribution.

Lastly, ONL appears to be very cheap at the current price of $8.40 with a forward P/FFO of just 4.7x, sitting well below that of other beaten down office REIT peers. This means that a simple reversion to a forward P/FFO of 5.0x would translate to a potential 11% total return including dividends.

Investor Takeaway

Orion Office is positioned to weather current economic challenges and take advantage of future growth opportunities. It has a strong tenant base with most tenants in recession resilient industries, and carries low leverage, providing flexibility to the company as it stabilizes its portfolio for the long-run.

Lastly, ONL's valuation is currently dirt cheap and pays a very well covered portfolio. However, I view ONL as being a Speculative Buy due to its limited experience as a standalone company and the comparatively small nature of its portfolio.

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