Author: Brad Thomas

The office REIT sector has been crushed so far this year, down a whopping 30% YTD, with shares trading at a 51% discount (based on P/FFO) versus normal valuation multiples.

Office REITs are yielding an average of 9.4% and the lowest P/FFO multiple (of 5.8x) compared with all other property sectors within the iREIT™ universe.

We has written extensively on the office REIT sector, as we have covered names such as:

Over the last few weeks, several office REITs have cut their dividend and we now have four on our dividend watch list: (BDN), (SLG), (PDM), (DEA).

As you can see (above), Orion Office REIT (NYSE:ONL) has dropped by almost 34% YTD and a whopping ~69% since it spun off from Realty Income (O) in late 2021 (as a result of spin-off from the Realty Income and VEREIT merger).

Realty Income opted to spin its office portfolio, versus sell, as it had hoped that the company could create value by utilizing a management team that had experience with the ONL book of business. As you can see below, the C-suite execs all had experience at VEREIT and were familiar with the existing office portfolio.

I also find it interesting that four of the board members had ties to either Realty Income or VEREIT, namely Reginald Gilyard (board member at Realty Income), Kathleen R. Allen, Ph.D. (former Realty Income Director), Richard Lieb (former Director at VEREIT), and Gregory J. Whyte (COO at Realty Income).

That’s not a knock on these Board members as they all appear to be qualified, however, as an investor in ONL I would like to see more outside influencers. Shares have been decimated since listing and the business models (office and net lease) require varying degrees of experience – one requires a lot of cap ex and the other (requires) very little.

The Basic Business Model

ONL’s portfolio is comprised of substantially all office properties (100% office exposure – predominantly single-tenant, suburban net lease). The diversified portfolio of properties is primarily mission-critical headquarters locations with favorable exposure to investment grade tenants (73.6%).

There are 81 wholly-owned properties in the portfolio in addition to 6 JVs with a combined rental square footage of 9.73 million. The Annual Base Rent is around $156.45 million or $16.08 per square foot. The weighted average lease term is 4.0 years (more on that later).

ONL is focused on single-tenant net lease office in attractive suburban markets, including the Sunbelt, that are experiencing economic and population growth. The top 10 states (as % of ABR) include:

• Texas 15.2%
• New Jersey 12.3%
• New York 8.7%
• Illinois 7.3%
• Kentucky 6.5%
• Massachusetts 5.1%
• Colorado 5.1%
• Oklahoma 4.3%
• Ohio 4.0%
• California 3.4%

The value proposition for ONL is to provide investors with an opportunity to invest in suburban net lease office with demand drivers that include demographic tailwinds associated with recent suburban migration.

The Sun Belt continues to benefit from migration which has accounted for 75% of U.S. population growth in the last 10 years and now represents 62% of the total population. Corporations remain attracted to low-cost, tax-friendly Sun Belt markets with industry clusters in tech, life sciences and finance. 8 of 10 lowest cost markets for real estate development are located in the Sun Belt.

Large corporations are focused on locations that are situated in strong suburban and secondary markets or order to align with the employee population. As they suburbanize, Millennials (one of the largest cohorts of today’s workforce) disproportionately value convenience and proximity to work.

A few examples of ONL markets include…

Phoenix – where the residential population grew 20% from 2010 to 2022 and the unemployment rate is hovering at 2.7% with over 90,000 jobs created from 2021-2022. The area is witnessing an inflow of foreign investment totaling $40 billion, creating 6,000 jobs with the new TSMC Facility.

Dallas / Fort Worth – Texas is the national leader for Fortune 500 company headquarters and is 1 of 9 states with no individual income tax. Net positive migration seen at both the residential and corporate level with notable relocations/ expansions that include Aviatrix, Alkegen, Goldman Sachs, and Caterpillar Inc.

San Diego – An industry-leading mature hub for life science assets (where employment has grown by 20.6% over the last 3 years and contributes over $33.6 billion to the local economy). In 2022, the San Diego office market set a record for amount of space subleased at 2.8 million square feet – which is 3.4% of total supply.

Atlanta – Large tech company expansions in 2022: Mailchimp, Google, Visa, Microsoft, and McKinsey. Suburban and CBD Office rents grew 4.0% and 6.0% year-over-year.

Here’s a snapshot of ONL’s Top Tenants:

Although Walgreens (WBA) is on the above-referenced list, the company has agreements currently in place to sell 8 properties, representing 631,000 square feet, for an aggregate sale price of $41.0 million, including the 6 property Walgreens campus in Deerfield, IL.

Digging Deeper

As referenced above, ONL’s weighted average lease term is 4.0 years, and given the fact that the internal management team has deep knowledge of the portfolio and should be able to achieve growth organically via active asset management and externally via value-added investment opportunities. As seen below, around 37% of the leases rollover in 2023 and 2024:

On the latest (Q1-23) earnings call management said,

“…like other office landlords, we are seeing some office tenants seeking less square footage on renewal, and this development will likely continue for the foreseeable future. As we stated last quarter, the pace of signing early renewals has slowed and the tenant decision-making process has lengthened. Nonetheless, we remain active on the leasing front.”

In Q1-23 ONL signed 4 leases for 83,000 square feet, including the renewal of a 64,000 square foot lease with the U.S. government in Parkersburg, West Virginia for 15 years.

Management also pointed out that,

“Given the timing of leases and the size of our portfolio, tenant retention will be volatile quarter-to-quarter and year-to-year, depending on the needs of our tenants. Our portfolio’s weighted average lease term was four years at quarter-end.”

Show Me The Money

Upon listing, ONL has maintained a conservative balance sheet that consists of $449.5 million of liquidity, comprised of $24.5 million of cash on hand, including a proportionate share of cash in the Arch Street JV, and $425 million of available capacity on the revolving credit facility. 100% of debt is fixed or swapped to fixed rate.

Net debt to annualized adjusted EBITDA was 4.27x for Q1-23, which is below the year-end 2023 guidance range of 4.3x to 5.3x. As seen below, ONL has a $175 million term loan set to expire on November 12, 2023 and the revolving credit facility that is scheduled to mature on November 12, 2024.

It has more than enough capacity on the revolving facility to retain the flexibility to refinance the term loan facility on to the revolver at maturity. On the latest call management said,

“We recognize the market for financing office real estate assets is currently dislocated. And over the past year, we have deliberately maintained significant liquidity on the balance sheet as a result. We remain committed to operating the business on a low leverage basis, which gives us good financial flexibility to execute on our business plan.”

ONL did not make any new acquisitions or repurchase shares in Q1-23.

In Q1-23 ONL generated total revenue of $50.2 million as compared to $53.2 million in Q1-22. It reported a net loss attributable to common stockholders of $8.9 million or $0.16 per share as compared to a net loss of $9.9 million or $0.17 per share reported in 2022.

Core FFO in Q1-23 was $25.3 million or $0.45 per share as compared to $29.3 million or $0.52 per share in Q1-22. G&A was $4.3 million compared to $3.5 million in Q1-22.

CapEx in Q1-23 was $3.3 million compared to $2.4 million in 2022, including tenant improvements of $1.6 million and other property improvements of $800,000, leasing commissions associated with the property’s leasing activity were an additional $900,000. As viewed below, analysts are modeling ONL’s FFO to decline by 11.3% in 2023 and another 16.0% in 2024:

The 2024 numbers don’t look good and that’s what has Mr. Market spooked. We like using AFFO (as opposed to FFO) since that includes CapEx and leasing commissions.

That’s scary …a 43% drop in AFFO over two years…

While the dividend appears safe, with a payout ratio of just 33% (based on FFO/sh), the 43% decline in AFFO/sh is no way to create shareholder value.

Meanwhile ONL’s 2023 G&A range is $18.75 million to $19.75 million and the market cap Is just $313 million.

Time for the Suggestivist to Speak

As you know, over the years I’ve written many articles in which I played the role as the “suggestivist” and I’ll remind you that what separates me as a “suggestivist” versus an “activist” is a few more zero’s.

I do own shares in ONL by way of the Realty Income spin, and I have yet to accumulate more shares, but I’m considering that now, as I may become much more “active” in my current role.

Although G&A appears high, I would like to see a few things…

1. Increase the board size and include a few outsiders with experience at M&A
2. Buy back shares

Share buybacks are a must as ONL is trading at an extremely cheap valuation:

With such a poor (analyst) outlook for 2023 and 2024, there will be a lot of wood to chop for ONL, and the only reason I’m staying in the game is in hopes of an M&A deal with the likes of Blackstone (BX), KKR (KKR), or similar private equity player.

It was certainly a good decision for Realty Income to spin the office assets, especially in this “toxic” office environment.

Needless to say, it doesn’t look good, and it’s now time for ONL’s management team to use its levers to reduce G&A, buyback shares, and recycle assets into accretive opportunities:

Stay tuned for more details as I will be attending REITweek in a few days in hopes of meeting the management team. I will of course let you know if my suggestivism becomes activism.

Thanks for reading and I look forward to your comments below.

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

This article was published at iREIT on Alpha on May 26, 2023 and was coproduced with Dividend Sensei.

The market is driving many investors crazy right now. How is the S&P 500 Index (SP500) within 11% of its all-time highs when we face a perfect storm of economic risks including:

• Congress is considering cutting spending by $500 billion in 2024

• The Fed refuses to cut rates even if we go into recession

• The Fed shrinking the money supply at the fastest rate since 1930

• Treasury is preparing to suck $1.5 trillion out of the economy by the end of the year with bond sales

• Student Debt payments restart in October, sucking another $129 billion out of the economy

• The debt ceiling negotiations are going nowhere, with a possible debt default just a week away

We potentially face a 1.5% to 4% GDP recession, 3X to 8X worse than economists recently expected.

Yes, in a worst-case scenario, we could be headed for another Great Recession…and that assumes we don’t default on our debt.

The answer is an AI-tech bubble in stocks like NVIDIA and Meta. This year, the nine largest US stocks generated 100% of the market’s gains.

But do you know what that means? It means the S&P 491 is down on the year, and some of the world’s best companies are down a lot more.

Let me show you why UGI Corp (NYSE:UGI), a 5.4% yielding dividend aristocrat, is a Buffett-style “fat pitch” table-pounding ultra-value buy.

In fact, it’s trading at the exact same P/E as the Pandemic lows and the Great Recession lows. The last time UGI was this undervalued, it went up 1400% in the next 15 years.

And today, it offers the chance to beat the S&P by 200% over the next six years, tripling your money while you lock in one of the safest 5.4% yields on Wall Street.

One Of The Best Values In High-Yield Aristocrats You’ve Never Heard Of

UGI has fallen off a cliff and is in its worst bear market since 1988.

• 51% bear market

• down 33% YTD.

What explains such a dramatic decline?

(Source: FAST Graphs, FactSet.)

Cash flow collapsed in 2022, though earnings came in at the 2nd highest level in history.

“The impact of headwinds faced at AmeriGas and in the European energy marketing operations stemmed from the geo-political situation and extreme variation in natural gas and electricity prices in Europe.”

– 2022 Annual report.

The war in Ukraine severely impacted UGI’s cash flows, sending EU energy prices soaring to record-high levels.

But that temporary shock is behind us, and management is confident that brighter times lie ahead.

In fact, management reiterated its long-term guidance for 6% to 10% EPS growth and 4% dividend growth on May 23rd at the AGA Financial forum.

Why UGI Is A High-Yield Aristocrat You Can Trust

UGI is one of the best utilities you’ve never heard of. It was founded in 1883 in King of Prussia, Pennsylvania, and has never missed a dividend in 139 years since it began paying in 1884. That’s through:

• 29 recessions

• 7 depressions

• two world wars

• a flu pandemic that killed 5% of humanity

• seven killer pandemics

• inflation as high as 22%

• interest rates as high as 20%

• over 24 bear markets.

It’s been raising its dividends for 36 consecutive years through:

• five recessions

• two economic crises

• seven bear markets

• inflation as high as 9.1%

• interest rates as high as 10%.

UGI is built to last and will likely outlive us all.

UGI is a global natural gas and propane utility operating in 18 countries, with 10,000 employees and over 2.5 million customers.

It is the 2nd largest regulated gas utility in Pennsylvania and the 2nd largest in West Virginia, and that regulated utility is A- stable rated by Fitch.

• 2.5% bankruptcy risk

“UGIU’s rating and Outlook are supported by the low-risk profile of its regulated and predominantly natural gas distribution operations, supportive regulation in Pennsylvania, and healthy customer growth.”

– Fitch

It owns a midstream business that transports the gas it serves to its customers and has 84% of its revenue from fee-based contracts. And it is also the largest propane seller in America and 17 countries in Europe.

It’s the #1 propane seller in France, Austria, Belgium, Denmark, Luxembourg, and Hungary.

Regulators have granted UGI a 10% rate base growth through 2026, which is the part of its business the company is focusing almost all its investments on.

UGI’s YTD results are OK, certainly not worthy of a 50% crash.

EPS YTD is flat compared to last year, and the regulated utility business, the A-rated part of the company, is now 36% of sales.

The company is investing $400 million YTD heavily into that regulated business and has $1.9 billion in liquidity remaining.

The company did cut guidance for the year, primarily due to reduced demand from conservation in Europe created by the war and supply shortage at AmeriGas Propane.

Management reduced guidance to $2.75, a 3% decline from previous levels.

The market’s reaction? A 33% YTD decline.

This is a major overreaction when this is a diversified company with solid management that has proven it can adapt and overcome any and all challenges for 140 years.

Management is working to cut expenses, boost margins by selling off non-core businesses in Europe and make its supply chain more resilient against future disruption.

The company refinanced $1.7 billion in debt in Q2, improving its credit facilities by $220 million and boosting liquidity by $700 million compared to the end of 2022.

UGI has de-risked by refinancing all maturing bonds in 2023, the recession year.

In 2024 it has $1 billion in debt maturing, but Fitch and the bond market aren’t worried because of its strong balance sheet.

• 3.1 debt/EBITDA vs. 5.5 safe for utilities

• 54% debt/capital vs. 60% safe

• a 53% payout ratio vs. 75% safe

• 4.8 interest coverage ratio vs. 3+ safe.

UGI is effectively BB+ rated by cash flow weighting of its other subsidiaries.

• UGI International BB+ stable

• UGI Energy Services BB stable

• AmeriGas BB- stable.

The parent company doesn’t pay for a credit rating, but BB+ is the weighted rating, implying a 14% long-term bankruptcy risk.

• Why UGI is a 13/13 blue-chip and not an Ultra SWAN

• 2.5% max risk cap rec for a technically speculative non-investment grade company.

Why is UGI growing dividends half as fast as earnings? So it can retain more post-dividend earnings to invest in its regulated business and diversify away from its struggling propane business.

UGI pays $315 million in dividends and this year is expected to retain $277 million in earnings after dividends.

Analysts expect steadily rising growth spending rising from $1.2 billion in 2023 to $1.4 billion in 2026.

That’s for increased spending to grow the rate base by 10% annually and diversify into renewable energy, taking advantage of tax credits from the inflation reduction act.

Through 2026 the company expects to require $1.4 billion in new debt while spending $5.1 billion to maintain, improve and grow its asset base.

It plans to target a 40% payout ratio, one of the lowest in the industry, while maintaining debt/EBITDA of 3.3X, also one of the lowest in the industry.

This is so UGI has plenty of financial flexibility to diversify its business away from riskier propane and towards natural gas.

Part of that plan is focused on investing $1.1 billion (about 20%) of its spending on renewable energy, specifically renewable natural gas.

That’s the methane coming off landfills, which is capable of powering 3 million US homes.

UGI’s RNG projects are in California, Idaho, South Dakota, West Virginia, Ohio, Pennsylvania, New York, and Scotland.

UGI’s renewable investments are earning double-digit returns on investment, just like its regulated utility investments.

UGI is also looking into bio propane and renewable dimethyl ether, which is used in petrochemicals and hydrogen.

• a $3 trillion global industry by 2030, according to Cummins.

UGI is also working on renewable jet fuel, which is going to be the only way for low-carbon air travel unless we can perfect room-temperature superconductors.

• Which would allow EV planes to become a reality.

In other words, collapsing fundamentals or growth prospects do not support UGI’s 50% crash, including a 33% YTD decline. Nor is it justified by rising dividend risk.

• 99% dividend safety

• 1.05% severe recession dividend cut risk

• 0.5% average recession cut risk.

In other words, even if the U.S. were to default on its debt and be plunged into another Pandemic or Great Recession economic hell, UGI would be almost certain to keep paying and raising its dividend just as it has for the last 139 and 36 years, respectively.

Solid Long-Term Growth Prospects

After a rough 2022, UGI is expected to recover in 2023 and beyond, growing steadily through 2026.

What about after 2026? Is growth going to fall off a cliff due to falling propane demand around the world?

The median consensus from all five analysts covering UGI is 6% long-term growth beyond the current guidance period of 2026.

The low end of current management growth guidance is 6% to 10%.

Over the last 20 years, UGI has grown as expected 92% of the time and misses 8% of the time, with the average miss being 10%.

In other words, a conservative estimate of future growth is 5.4%.

Long-Term Total Return Consensus

(Sources: DK Research Terminal, FactSet, Morningstar.)

Analysts expect 11.4% long-term returns from UGI, more than the S&P and dividend aristocrats.

Total Returns Since 1988

UGI has been delivering 11.4% annual returns (just as analysts expect in the future) since 1988. $1 invested in 1988 is worth $46 today, or $18 adjusted for inflation.

UGI’s average rolling returns have consistently been beating the S&P by 3% to 6% annually across every time frame, from 1 year to 15 years.

But I’m recommending UGI today because its valuation is literally at severe recession lows.

UGI Is The Same Valuation As The Pandemic And Great Recession Lows

Today you can buy UGI at the same valuation as you could have in the darkest days of the Great Recession and Pandemic.

That means a potential 100% return in the next three years.

What kind of medium-term returns can buying a 92% quality blue-chip aristocrat during the worst bear market since 1988 get you?

Best Bear Market Recovery Rallies Since 1988

The last time UGI was this undervalued, it delivered 15X returns over the next 15 years.

• The best 15-year return for the S&P is 447%.

In other words, UGI has the potential to triple the S&P’s returns over the next 15 years.

2029 Consensus Total Return Potential

Through 2029 UGI has the potential to almost triple, delivering Buffett-like 18% annual returns.

• 15% to 21% CAGR consensus return potential range.

A Wonderful Company At A Mind-Blowing Great Price

For 20 years, outside of bear markets and bubbles, millions of income investors have paid 15 to 18X earnings for UGI.

• 91% statistical probability this is range includes intrinsic value

UGI is historically worth about 17X earnings and today trades at 9.1X and just 8X cash-adjusted earnings.

• priced for -1% long-term growth

• actually growing 6%

• and 6% to 10% expected through 2026.

UGI is a potential Ultra Value Buffett-style “fat pitch” buy for anyone comfortable with its risk profile.

Risk Profile: Why UGI Isn’t Right For Everyone

There are no risk-free companies, and no company is right for everyone. You have to be comfortable with the fundamental risk profile.

UGI’s Risk Profile Includes

• industry/economic cyclicality (gas and propane demand are more cyclical than other types of utilities)

• industry disruption risk (from shifting consumer and regulatory tastes)

• political/regulatory risk (rate cases and potential shift to electric heating)

• litigation risk (modest for new midstream projects)

• M&A execution risk (lots of tuck-in acquisitions over the years)

• talent retention risk in the tightest job market in 54 years

• supply chain disruption risk (causing havoc globally right now, making completing new growth projects challenging)

• currency risk (36% of sales overseas)

• commodity price risk

• refinancing risk in a rising rate environment.

How do we quantify, monitor, and track such a complex risk profile? By doing what big institutions do.

Long-Term Risk Management Analysis: How Large Institutions Measure Total Risk Management

DK uses S&P Global’s global long-term risk-management ratings for our risk rating.

• S&P has spent over 20 years perfecting their risk model

• which is based on over 30 major risk categories, over 130 subcategories, and 1,000 individual metrics

• 50% of metrics are industry specific

• this risk rating has been included in every credit rating for decades.

The DK risk rating is based on the global percentile of a company’s risk management compared to 8,000 S&P-rated companies covering 90% of the world’s market cap.

UGI scores 54th Percentile On Global Long-Term Risk Management

S&P’s risk management scores factor in things like:

• supply chain management

• crisis management

• cyber-security

• privacy protection

• efficiency

• R&D efficiency

• innovation management

• labor relations

• talent retention

• worker training/skills improvement

• occupational health & safety

• customer relationship management

• business ethics

• climate strategy adaptation

• sustainable agricultural practices

• corporate governance

• brand management

• interest rate risk management.

UGI Long-Term Risk Management Is The 313th Best In The Master List (37th Percentile In The Master List)

(Source: DK Research Terminal.)

UGI’s risk-management consensus is in the bottom 37% of the world’s best blue-chips, and is similar to:

• NextEra Energy (NEE): Super SWAN dividend aristocrat utility

• Dover (DOV): Ultra SWAN dividend king

• Automatic Data Processing (ADP): Ultra SWAN dividend aristocrat

• PPG Industries (PPG): Ultra SWAN dividend aristocrat

• Polaris (PII): Super SWAN dividend champion.

The bottom line is that all companies have risks, and UGI is average at managing theirs, according to S&P.

How We Monitor UGI’s Risk Profile

• 5 analysts

• one credit rating agency

• 6 experts who collectively know this business better than anyone other than management

“When the facts change, I change my mind. What do you do, sir?”

– John Maynard Keynes.

There are no sacred cows at iREIT or Dividend Kings. Wherever the fundamentals lead, we always follow. That’s the essence of disciplined financial science, the math behind retiring rich and staying rich in retirement.

Bottom Line: This 5.4% Yielding Dividend Aristocrat Is 50% Undervalued

Let me be clear: I’m NOT calling the bottom in UGI (I’m not a market-timer).

Even Ultra SWANs and aristocrats can fall hard and fast in a bear market.

Fundamentals are all that determine safety and quality, and my recommendations.

• over 30+ years, 97% of stock returns are a function of pure fundamentals, not luck

• in the short term; luck is 25X as powerful as fundamentals

• in the long term, fundamentals are 33X as powerful as luck.

While I can’t predict the market in the short term, here’s what I can tell you about UGI.

• one of the best high-yield aristocrats you’ve never heard of

• very safe 5.4% yield (1.05% risk of a dividend cut), growing 4% through 2026 and 6% long-term

• 11% to 12% long-term return potential vs. 10.2% S&P

• historically 46% undervalued

• 9.1X earnings vs. 15 to 18X historical

• 8.0X cash-adjusted earnings = -1% growth priced in

• 185% consensus return potential over the next six years, 18% annually, 3X more than the S&P 500

• 100% better risk-adjusted expected returns than the S&P 500 over the next five years

• 3X the income of the S&P over the next five years.

It’s always and forever a market of stocks, not a stock market. Today the market is 16% overvalued, but UGI is one of the most undervalued blue-chip bargains on Wall Street.

It’s a steadily growing 5.4% yielding aristocrat utility that could triple in six years.

The last time it was this undervalued, it soared 1400% in the next 15 years.

How would you like to buy a wonderful company at a wonderful price, locking in a wonderful, very safe yield, and likely run circles around the S&P and Nasdaq in the coming years?

That’s what UGI Corporation offers today.