It’s been more than three months since I last wrote about Corporate Office Properties Trust (NYSE:OFC), and since then, the shares have posted a total return of -12.3% (including dividends). In this article, I evaluate whether if the stock now presents a better value or if it is something to be avoided, so let’s get started.

(Source: Company website)

A Look Into Corporate Office Properties

Corporate Office Properties Trust is a REIT that is focused on owning and acquiring properties that are leased to the U.S. government and its contractors for defense/IT purposes. It currently owns 174 properties, of which 27 are data-center facilities. Its Class A office properties cover 19.6M square feet, and last year, the company generated $643M in total revenue.

What I like about COPT is the defensive nature of its portfolio, the majority of which house mission-critical operations for the government. At the end of Q2, COPT derived 88% of its core portfolio ARR (annual recurring revenue) from Defense/IT locations that support the U.S. government and its contractors. This provides a high level of stability for COPT and provides a recession-resistant business model.

This stability helped COPT to deliver solid results in its latest quarter. As seen below, its second-quarter FFO/share of $0.51 exceeded its guidance and was flat on a sequential basis. This is favorable compared to some other REIT sectors, such as retail, which posted FFO declines due to the effects from COVID-19. Occupancy also remained stable at 92.3%, and cash NOI grew by 1.7% on a YoY basis.

(Source: Company Investor Presentation)

Since the end of Q2, rent collection has also remained strong. COPT collected 98.5% of its rents in July, which is down just slightly from the 99.1% collection rate in June. While COVID-19 has affected vacancy leasing, management does not expect it to impact full-year 2020 results. In addition, I’m encouraged to see that management expects tenant retention to hit a 20-year high this year.

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These results gave management confidence in maintaining 2020 FFO/share guidance of $2.07, representing a potential 2% YoY increase from 2019’s FFO/share of $2.03. While this growth is not spectacular, I’m encouraged by the active development projects that the company has, which could boost FFO in future years. The development projects appear to be on track, as noted by management on the latest conference call:

“We have 1.9 million square feet under development, representing 14 separate projects that are 84% pre-leased. Before year-end, we expect to place an additional 820,000 square feet into service that are 100% leased. This will bring our total for the year to approximately 1.5 million fully leased square feet and represents a total of investment of $344 million. My final comment is an update on our wholesale data center, DC-6. During the quarter, we completed a new 3.1 megawatt lease with a government contractor that will bring a long-term supercomputing contract into our facility.”

One of the risks to COPT’s business model stems from the level of government funding for the Department of Defense, as material reductions in funding could have a disproportionate effect on COPT’s tenant base. While this may be a risk in the long term, I see it as being low in the near to medium term.

As seen below, the DoD budget is expected to grow in the low-single digits through 2024. In addition, the Budget Control Act of 2011 sunsets after FY21, and there has been bipartisan agreement for the FY20 and FY21 budgets, which eliminates the sequestration (across-the-board spending reduction) threat.

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(Source: Company Investor Presentation)

Turning to the balance sheet, COPT maintains sound debt metrics. As seen below, the company’s net debt to EBITDA ratio is currently at the low end of its 6.0x to 6.4x range over the past four years. COPT also has BBB- or equivalent credit ratings from the three major ratings agencies.

(Source: Company Investor Presentation)

Most recently, on September 10th, COPT was able to take advantage of low interest rates by issuing $400M worth of debt with a 2.25% interest rate, and a maturity date in 2026. Management intends to use the proceeds to tender its $300M notes, which carry a higher interest rate (3.7%) and have a 2021 maturity date. This benefits COPT through both savings on interest expense and a strong boost to liquidity.

Lastly, I find the 4.7% dividend yield to be attractive. Based on the annualized $1.10 dividend and management’s 2020 guidance for $2.07 in FFO/share, I arrive at a relatively low payout ratio of just 53%. This is well within safe territory, especially considering that COPT has held steady FFO/share in recent years.

Investor Takeaway

Corporate Office Properties Trust is focused on owning and acquiring properties that are leased to the U.S. government and its contractors for defense/IT purposes. Its recession-resistant business model has been demonstrated by its steady FFO/share performance in the latest quarter. In addition, tenant occupancy and retention metrics remain strong.

While the dividend and FFO/share growth has been flat over the past five years, I do see merits in investing in COPT for the defensive/income portion of an investor’s portfolio. In addition, the company’s development pipeline could provide a meaningful boost to FFO growth in the coming years.

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Taking a look at valuation below, I see the shares as being undervalued at the current price of $23.52, and a blended P/FFO of 11.4, which sits below the stock’s normal P/FFO of 13. Analysts seem to agree that the shares are undervalued, with an average 3.9 rating (implying a Buy rating), and an average price target of $29.17. For this, and the reasons stated above, I have a favorable view of the shares and see upside potential from the current price.

(Source: F.A.S.T. Graphs)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.