INVESTMENT THESIS
Brandywine Realty Trust (NYSE: BDN). The company posted third-quarter FFO that met consensus expectations, but missed Street expectations on revenue. Brandywine’s core portfolio added 102,000 square feet of leased properties, including tenant expansions, in 3Q20. At the same time, it saw 58,000 square feet of COVID-related terminations.
In October 2020, we downgraded BDN to HOLD from BUY due to unfavorable timing on the company’s upcoming lease expirations. Brandywine faces expirations that amount to 11% and 13% of 2021 and 2022 projected annualized revenue, respectively, well above the peer averages for these years of 8% and 7%. Renegotiating leases during a period of coronavirus-related uncertainty will likely result in less favorable renewal terms, or, in some instances, renewal opt-outs.
We think the company has done a good job of selling assets in recent years, taking a quality-over-quantity approach to its portfolio. Since 2015, the firm has lowered total net rentable square feet to 24.1 million from 29.1 million. We view the reductions favorably, and would consider reinstating our BUY rating once the company is able work through lease renegotiations to the point that expirations are more closely aligned with those of peers.
RECENT DEVELOPMENTS
BDN’s beta is 1.16.
On October 21, Brandywine posted third-quarter FFO of $60 million, down from $64 million in 2Q19. FFO per share fell more modestly, to $0.35 from $0.36 in 3Q19, reflecting the impact of a lower share count. Revenue fell 5.1% to $137 million.
During the quarter, Brandywine realized a $272 million gain on its Commerce Square joint venture. As a result, GAAP net income rose to $1.60 per share from $0.04 a year earlier.
Along with third-quarter earnings, management narrowed its 2020 FFO guidance to $1.40-$1.42 per share from $1.38-$1.44. Management’s guidance calls for year-end core occupancy of 92%-93% and a tenant retention rate of 52%, both unchanged from July guidance. Management also expects same-store cash NOI to be flat to down 2%, and accrual NOI to be up 2% to flat.
EARNINGS & GROWTH ANALYSIS
Below are some observations, highlights, and forecasts following the company’s 3Q20 results.
-Philadelphia CBD: Total revenue came to $53 million, down 20% from 3Q19. Net operating expense declined to $18.5 million from $24.8 million a year earlier. Net operating income declined to $34 million in 3Q20 from $41 million a year earlier. During the quarter, Brandywine closed its $600 million joint venture for One and Two Commerce Square, selling a 30% preferred equity interest to a global institutional investor for $115 million. The transaction is subject to a $222 million mortgage, and Brandywine realized approximately $100 million in net cash proceeds. The company recorded a total gain on the transactions of $272 million.
-Pennsylvania Suburbs: Total revenue came to $35 million, flat with 3Q19. Net operating expense declined to $11.1 million from $11.7 million a year earlier. Net operating income rose to $25.5 million from $25.2 million a year earlier.
-Austin, Texas: Total revenue came to $25 million, down from $26 million in 3Q19. Net operating expense increased to $9.9 million from $9.4 million a year earlier. Net operating income decreased 9% to $15.5 million.
-Washington, D.C.: Total revenue. Net operating expense decreased to $5.2 million from $6.0 million a year earlier. Net operating income fell 39% to $4.4 million.
The two remaining segments, Other & Corporate, did not account for a meaningful portion of revenue. We are raising our 2020 FFO per share estimate to $1.41 from $1.40 as Brandywine’s markets continue to stabilize. The company Analyst’s Notes…Continued has not issued any guidance for 2021.
FINANCIAL STRENGTH & DIVIDEND
S&P has a BBB- rating on the company’s debt with a stable outlook. Moody’s has withdrawn its credit rating; it previously had a Ba1 rating.
BDN has a $150 million share repurchase plan and bought back 6 million shares during the first quarter for $60 million.
The company did not issue any shares under its equity offering program during the second or third quarters and management does not plan to issue shares in 2020. The plan has 13 million shares remaining for sale on a total authorization of 16 million.
MANAGEMENT & RISKS
The CEO and president of Brandywine is Gerard Sweeney, who has served in those roles since the company’s founding in 1994.
Risks for Brandywine are related to growth strategies; bidding on future office or industrial centers; acquisitions or dispositions of properties at unfavorable prices; the re-leasing of existing office facilities; the funding of future projects by lenders; changes in interest rates; the effectiveness of management; economies of scale; high leverage; and competition from other developers.
The possibility of changing consumer demand in the wake of the pandemic could be a material headwind for Brandywine’s office space. Consumers are becoming more comfortable working from home and may be more inclined to do so on a permanent basis, especially in large metro areas like Philadelphia and Washington with longer-than-average commute times.
Brand ywine’s business depends on the performance and financial health of its key tenants. The company’s tenants are diversified in business services (21% of square footage), legal services (14%), finance (14%), and engineering and management services (11%). The largest single tenant is IBM, which accounts for 5% of annualized rent. Rent relief requests stemming from COVID-19 are primarily from co-working and retail tenants who together account for 4% of billings.
COMPANY DESCRIPTION
The company participates in the following markets: Philadelphia; Washington, D.C.; New Jersey/Delaware; and Austin, Texas. Following a period of extensive asset sales, Brandywine owns, leases, and manages an urban, town center, and suburban office portfolio of 172 properties and 24 million square feet.
VALUATION
The shares are trading at 8.2-times our 2020 FFO estimate and 8.0-times our 2021 estimate, both below the peer average of 10.5.
On December 23, HOLD-rated BDN closed at $11.74, down $0.03. Report created Dec 24, 2020.
Source: Argus
