Corporate Office Properties Earns An Upgrade For These 2 Reasons

As such, Jefferies upgraded shares of Corporate Office Properties from Hold to Buy and lifted its price target from $36 to $39.

At time of writing, shares of the company were up 1.14 percent to $32.90.

1. Positive Macroeconomic Backdrop

Analysts Jonathan Peterson and Omatayo Okusanya expect the annual defense spending growth to return to more than 5 percent, going forward, given that the Republicans are controlling all branches of the government and the global tensions are creating bi-partisan support.

Specifically, the analysts noted that the proposed budget for 2018 calls for a 10-percent increase in defense spending, with the growth expected to return to about 5 percent in 2019 and 2020. The analysts also think an increase in funding should lead to new demand and development opportunities for the company.

The analysts estimate 7–9-percent annual funds from operations per share growth as the new run-rate against this backdrop.

2. Attractive Valuation

Jefferies noted that the company's shares have pulled back about 9 percent in the past three months after being a top performer since Donald Trump's election as president. The firm sees this weakness as an opportunity to buy the stock, especially as the 2018 budget is up for ratification in December.

"OFC trades at 15.5x FFO, a +15% premium to its 10-yr avg, but the 10-yr avg is not an appropriate measure given the unusual weakness in defense spending growth in that time frame," the firm said.

"From '05 to '07, when defense spending growth reflected today's levels, OFC traded at an average FFO multiple of 18.2x and reached a peak of 24.0x."

The firm views its 12-month price target of $39 as conservative, as it implied a 16.2 times multiple on its 2019 FFO/share estimate.

While noting that the company has reduced debt and preferred-to-EBITDA to the mid-6 times range from more than nine times since 2011, the firm said it believes the company can return to normalized growth levels. As such, the firm believes Corporate Office Properties is one of the few REITs that should accelerate FFO growth in the next two years.