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The GEO group (GEO) has received investors' favor this year, and it has outpaced the S&P 500 by rallying 34%. It trades at 52-week high levels of $37-38. It is trading with a P/E of 15.24, and a Forward P/E of 20.80. Although the company may be targeted by dividend-oriented investors due to a hefty 5% dividend offer, the company may have rough times in the interim to maintain its dividend payment for reasons herein described.

Description of business

GEO Group Inc. is a company dedicated to providing correction and detention facilities to federal, state, and local government agencies of the United States, United Kingdom, Australia and South Africa. The detention facilities range from low to maximum security facilities so the whole spectrum is covered. GEO Group operations include the management and/or ownership of 96 detention facilities housing approximately 72,000 beds with a presence in four countries. It is also an employer that hires military veterans.

Signs of warning

According to the company's most recent annual earnings report, the company increased its 2012 revenue by 5% from $1.47 billion in 2011 to $1.40 billion in 2012. However, on a forward-looking statement, I believe the sequester will have a negative impact on the company's revenue and a reduction in revenue may be appreciated.

The company elected a REIT status in January 2013, and it is offering a $0.50 quarterly dividend payment which accounts for a dividend yield of 5.36%. However, its dividend payout ratio is 301% which clearly places the dividend's safety in jeopardy in the near future. When a company cuts its dividend offer, its stock is severely punished by investors. A company that recently cut its dividend offer is Atlantic Power (AT). The company could not sustain its juicy 13% dividend offer, and its price-per-share dropped more than 50% at the beginning of 2013.

The second reason is the negative effects that the sequester will have in the company. Due to the nature of the company's business, I strongly believe that its revenues will be significantly impacted by the government spending cuts. In 2012, the company reported that 14% of its revenue came from a contract with the U.S. Immigration and Customs Enforcement agency (ICE). However, recently, many immigrants incarcerated in federal prisons waiting for deportation were released due to sequester effects, the story can be read here. Since the government is reducing the budget allocated for prisons, companies such as the GEO group will see their revenues decline beginning in the second quarter of 2013.

The take-home message

The GEO group has rallied 34% YTD and 88% on a 12-month basis. Although the company may appear attractive to the dividend-seeking investor, I believe the stock's rally may be about to end. The company has a dividend offer of above 5% which represents a 301% payout ratio. Further, the company's large exposure to the U.S. government may endanger future revenues which will put more pressure on its dividend offer. For these reasons, an exit strategy should be considered after a long run.

Disclosure: I do not hold any position in the mentioned stocks, and I have no plans to initiate a long or short position within one week.

Source: GEO Group: A Pressing Issue Regarding Its Dividend Safety Deserves Your Attention