- Two weeks ago, Iron Mountain announced Q4-17 and full-year results. The market sentiment was negative and shares fell 10%.
- As the company continues to shift its business mix to data centers, it will generate higher margins and the valuation gap should continue to narrow.
- I am upgrading Iron Mountain from Buy to Strong Buy, as I believe shares could return over 25% annually in 2018 and 2019.
I began covering Iron Mountain (NYSE:IRM) in 2012, when the company announced it was considering a REIT conversion. The CEO at the time said “a key element of our strategic plan is a disciplined capital allocation strategy to increase stockholder payouts and the REIT structure supports this plan.”
In December 2014, Iron Mountain announced that its registration statement was declared effective, and on January 20, 2015, the company held a special meeting for the purposes of voting on the REIT merger (between the company and Iron Mountain REIT). As I explained then:
“That's just a ‘rubber stamp’ though since Iron Mountain is already a REIT in many ways. The biggest hurdle for the Boston-based company was receiving a Private Letter Ruling (or PLR) from the IRS and specifically a ruling regarding the characterization of the company's steel racking structures as real estate. Earlier this summer Iron Mountain achieved IRS approval for REIT status retroactively as of January 1st, completing the process that began in 2012.”
By converting to a REIT, Iron Mountain was forced to pay out at least 90% of taxable income to investors, resulting in a substantially higher dividend than it previously paid. Also, in addition to the clarity with regard to the definition of steel racking as real estate, Iron Mountain is considered somewhat of a hybrid as it relates to its REIT peer classification.
Although Data Center REITs have racking systems (like Iron Mountain), the business model is entirely different from traditional data storage or self-storage because of the service component that is associated with Iron Mountain's integrated data management business.
Conversely, Iron Mountain rents out space in larger buildings that are comparable to Industrial REITs. So in terms of peer orientation, it does not trade at full real estate values, and that valuation gap is the topic of this article.
Two weeks ago, Iron Mountain announced Q4-17 and full-year results. The market sentiment was negative, and shares fell 10% since February 15th.
Like most REITs, Iron Mountain shares have also pulled back aggressively year to date. As you can see below, the Vanguard Real Estate ETF (VNQ) is down-11.5%, compared to -16.11% for Iron Mountain.
Of course, for a value investor, it’s really easy to spot a “spring sale.” As Thomas Bohjalian, CFA, executive vice president at Cohen & Steers, explains:
“One of the things we find that some investors and the financial press consistently get wrong about REITs is the relationship with interest rates - that if rates are rising, you shouldn’t own REITs. This belief, however disconnected from historical evidence, often seems too ingrained to suggest otherwise.
Interest rates are part of the equation, and sudden moves in bond yields can create volatility. But REITs are not bonds. In an improving economy, landlords can raise rents as tenants fight for more space, potentially increasing cash flows to offset the effects of higher rates. In other words, it should matter why rates are rising, not simply that rates are rising.”
Iron Mountain is now trading at a wider margin of safety, and I see credible indications of value that this REIT should deliver strong shareholder returns in 2018 and 2019. In a few days, I will be releasing my annual March Madness in REIT-dom research (for Marketplace subscribers), and are there some real bargains. I’m sharing one of these with you today.
Iron Mountain Deserves Shelf Space
Over 67 years ago, Herman Knaust purchased an underground storage facility to store mushrooms. The business was not profitable, so he decided to use the old mine to store personal records.
As his storage needs grew, Knaust decided to change the name of the business to Iron Mountain Atomic Storage, Inc. He opened a sales office to market the space inside the Empire State Building, and he even persuaded General Douglas MacArthur to visit the Iron Mountain storage site.
As companies saw the growing demand for storage, Knaust's business model evolved.
IRM continued to grow in the New York City market, expanding beyond the original facility into a depleted limestone mine closer to the city. It became the premier vital records protection company, including storage for high-volume paper records.
In 1978, the company opened its first above-ground records storage facility in New York, and later expanded beyond the New York City market in 1980, when it opened a site in New England to service the emerging need to protect computer backup data.
In 1983, it expanded further in New England with the purchase of New England Storage Warehouse in Boston. This was Iron Mountain's first acquisition, and it gave the company a strong entry into the medical and legal records management markets.
By the mid-1980s, Iron Mountain had accumulated all the product lines that comprise the foundation of the current company. It offered paper records storage and management services (including major operations in the medical and legal vertical markets), offsite data protection services and vital records protection services in the New York and New England markets.
Expansion continued to increase, and by 1995, the company had grown to exceed $100 million in annual revenue. Senior management felt the time was right for the records management industry to consolidate.
So, in February 1996, Iron Mountain became a public company, raising capital in part to initiate this consolidation. Then, as I stated above, it achieved IRS approval for REIT status retroactively as of January 1, completing the process that began in 2012.
Today, Iron Mountain is an industry leader in storage and information management services, serving 230,000 customers in 45 countries on six continents (with over 24,000 employees worldwide).
According to the company's website, it serves organizations in every major industry and of all sizes, including more than 95% of the Fortune 1000, which rely on Iron Mountain as their information management partner.
The company's business model is to provide integrated solutions to unify the management of both physical and electronic documents. As you see (below), storage rental remains IRM's core business (62% of revenue and 82% of profits), and service represents 38% of revenue (18% of profits).
Records & Information Management remains IRM's core business (75% of revenue), and the company also has Data Management (15% of rev.) and Shredding (10% of rev.) services. Iron Mountain has a well-balanced platform that consists of by more than 225,000 organizations around the world, with over 85 million square feet of real estate and over 1,400 facilities in over 50 countries.
This REIT Has Exceptional Shelf Life
One thing that distinguishes Iron Mountain's business from that of other REITs is the relative insensitivity to higher interest rates. IRM customers' storage needs are largely unaffected by interest rate movements, and the company's core storage NOI doesn't change with the value of the underlying real estate.
The REIT has an operating business, and that means it effectively controls real estate through long-term leases, with multiple lease extension options and direct ownership in strategic locations of about one-third of its properties. IRM controls 86 million square feet (27 million owned and 59 million leased), and the average building size is ~60K square feet.
In a rising rate environment, this structure reduces Iron Mountain's exposure to real estate value fluctuations compared with REITs that own their entire portfolios. Additionally, it should be noted that the company enjoys higher levels of real price increases during periods of greater inflation.
Since it owns less real estate (owns 27 million sq. ft. and leases 59 million sq. ft.), the operations drives the value for the company. Because IRM has hundreds of customers, it can pass through increases, and this means the REIT is less impacted by rising rates.
Also, it has only 2% customer turnover in a given year, and this means 50% of the boxes that were stored 15 years ago still remain. Now you know what I mean when I say, "This REIT has exceptional shelf life."
On the latest earnings call, Bill Meaney, Iron Mountain’s president and CEO, explained:
“I’d like to briefly note that whilst we’re disappointed with the market selloff of REITs in anticipation of increasing interest rates, it is important to recognize that those rate hikes are generally associated with inflationary pressure. Unlike many REITs, we have the ability to pass through inflation-based rental rate increases on an annual basis, and we see meaningful flow-through on those increases given the high-margin characteristics of our storage business.
In a nutshell, given our 75% storage gross margin, coupled with the ability to increase pricing in line with inflation, higher inflationary environments generally expand our margins and accelerate our cash generation well ahead of inflation. In a word, inflation helps us further helps us further outperform as a business, which is pretty unique in the world of income-oriented stocks.”
Iron Mountain’s Balance Sheet
The REIT is rated BB- by S&P and Ba3 by Moody’s:
The company prices in line with the bottom end of investment grade, and that validates the durability of the business model. I would like to see Iron Mountain become investment grade in the future; however, on January 10th, the company closed on the acquisition of the $13 billion IO Data Centers transaction that moved its leverage ratio to the mid-5x EBITDAR.
Iron Mountain has over 80% of debt at fixed rates, with a weighted average interest rate at 5% (year-end). In addition, the company is continuing to extend its average maturity to 6.8 years with a well-laddered maturity schedule.
As noted, Iron Mountain expects its leverage ratio to be closer to the mid-5x EBITDAR for Q1-17 and remain there for most of the year, and then decline as the company begins recognizing growing cash flows from data centers, acquisition synergies and lease-up. The company remains on track with its plan to reduce the lease-adjusted leverage to about 5x by 2020.
For 2018, Iron Mountain expects to spend $150 million on core M&A transactions, as well as $100 million to acquire two Credit Suisse data centers. The bulk of the core activity is expected to be in higher-growth emerging markets, consistent with the company’s 2020 plan.
In addition, Iron Mountain expects to invest $185 million on data center development in Northern Virginia and expansion in Phoenix, which will come on-line and generate storage revenue beyond 2018 with stabilized double-digit NOI yields.
The company expects to fund these growth investments through a combination of cash from operations, debt, capital recycling from the sale of real estate as well as potential ATM issuances to fund the Credit Suisse data center acquisition.
It Boils Down To Predictable Profits
Iron Mountain is a real estate company generating more than 80% of gross profit from storage rental-related activity, and one unique feature is that it has the ability to pass through inflation in the form of upward-only, CPI-type escalators in its contracts. Typically, these are annual escalation provisions.
Also, rising interest rates don't have an impact on customer storage demand, and the net operating income doesn't change if the market value of the underlying real estate fluctuates.
Iron Mountain’s Q4-17 total revenues grew 6.1% over last year, or 4.1% on a constant-dollar basis. Internal storage rental revenue increased a strong 4.2% in the quarter, while internal service revenue declined 0.1% as the company cycled against a large entertainment services project a year ago.
The REIT’s gross profit margin improved by 130 bps year over year, primarily driven by synergies from the Recall acquisition reducing labor expenses and the flow-through of the revenue management program. Compared to a year ago, its adjusted EBITDA in Q4-17 increased over 10% to almost $327 million, leveraging growth of approximately 8% on a constant-dollar basis.
The company’s EBITDA margin increased 120 bps to 32.9% and Adjusted EPS for the quarter was $0.29 per share, inclusive of a $0.02 per share increase in amortization expense, reflecting a catch-up associated with an adjustment to the life of Recall’s customer relationship value. Adjusted EPS would have been $0.31 per share excluding this catch-up.
AFFO was $154 million in the fourth quarter, in line with the expectations, but down year over year due to timing of capital expenditures and cash expenses. Maintenance and non-real estate investments increased $28 million compared to a year ago, as the costs were more back-end weighted this year.
For the year, Iron Mountain’s results were generally in line with guidance discussed on the last quarter’s call. Revenue came in at $3.8 billion and just above the range as a result of strong internal storage revenue growth, driven by management efforts as well as currency translation benefits.
Adjusted EBITDA of $1.26 billion was in the middle of the range compared to the full-year 2016, the adjusted EBITDA margin improved 180 bps to 32.8%, with higher gross margins and lower SG&A as a percentage of revenues. AFFO came in at the higher end of the range due to efficiencies in capital maintenance projects following the acquisition of Recall.
The only negative result that I could determine related to recent earnings was Iron Mountain’s North American growth. In North America Data Management, adjusted EBITDA margins were down slightly year over year as the company continues to invest in more new product development than a year ago.
However, Iron Mountain is well on track to have a business mix that will structurally deliver north of 5% EBITDA growth before acquisitions, up from about 3.5% as of the end of 2017. The company achieved internal storage rental revenue growth of more than 4% in Q4-17, while internal service revenue growth was essentially flat, as expected, at minus 0.1%.
The company’s AFFO for the full year was up more than 12%, and as illustrated below, it is forecasting 11.2% annual AFFO growth through 2020.
At the midpoint and on a constant-currency basis, Iron Mountain expects total revenues to grow by 8%, adjusted EBITDA by 14% and AFFO to grow by 9% in 2018 compared with 2017.
2018 total revenue growth will be driven by internal storage revenue growth, which is expected to be between 3% and 3.5%, reflecting ongoing revenue management efforts in developed markets and volume growth in emerging markets.
For the full year, the company expects to see positive internal volume growth in Western Europe, while it anticipates lower income and volume from existing customers in North America, leading to a slight volume decline overall in developed markets.
Follow the Money
Iron Mountain’s cash available for distribution (or CAD) continues to fund the dividend as well as maintenance and core growth investments. As you can see below, on a compounded annual growth rate basis, the REIT anticipates revenue to grow by almost 7% from 2017 to 2020; adjusted EBITDA to grow by 11%, and AFFO to grow over 11%, or over 7% on a per share basis.
Iron Mountain expects a dividend per share growth rate of around 4%, as it expects an AFFO payout ratio in the mid-70s. The company said it was “excited to accelerate growth as it expands in the data center space and is confident in the value it will create for shareholders over time by the platform we've built.”
Now let’s compare Iron Mountain’s dividend with that of the peers:
As you can see, the company has the highest dividend in the peer group. Now take a look at the P/FFO multiple:
Again, Iron Mountain is cheap on this metric. Let’s examine the company’s FFO/share forecast:
Using AFFO/share, Iron Mountain is forecasted to grow by 4% in 2018, and this is a better indicator for growth (than FFO/share). However, I find this consistent with the peers above. This validates the fact that Iron Mountain is somewhat of a hybrid Industrial/Data Center REIT and should trade in a similar range.
However, there is one notable difference in that Iron Mountain’s “core business” is centered on its 75% storage gross margin, coupled with the ability to increase pricing in line with inflation (higher inflationary environments generally expand margins and accelerate cash generation well ahead of inflation).
In other words, inflation helps Iron Mountain outperform as a business, which is pretty unique in the world of income-oriented stocks.
Iron Mountain has underperformed Industrial REITs, Self-Storage REITs and most Data Center REITs year to date; however, the company is actually better equipped, as it structures its contracts with annual bumps. As the company continues to shift its business mix to data centers it will generate higher margins and the valuation gap should continue to narrow.
I am upgrading Iron Mountain from Buy to Strong Buy, as I believe the shares could return over 25% annually in 2018 and 2019.
Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
Source: F.A.S.T. Graphs and IRM Investor Presentation.
Peers included: Terreno Realty Corp. (TRNO), First Industrial Realty Trust (FR), Prologis (PLD), CyrusOne (CONE), QTS Realty Trust (QTS), EastGroup Properties (EGP), Digital Realty Trust (DLR), CoreSite Realty Corp. (COR), Extra Space Storage (EXR), CubeSmart (CUBE), National Storage Affiliates Trust (NSA), Life Storage, Inc. (LSI).
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This article was written by
Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 175,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
Thomas has also been featured in Barron's, Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox.
He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2021, 2022 and 2023 (based on page views) and has over 111,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley) and is writing a new book, REITs For Dummies (Wiley/Amazon).Thomas received a Bachelor of Science degree in Business/Economics from Presbyterian College, and he is married with 5 wonderful kids. He has over 30 years of real estate investing experience and is one of the most prolific writers on Seeking Alpha. To learn more about Brad visit HERE.
Analyst’s Disclosure: I am/we are long ACC, AHP, APTS, ARI, BRX, BXMT, CCI, CHCT, CIO, CLDT, CONE, CORR, CUBE, DDR, DEA, DLR, DOC, EPR, EXR, FPI, FRT, GEO, GMRE, GPT, HASI, HTA, INN, IRET, IRM, JCAP, KIM, LADR, LAND, LMRK, LTC, MNR, NXRT, O, OFC, OHI, OUT, PEB, PEI, PK, PSB, QTS, REG, RHP, ROIC, SBRA, SKT, SPG, STAG, STOR, TCO, UBA, UMH, UNIT, VER, VTR, WPC. 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.
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