The Risks In Iron Mountain Are Worth It
- The company is an attractive investment that can beat the S&P 500.
- The company is going through transformation and leverage is high.
- A successful transformation and the fading pandemic will drive results higher.
I am always looking for new opportunities in my dividend growth portfolio. As an investor, I try to follow my sector allocation, and at the moment I lack some exposure to REITs, so it makes sense for me to analyze several REITs which can offer additional dividend income, but should also be able to achieve long-term dividend growth.
I have exposure to four REITs in my portfolio. Realty Income (O), W. P. Carey (WPC), Digital Realty Trust (DLR), and Omega Healthcare Investors (OHI). The REIT that I will analyze in this article is Iron Mountain (NYSE:IRM), which is very different from the REITs that I already own, and this is a plus for me, as it increases my diversification even further.
I will analyze the company using the graph below which represents my methodology for investing in dividend growth companies. I use the same methodology so I can easily compare between investments, and pick the best fit for my goals. I will analyze the company fundamentals, valuation, growth opportunities, and risks, and try to determine whether Iron Mountain is a good company and a good investment.
(Graph made by author)
According to Seeking Alpha company overview, Iron Mountain is the global leader for storage and information management services. Trusted by more than 225,000 organizations around the world, and with a real estate network of more than 90 million square feet across approximately 1,450 facilities in approximately 50 countries, Iron Mountain stores and protects billions of valued assets.
The company has managed to grow its top line significantly in the last five years as sales grew by over 30% despite the pandemic year. The decline during the time of the pandemic was since as many office spaces were closed there was less demand for the company's services such as record storage and document shredding. The company expects a low to mid-single digits growth rate in 2021, and the analysts covering the company expect it to grow at a similar pace in the medium term.
AFFO is the best measure to judge the REIT's bottom line. The graph below shows the FFO, and the adjustment includes accounting for maintenance costs. The company managed to grow its FFO by 63% and its AFFO by 22% in the last five years. Next year the company's forecast is for 10% AFFO growth which will increase the breathing room for the dividend and will allow for additional investments in the business. Analysts covering the company expect it to grow the AFFO by mid-single digits in the medium term.
The dividend has been steadily growing in the last five years. In the last five years, the CAGR was 5%. The dividend yield is impressive at 6.6%, but investors should take into account a halt in dividend increases in the short term. While the company's dividend seems safe as the company pays 80% of its 2020 AFFO, the company is willing to unlock value by lowering the payout ratio and the debt level, and therefore, the dividend will either be frozen or grow extremely slow in the short term.
Shares outstanding have grown significantly but it is not the full picture. REITs usually grow the number of shares outstanding to grow. The increase you see below was due to acquisitions of peers and other companies in M&A deals paid with cash and stocks. The company is actually very cautious about diluting shareholders to raise cash and in the last three years, the number of shares outstanding has increased by less than 1%.
When I look at the company's P/E ratio I see that it is lower compared to where it was in the last five years. However, this metric is not an accurate way to look at the valuation of a REIT. The better metric is the price to AFFO, and the current P/AFFO when taking into account the 2021 estimates is 11, which is low compared to other REITs, and the low valuation is due to the company's higher risk profile.
The graph below from Fastgraphs shows that the company is trading for the same valuation it traded for since it became a REIT. I believe that this valuation is attractive since the projected AFFO growth rate is higher than the average growth rate. Besides, I believe that the growth opportunities presented below will promote multiples expansion.
To conclude, in my opinion, Iron Mountain has fairly strong fundamentals with growth in sales, AFFO, and a safe and impressive dividend. While the company does have risks, I believe that the current valuation is attractive when I take into account the company's fundamentals and past growth, and if there are future growth opportunities, Iron Mountain will be an attractive investment.
The company is implementing Project Summit, and it has even accelerated it. Iron Mountain has taken advantage of the pandemic challenges to accelerate cost-cutting and restructuring. The initial plan was to increase EBITDA by $200 million, and now the goal is $375 million, which accounts for over 20% of the 2020 EBITDA. This alone will free much-needed cash for additional investments as the company is adapting the business model to the 21st century.
(Source: Investor Presentation Q1 2021)
The company is working on improving its capital structure as well. I believe that this will also drive medium-term returns forward as it will unlock value due to the lower risk profile. The payout ratio will be lower and the debt level will be lower as well. Therefore, investors in the coming years will give Iron Mountain a better valuation resulting in higher total returns.
(Source: Investor Presentation Q1 2021)
Digital transformation is the third growth opportunity. The company understands that while records storage accounts for the majority of its revenues, the growth is not there as the world is transforming and becoming more digital. Therefore, the company has expanded and continues to expand its faster-growing businesses such as data centers and Secure IT AssetDisposition (SITAD). The transformation will take time, but as Iron Mountain shifts to faster-growing businesses the AFFO will grow faster, and the company will be able to take advantage of its massive client base to achieve faster penetration.
(Source: Investor Presentation Q1 2021)
Leverage is the first risk. The company credit rating is BB-, and without an investment-grade credit rating, the company will pay higher interest rates, and as treasury yields are increasing, so is the interest expense. The company also has a high debt to EBITDA ratio, and it is still far away from the company's goal of debt to EBITDA of 4.5-5.5. The debt may limit flexibility, and if it raises consistently above 6.5, the company will be violating its debt covenants and cause a dividend cut.
Muted dividend growth is another risk especially when inflation estimates are on the rise. The company has a decent capital structure plan, which I believe is a good plan in the long term. However, dividend growth investors, as well as income investors, will see their purchasing power being eroded. If you need the cash right now, it is a notable risk, but long-term investors will see this risk as less relevant for their investment thesis.
Another risk is execution. While the company proved to execute well, it is still challenging in the short and medium-term. The company has limited access to debt markets due to the debt level, and it also pays the vast majority of its AFFO to shareholders. Therefore, it's harder to fund the investments needed, and it slows down the transformation. Project Summit that was described above was meant to free some more cash for investments.
If you are looking for your safest REIT in the digital world, I honestly believe that Iron Mountain is not the right choice for you. You'd be better with Digital Realty Trust and CyrusOne (CONE), which are both leading in this sector. Iron Mountain is a transforming REIT. However, I see signs of very efficient execution and a good business plan together with an improvement to the capital structure.
The company offers decent fundamentals, attractive valuation and in my opinion, its growth opportunities outweigh its risks in the medium term. Therefore, I believe that Iron Mountain can beat the S&P 500, and offer over 10% total return with half coming from the dividend, and the second half from AFFO growth. Multiples expansion will be the cherry on top.
This article was written by
Analyst’s Disclosure: I am/we are long DLR, O, WPC, OHI. 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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