- GEO finally eliminated its dividend - sending the stock down 20%.
- Even after the crash, the stock still is not cheap when you dig deep into the numbers.
- I estimate that 49% of revenues are attributable to entities that are likely to significantly pare back their exposure with GEO.
- I reiterate my sell rating.
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On April 7th, Geo Group (NYSE:GEO) announced that it was cutting its dividend. The stock subsequently fell 20%, perhaps due to yield investors fleeing a yield-less equity. In spite of the stock price correction, the future remains murky for this private prison real estate operator. While investors might have expected U.S. Immigration & Customs Enforcement revenues to decline during the Biden administration, they might not have expected the non-renewal of U.S. Marshals Service contracts. This has all the looks of a sinking ship, exacerbated by a large debt load. I reiterate my sell rating.
Geo Group Stock History
GEO has been a difficult stock to own over the last several years. After peaking in 2017 above $30 per share, GEO has been in a constant downward trend.
After the 20% decline on April 7th, the stock is now trading even lower than it did during the pandemic crash.
Why Did Geo Group Cut The Dividend?
GEO stock crashed because it announced that it would "immediately suspended GEO's quarterly dividend payments with the goal of maximizing the use of cash flows to repay debt, deleverage, and internally fund growth."
It also stated that while it currently intends to maintain its REIT structure, it would reevaluate that decision in the fourth quarter of this year.
Just two months earlier, I predicted that GEO would have to cut its dividend. At the time, many investors seemed to prefer GEO to CoreCivic (CXW) because whereas the latter completely eliminated its dividend (and converted to a c-corp to do it), GEO instead avoided making the cut. This appears to be yet another warning against reaching for yield.
There might have been a significant catalyst that accelerated GEO's decision to eliminate its dividend. In mid-March, the company announced that the United States Marshals Service ('USMS') would not be renewing its contract for the Queens detention facility in New York. While that is just one facility, it is the implication that matters.
Investors likely anticipated that the U.S. Immigration & Customs Enforcement ('ICE') would likely reduce its business with GEO during the Biden administration. Revenues from ICE increased 74% from approximately $317 million in 2015 to $550 million in 2019. I don't think many shareholders would have been surprised to see that figure fall down significantly. The stock prices of GEO and CXW seemed to reflect that (perhaps the latter more so than the former), but the problem is that other tenants were not as reliable as first assumed. As we can see below, the USMS accounts for 11.5% of GEO's revenues and that is not including another 1.3% in managed-only revenue.
Furthermore, GEO announced on its conference call that the Bureau of Prisons ('BOP') would not be renewing 3 of its contracts in the first quarter. As seen above, BOP makes up 13.7% of revenue (plus 0.3% in managed-only revenue).
Between ICE, BOP, and USMS, we are looking at roughly 48.9% of overall revenue that is under question. That should terrify shareholders because GEO has a highly leveraged debt position. As of the most recent quarter, debt to EBITDA stood at 5.9 times and based on GEO's previous guidance, would stand at 6.5 times at year end.
It is reasonable to assume that leverage may end up even higher than that as more contracts do not renew. It is arguable that the fact that GEO is eliminating its dividend now as opposed to doing it during its recent earnings release suggests that it will significantly miss guidance this year.
GEO has $1.7 billion in long-term debt maturing in 2024. CXW is targeting debt to EBITDA of 2.75 times (excluding non-recourse debt). It is unclear if GEO is also targeting a similar leverage ratio, but I emphasize that GEO faces an even greater uphill battle than CXW, as GEO's higher leverage ratio of 6.5 times debt to EBITDA may even be understated in light of future non-renewals of federal government contracts.
Is Geo Stock A Buy?
Every stock is a buy at the right price, right? That is not always the case - perhaps every company might be a buy at the right price, but that price might not leave value for shareholders. In the case of GEO, there appears to be too much debt, meaning shareholders do not have a claim to underlying earnings in the near term. That means that investors should ignore the fact that the stock trades for less than 3 times trailing AFFO, as none of those cash flows truly belong to shareholders and must be used to pay down debt.
To reduce its leverage to 2.75 times, then GEO would have to pay down $1.2 billion of debt. It has $242 million in AFFO available, meaning GEO theoretically might need to put all of free cash flow towards paying down debt for the next 5 years. If more unexpected non-renewals occur, then GEO's leverage would increase (meaning that it would need to pay down even more debt) and it would have even less cash flow available to pay down debt. This is a negative feedback loop that is difficult to break out of. Perhaps shareholders might be hoping that President Biden is not re-elected in 2024, at which point private prison usage might increase, but the problem is that its 2024 debt would mature before then. GEO trades for an implied 11% cap rate, which might not be high enough if there are more non-renewals over the next several years.
If even 40% of the aforementioned 49% in vulnerable revenues are not renewed, then I estimate that AFFO would decline by $120 million, or by half. What if GEO is unsuccessful in bringing leverage down before the 2024 debt matures? That debt currently trades for a yield to maturity in excess of over 12%, suggesting that GEO may need to refinance that debt at a 12% yield or higher. If that were to occur, then interest expense would increase by over $119 million - which is also about 50% of AFFO. The low AFFO multiple does not provide a sufficient margin of safety if GEO is unable to stabilize cash flows and bring down leverage. Considering that 49% of revenues is attributable to tenants who have already decided to not renew certain leases, that is a tall task.
Even after the crash, it is difficult to recommend buying shares of GEO. There appears to be a greater likelihood of downside surprise than upside surprise. If GEO did not have the large debt load that it does, then the secular headwinds facing the private prison industry might not be a deal-breaker, as the company might be able to pay out its earnings as dividends to shareholders. However, because GEO has both a large debt load and a high potential for rapidly decreasing cash flows, it seems likely that GEO may find itself in a vicious cycle of having to spend every last dollar to pay down debt - and that not being enough. I remain bearish on GEO and rate shares a sell.
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This article was written by
Julian Lin is a financial analyst. He finds undervalued companies with secular growth that appreciate over time. His approach is to look for companies with strong balance sheets and management teams in sectors with long growth runways.Julian is the leader of the investing group Best Of Breed Growth Stocks where he only shares positions in stocks which have a large probability of delivering large alpha relative to the S&P 500. He also combines growth-oriented principles with strict valuation hurdles to add an additional layer to the conventional margin of safety. Features include: exclusive access to Julian's highest conviction picks, full stock research reports, real-time trade alerts, macro market analysis, individual industry reports, a filtered watchlist, and community chat with access to Julian 24/7. Learn more.
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