In the last couple of weeks, we have seen two REIT stocks at their 52 week low. The first company leading the market cap for private prison was GEO Group Inc, a real estate investment trust that invests in private prisons and mental health rehabiliation centers across North America, Australia, South Africa, and the United Kingdom. Following close after, is CoreCivic, a company that runs private prisons and correctional facilities across primarily in the United States. Prior to the 2nd qurter of 2021, CoreCivi was the second largest private corrections facility in the US.
The Story of GEO Group
GEO Group is one of the two REIT's heavily invested in private prisons. Both GEO and CXW suffers from decreasing contract renewal from the states, and limited access to borrowing. GEO Group had annouced on April 7th that they will suspend their dividends to pay off thier existing debt. For 2021, GEO plans to repay a minium of $125-$150M in net debt over the course of the year, while the decision is resonably made, it was done late compared to CoreCivic it their cutting of dividends in early August 2020.
Data by ThinkorSwim
GEO Group has four business segments: GEO Secure Services (formerly named U.S. Corrections & Detention), GEO Care, International Services, and Facility Construction and Design. GEO Secure Services focuses on running and leasing detention centers. The GEO Care segment brings in revenue from is community-based service business, youth services, eletronic monitoring and other supervision services. The Internatioanl Services manages rehabiliation facilities across Australia, South Africa and the United Kingdom. Finally, the Facility Construction & Design gets revenue from management contracts from both local and federal agencies for its design and constructions of facilities.
Criticisms of the Industry
Even prior to the election to Joe Biden, we can observe that United States have slowly diverged from privatised prisions into alternative punishments into ... In fact, both GEO Group and CoreCivic have long faced controversy on spending millions on lobbying legislators, and thier use of prison labor. These companies has been critized by Scott Stringer, the 44th New York City Comptroller, as part of a "financially risky and morally bankrupt" industry. As such, I will value these comapnies accordingly to public sentiment.
Photo by Randall Enos via Cagle
Historical View of their Performance
From the end period of Q1 2021 to Q2 2021, the market cap of GEO Group Inc had gone from 1.04 billion to 693 million. For CoreCivic, it went from 801 million to 920 million (...and change). These represent 12.11 percent decrease and 14.78 percent increase respectively. My job now, as a value investor, is to determine wether the paris will continue on their trend on diverging prices, with CoreCivic leading the private prison industry, or can GEO Group Inc prove to be a tangible investment.
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Before using our historical data of cash flows to compute the value of the two companies. There are first several macro questions we must consider.
1. Overall decline of the industry
2. Riskiness of Cash Flows
3. Obligation to Debtors
My Deep Dive into Financials
Prima facie, the value of GEO group seems to weigh more than CoreCivic, I have based this claim based on the overview of several metrics.
GEO vs CoreCivic
1. P/E Ratio 5.95 vs 18.56 for relative valuation lower P/E is indicates better value
2. P/BV ratio 0.74 vs 0.72 lower P/BV is better in terms of accounting value
3. P/FCF 2.018 vs 3.716 lower P/FCF indicates one is undervalued
However, we can devle even deeper into the financial health. Specifically, lets take a look at their debt, which Dane Bowler has claimed will be the undoing of GEO Group. While is is true that GEO Group faces higher debt obligations of 2.73 billion, compared to 1.79 billion of CoreCivic and their Debt-to-Equity Ratio 3.189 compared to 1.285. The return on equity of GEO Group Inc is, for the most current quarter, is 11.91%, comapred to CoreCivic's 3.91%. The delta for thier ROE have been moving relatively constaly, and there is nothing to indicate, as far as operating efficecny, that CoreCivic would grow to have a higher Return on Equity compared to GEO Group. Both companies have annouced that the State does not plan to renew their contracts for their correctional facilities. source, source. Given the inevitable decline of the industry, their earnings will rely soley on the continuing operations of their facilities.
GEO vs CoreCivic
1. Debt-to-Equity Ratio 3.189 vs 1.258 lower better
2. Return on Equity 11.91% vs 3.91% higher better
I think, given the current measures GEO Group's managment have taken to address its debt issues, shows good promise that they will transition into taken on less debt in the future to finance their growth.
Valuation
I used a DCF model to value GEO. Key inputs to estimate NPV(Net Present Value) are operating margin, return on invested capital, discount rate, cost of capital. NPV is calculated =NPV(discount rate, series of cash flow).
My value per share is about 8.74, close to 52% higher than the current share price. My key assumptions as follows.
Revenue Growth
In my model, I used a prediction of 1 percent revenue growth in perpetuity.
Net Operating Margin
I won't bother breaking down the NOI margin sector-by-sector, rather I opted to go for an overall estatimate. Given in the last eight quarters, their 10, 11, 9, 12 percent respectively. I will assume their overall operating margin will continue to hold constant at an average of 10 percent. I set the model to reflect this feature and forecast what might happen in the next four quarters.
Effective Tax Rate
To calculate FCFF, a tax rate should be estimated. The simple-average tax rate for the past 4 years was 12%. I used an estimate of 10%. I used this tax rate to compute the after-tax Net Income and the cost of debt and capital. GEO's historical sales-to-capital ratio is
Discount Rate
For the discount rate, I used their 10 year bond. 5%.
Conclusion
GEO group, relative to CoreCivic, is oversold. The dividend cut does not justify its 27.31% drop. Further, at the current price of 8.42, CoreCivic is overvalued. Buy GEO and short CXW.
Disclaimer: Not Financial Advice
In life and in death, glory to Wall Street Bets.
Shout out to my bois on WSB. Possible squeeze window.
Terms and Definitions (For those 'Not in the Know') :
Price-to-Free Cash Flow lower better; a higher P/FCF ratio might indicate that a firm is trading at a high price but is not generating enough cash flows to support the multiple
Debt-to-Equity Ratio lower better; a higher ratio suggest higher risk that the company is financing its growht with debt; and signals that the comapny is in financial distress and unable to pay debtors
Return on Equity higher better; a higher ROE suggest that the company is increasing a profit generation without needing much capital
