A Market Correction for the Corrections Market

Once we accept that the returns from traditional stocks and bonds are going to be subpar for a very long time, we have to start thinking differently.

Private equity replication, community banks, and REITs should continue to lie at the heart of your approach to investing for the next decade…

But in this low-to-negative interest rate world, we will need to think differently and explore the corners of the market that no one else is even thinking about right now.

As a speaker expressed it this past weekend, “It’s time to get weird.”

There is one segment of the REIT markets that’s considered controversial by pretty much everyone.

It has also been a favorite political target in the last couple of election cycles.

However, the core fundamentals across the sector demand that we at least have the discussion…

Looking at the Numbers

For-profit prisons have been under attack in a big way this year.

Now, I know some folks will have personal objections that make it difficult for them to own a prison REIT.

That’s fine.

Never do anything that will cost you sleep.

While I’m not necessarily a fan of prisons, I am a ruthless follower of the numbers, and the numbers tell me that prison REITs are very undervalued right now.

I’m not a fan of broccoli or smooth jazz, but if the numbers said that we need to own broccoli farms and radio stations that only play Chuck Mangione, I would be a buyer.

It’s been all but impossible to make big money within a six-hour, four-hour, or two-hour time frame – until today.

Political Volatility

This sector does have exposure to political pressures, and a potential administration change could create some volatility…

But the bottom-line truth here is that a president cannot outlaw private prisons.

Something like that would need to get through Congress, and that’s a crapshoot.

The system as it is now running well over capacity, so closing facilities is a non-starter.

Even if one of the most liberal candidates were to win and push this through Congress, the impact would likely be small for the bigger corrections and detention REITs.

The loss of the Federal contracts would sting, but most of their business comes from state facilities.

Although California recently passed a law that forbids the use of private prisons and makes it illegal to sign or renew a contract with a private operator after January 2020, it will take at least eight years before those facilities begin to change over.

An Industry Leader

CoreCivic Inc. (NYSE:CXW) describes its business as “providing corrections and detention management, a growing network of residential reentry centers to help address America’s recidivism crisis, and government real estate solutions.”

They own 51 correctional and detention facilities with a total capacity of approximately 73,000 beds.

Through the CoreCivic Community segment, they own and operate 26 residential reentry centers with a total capacity of about 5,000 beds.

In addition, through the CoreCivic Properties segment, they also own 27 properties leased to third parties and used by government agencies, totaling 2.3 million square feet.

Damon T. Hininger, CoreCivic CEO, talked about the state of the business on the most recent conference all telling us that “Cash flow decline from the past 5 years particularly from declining populations from California and the Federal Bureau of Prisons are behind us, as we have been able to meet the critical needs of new and existing government partners. Our total revenue and cash flows are at or near record highs thanks to the growth of CoreCivic Properties and CoreCivic Community in our steadfast commitment to helping people. Our current dividend is well covered. Our AFFO dividend payout ratio of 68% is below the REIT industry average of 78%, and our cash flows are growing. New and expanded contracts from multiple customers are coming online in the second half of 2019, setting up 2020 for continued cash flow growth. Our debt leverage, while already very conservative compared to other REITs, is declining as a result of cash flow growth, which further improves the financial strength of the company. We currently have no need to deploy new capital in 2020.”

Digging into the numbers confirms this statement, this is a high-quality company that is growing cash flows, yielding over 10%, and paying down debt trading for about half what it should right now.

If the political landscape remains flat, the shares will move towards fair value after 2020.

Even if that changes, there will be a lot of noise, but I don’t think that the actual value of the business will be impacted in any meaningful way.

To the Max,

Tim Melvin

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