Prison Pops Are Shrinking, But GEO Is Looking Up

For a while there, it seemed that being in the prison business was a no-brainer. The U.S. was detaining more and more people and needed the private sector to provide facilities and management. Well, facing mounting pressure to put a cap on our inmate population along with a whole slew of political issues, it seems that the great prison race has subsided, for now.

For prison contractor GEO Group (NYSE: GEO  ) , this could have spelled long-term issues, but management has diversified the business here and abroad while switching over the corporate structure to a REIT. While the company may not be adding tens of thousands of new detention beds these days, it is paying 6.4% to investors with the added promise of smart management and new contracts.

Earnings recap
For a real estate income play such as this one, the go-to metric is adjusted funds from operations, or AFFO. In the latest quarter, GEO brought its AFFO to $51.8 million ($0.72 per share) up from $39.1 million ($0.64 per share) in the year ago quarter -- a gain of more than 32%. The company found new contracts totaling 5,700 new beds expected to generate nearly $100 million in additional annual revenue.

Total revenue ticked up to $379.8 million -- around $10 million more than in 2012's third quarter.

Looking ahead, the company is expecting to generate fourth-quarter sales of $378 million-$383 million, in line with previous guidance. GEO management also held steady on AFFO guidance of $0.70-$0.73 per share. Full year 2013 AFFO is now in the range of $2.85-$2.88 per share.

In a slightly contracting industry, GEO appears to be doing quite well and has set the stage for continued strong performance for the remaining months of the fiscal year. Is there a downside to this attractive income play?

Business prospects
GEO not only builds detention facilities; it also manages them. The latter is a less capital-intensive practice that can easily build cash flow. The state of Florida recently gave the company a contract for facility management at three locations, expected to generate $56 million annually starting in February. Management is trying to make the business as profitable as it can be, understanding that the megacontracts of years past may not be in supply going forward.

The company also just refinanced with a $250 million senior note offering at 5.875%. The previous rate was 7.75%.

In the coming periods, investors should keep an eye on dormant facilities owned or managed by GEO that may come back on line. In the earnings conference call, management appeared enthused by the 6,000 idle beds, which could generate up to $0.70 per share in additional AFFO.

Though in a very depressing line of business, GEO Group is run by intelligent capital allocators that have wisely shifted their business to a cash-generating real estate trust with an increasingly diversified operational portfolio.

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  • Report this Comment On November 27, 2013, at 10:36 AM, stein919 wrote:

    GEO Group is indeed a sound investment, if you don't mind supporting an immoral and ethically-challenged industry that incarcerates people for the sold purpose of generating corporate profit.

    I know, it's all about money, right? There are, sadly, no toxic stocks for most investors -- tobacco companies, arms manufacturers, companies that make torture devices -- all are fair game to make a buck on the stock market.

    There are better stock picks than GEO, though -- ones that are not based on profiting from people's misery, incarceration and being separated from their families.

    We need prisons - many people belong in prison. But we don't need for-profit prisons, and, respectively, we don't need to invest in them.

    Even a Fool should know this.

  • Report this Comment On November 28, 2013, at 2:37 AM, kungfupanda1990 wrote:

    There are currently over 2 million inmates in the U.S. federal and state prisons and many are becoming overcrowded. The privatization of criminal incarceration is nothing more than the government trying to reduce overhead while ensuring humane conditions are met for criminals. This is no different than the government hiring out food, waste disposal, or any other type of service.

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