Bad Headlines Haven't Stalled Prison Profits

The boom may be over and news about industry leaders CCA and GEO hasn't been good, but stocks stay stable in the billion-dollar business of gaurding people.

Jan 28, 2014 at 10:43AM

Despite news reports in numerous states that put private prison ownership in a bad light, investors may not have need for concern. Unlike many stocks that are teetering wildly on public perception, private prison operators Corrections Corporation of America (NYSE:CXW) and GEO Group (NYSE:GEO), at least so far, have been largely immune from the negative effects of bad press.

The boom years
Prison economies enjoyed a tremendous boom for the past decade as "tough-on-crime" legislation and mandatory minimum sentencing exploded the number of people imprisoned in America. This meant more police, more guards, more counselors, more probation and parole officers, more vendors supplying to goods and services and especially more prisons.

But in this decade the true costs of those inmate populations began to take root in state budgets reeling from the recession looked desperately for financial solvency. A Time cover story that year cited the growing crisis faced by state budgets.

"From Hartford to Honolulu, once sturdy state governments are approaching the brink of fiscal calamity, as the crash of 2008 and its persistent aftermath have led to the reckoning of 2010," the article stated.

The boom years appeared to be drawing to an end. Certainly a surface scan of the recent events suggests as much. Idaho recently took back control of its prison from industry leader Corrections Corporations of America. Construction of prisons have stalled in states around the country. Many states have begun efforts to reduce inmate populations.

Most significantly, the federal government under the direction of U.S. Attorney General Eric Holder initiated a new nationwide policy to reduce drug-related sentences. President Barack Obama sent the strongest message yet about coming reform when he reduced eight lengthy prison sentences and issued thirteen pardons shortly before the end of the year.

As Bob Dylan warbled, "the times they are a changin'."

Profits remain strong
So is it bad news for the publicly held companies that rely on revenue streams based on swelling prison economies? Perhaps not.

A bellwether stock in this market is Corrections Corporations of America, which in December announced continued dividend payments to stockholders of $0.48 per share. CCA's public statement to the stockholders states that the company is the one of the largest prison operators in the United States, "behind only the federal government and three states."

The company owns or controls 53 facilities and manages 16 facilities owned by governments. The company's market cap is $4.011 billion with a price-to-earnings ratio of 12.35. Its year-ahead P/E is 13.22. The company's third quarter reported revenue was down by 3.3% from the previous year, but it didn't keep the earnings per share from rising by 7.1% for the same quarter, which indicates sound management principles smoothed out over the course of the rapid growth of the last decade. Its net income increased from around $42 million to nearly $52 million in this quarter, compared to a year ago. This 22.4% rise exceeds the S&P 500 industry average. CCA's net-operating cash flow increased by 8.28% in 2013 to $100.75 million. 

 Analysts have responded with mixed results, according to one report.

"One research analyst has rated the stock with a sell rating, two have issued a hold rating and two have assigned a buy rating to the company's stock. The stock presently has a consensus rating of "Hold" and an average target price of $29.25," the report stated.

Another significant for-profit, prison operator is the GEO Group. GEO manages 95 facilities in countries like Australia and The United Kingdom in addition to the United States. GEO's stock is currently trading near $33 down from its 52-week high of $39.35 but above the low of $30.11.

In September, California award a $30-million, three-year contract for 1,400 beds to the GEO Group. The state has been mired in federal receivership over inmate overcrowding and inadequate health services for several years. Gov. Jerry Brown is increasingly looking to private prison operators to help meet the state's legal responsibilities.

Both CCA and GEO recently reclassified themselves as real estate companies, REITs, to limit their corporate tax liability and enhance their financial outlook. 

Look beyond the headlines

CCA lost control of the Idaho Corrections Center when the state reversed course and announced earlier this month that it would take over operations of its largest prison after a decade of outsourcing to CCA. The state is investigating a host of complaints regarding operation of the prison. CCA admitted in 2013 that it falsified records submitted to the state that claimed staffing during times that were actually vacant.

If investors judge these companies just by the press or media reports about the decline in prison populations, they'd have every reason to move away from the likes of CCA or GEO. But the move seems premature.

CCA shows little sign of alarm, continuing to increase revenue and expand both its real estate holdings and the prisons it operates. On the same day in November the company announced its dividend payment it also announced a deal to build a 2,500-bed Trousdale Correctional Center in Trousdale County, Tenn. 

A sea change may be coming, though no political expert would suggest its coming any time soon. Savy investors would do well to follow these trends closely as this billion-dollar, taxpayer funded economy has been an unheralded, rock-solid, long-term investment for years. But don't get swayed by some bad press. Rest assured those that matter -- the government agencies pressed for cash and increasingly looking to private prison operators -- don't care much about bad press.

Any change that's coming is still a long, long way off.

Fool contributor Andrew Bolsinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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