President Joe Biden banned new Bureau of Prisons (BOP) contract renewals when he took office. But this did not stop GEO Group (NASDAQ:GEO) yesterday from raising its 2021 outlook with its second-quarter earnings report. Bottom line, GEO stock is likely to do well.
The Group will lose two BOP prison renewal contracts in the fall. However, GEO Group is not only going to survive but probably thrive. For example, it raised its financial guidance for 2021 net income to be in the range of $167.5 million to $174.5 million on annual revenues of $2.23 billion.
That will mean good things for GEO stock, especially since investors were expecting bad news from the BOP cancellations. I estimate that, after its debt reduction plans, the stock could rise another 20%.
Where This Leaves GEO Group
In the company’s conference call, the company’s executive chairman, George Zoley, said that the census at its U.S. Marshals’ facilities rose about 10%. In addition, it is taking in more people with the Immigration and Customs Enforcement (ICE) facilities — up 100% over the last year. They were able to get around some of the U.S. Marshals renewal bans by using other “inter-governmental agreements.”
The bottom line is that, despite expecting to lose two major BOP prison contract renewals in the fall, it raised its guidance for this year. The reason appears to be that President Biden’s open border policies have allowed the company to take in more people on government contracts, just not BOP contracts.
In short, the company is going to continue to be significantly profitable.
However, that leaves its huge debt overhang. Right now GEO Group has $2.632 billion in long-term debt, plus $27.24 million in the current portion of that debt. This is a problem since interest expenses eat up a huge portion of the company’s cash flow. Last quarter alone, its interest expense was $32 million (on its quarterly income statement) or 76% of its $41.93 million.
The company is attempting to pay down a portion of this debt from asset sales, cash flow, and other measures. Its plan is to reduce by $150 million to $175 million. But GEO may have to act quicker if it loses more BOP and other federal contracts.
However, the company does have $483 million in cash so its net recourse debt stands at just $2.1 billion. Last quarter its adjusted Funds from Operations (AFFO) was $84.4 million, or $337.5 million on a run-rate basis. That puts its debt at 6.22 times its AFFO. If its debt falls by $175 million to below $1.95 billion net debt, the ratio will fall to 5.7 times. That is still high, and GEO may have to reduce it to below 4 times before the market is no longer concerned.
What to Do With GEO Stock
The company has not officially said it will leave its REIT (real estate investment trust) status by the end of the year, but it is considering doing this. Right now it is not paying a dividend, even though REITs have to pay out 90% of their net income in dividends. So becoming a regular C Corp again, not a REIT, would eliminate this requirement.
However, the market may not like GEO stock if it does that. Investors in REITs expect to get paid a dividend. The company said in the conference call that even if it pays a dividend, it would likely be a non-cash stock dividend. That would act to dilute shareholders. This would probably make the stock fall.
So I expect they will no longer be a REIT and act to reduce their debt. That will likely help push GEO stock higher in the long run, especially if the company stays profitable and meets its higher 2021 earnings targets.
On the date of publication, Mark R. Hake held a long position in Bitcoin but not in any other security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.