This week, Durig Capital looks at a company providing private prison services for governmental agencies both domestically and abroad. Geo Group, Inc. (NYSE:GEO) is one of only a handful of private prison service companies. With the election of President Trump, private prison companies have gotten a boost due to more stringent prosecutions as directed by our new attorney general, as well as Trump’s zero tolerance policies on immigration. The company’s first quarter 2019 results reflect this new political climate.
- First quarter revenues were up 8.1% year-over-year.
- Net income grew by 16.2%.
- Funds from operations increased by 14.6% over the first quarter 2018.
- The company increased annual 2019 revenue guidance from $2.4 billion to $2.47 billion.
Geo Group is awaiting decisions from the Federal Bureau of Prisons on two procurements (CAR 18 and CAR 19) that total close to 12,000 beds. If these decisions come back in favor of Geo Group, the company would likely again increase its current guidance (as it just did with the release of its first quarter results). Geo Group’s 2023 bonds, couponed at 5.125%, are currently trading at a discount, giving them an enticing yield-to-maturity of over 9%. With the most recent increase in guidance and the possibility of more on the way, these short-term maturity bonds (maturing in only 44 months) are an ideal addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
First Quarter Results
Geo Group recently released its results for the first quarter of 2019 (three months ended March 31, 2019). The company posted impressive increases in many of its metrics.
- First quarter revenues totaled $610.7 million as compared to $564.9 million for first quarter 2018. This represents an increase of 8.1%.
- Net income in the first quarter was $40.7 million, 16.2% higher than the $35.0 million net income from a year ago.
- Normalized funds from operations (FFO) were reported at $60.3 million, compared to $52.6 million in first quarter 2018, an increase of 14.6%.
Geo Group recently increased its 2019 guidance due to the successful renewal and reactivation of contracts with various governmental agencies. Geo Group now expects full-year 2019 revenues to be approximately 2.47 billion, as compared to its initial guidance of $2.4 billion. This increase is due to the reactivation of a currently idle facility in Louisiana, a new 10-year contract renewal with the U.S. Marshals Service, as well as three other contract renewals secured during the first quarter. George Zoley, Chairman and CEO of Geo Group commented on the company’s results. “We are pleased with our strong quarterly financial and operational performance, as well as, our improved outlook for the balance of the year.”
About Geo Group
The Geo Group (NYSE: GEO) is the world’s leading provider in the delivery of diversified correctional, detention, and residential treatment services to government agencies around the globe. GEO is a real estate investment trust (“REIT”) specializing in the ownership, leasing and management of correctional, detention and reentry facilities and the provision of community-based services and youth services in the United States, Australia, South Africa, and the United Kingdom. GEO provides complementary, turnkey solutions for numerous government partners worldwide across a spectrum of diversified correctional and community reentry services. From the development of state-of-the-art facilities and the provision of management services and evidence-based rehabilitation to the post-release reintegration and supervision of individuals in the community, GEO offers fully diversified, cost-effective services that deliver enhanced quality and improved outcomes.
The Growth of Private Prisons
The first private prison at the state level opened in 1986 in Kentucky. Since that time, the use of private prisons at both the state and federal levels has continued to increase. In the 1980’s and 1990’s, incarceration rates and sentencing lengths grew partly due to stricter sentencing laws. The population of the country’s state prison’s reached 115% of its highest capacity. Traditionally, state officials finance the construction of new prisons using general obligation bonds, which requires voter approval. While most voters support policies that increase prison time for criminals, that doesn’t always translate to supporting the referendum to expand prison capacity. In fact, voters rejected roughly 60% of prison bond referenda in the 1980’s.
Today, private prisons are a $5 billion industry. What began at the state level, now encompasses the federal Bureau of Prisons (BOP), the U.S. Marshal Service as well as Immigration and Customs Enforcement (ICE). Private prisons currently hold approximately 9% of all U.S. prisoners, and 19% of all federal prisoners. Roughly 75% of all immigrants detained by U.S Immigration officials are also in private prisons. In 2016, then Deputy Attorney General, Sally Yates, declared that the U.S. Bureau of Prisons’ contracts with private prisons would be phased out as they expired, with a goal to phase out all private prisons by 2020. But when President Trump took office, he reversed this decision. Part of this is due to current Attorney General Jeff Sessions’ pledge to lock up more people by reinstating mandatory minimum sentences for low-level offenses. Add to this, President’ Trump’s zero tolerance policy on immigration and it’s easy to project the continued need for private prisons.
Interest Coverage and Liquidity
For bondholders, interest coverage is a quick indication of the bond issuer’s ability to service its existing level of debt. For Geo Group, first quarter operating income totaled $74.8 million, while first quarter interest expense was $40.3 million. This gives Geo Group an interest coverage of nearly 2x (1.9x). In terms of liquidity, as of March 31, 2019, Geo Group had cash and cash equivalents totaling $67.7 million, as well as $290 million in available capacity under its revolving credit facility.
The risk for bondholders is whether Geo Group can continue to grow revenues while also supporting its growth initiatives. The recent increase in the company 2019 revenue guidance is encouraging, as is the recent contract renewals and the reactivation of a previously idle facility in Louisiana. The current political climate for private prison services does seem to favor companies like Geo Group ever since President Trump and Attorney General Jeff Sessions took office. In light of these considerations, the very competitive yield-to-maturity of more than 9% on these 2023 bonds does appear to outweigh the risks identified.
On July 15, 2019, Fifth Third bank announced it would no longer provide future financing to companies that manage private prisons and immigration holding centers. This follows similar announcements by BNP Paribas (France), JP Morgan Chase, Bank of America, Wells Fargo, and SunTrust Banks. This list does appear to read like a who’s who in the banking world, but George Zoley, Geo Group CEO, commented on the announcement of its first quarter results, “We believe we will continue to have access to cost-effective capital to support the growth and expansion of our high-quality services.”
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Private prisons and private prison services have stepped in to provide an essential need within our country and culture – the incarceration of criminals, along with correctional and reentry services. These facilities help fill the void where governmental facilities and services have been unable to keep up with demand. Geo Group has had a long history of working with various U.S government agencies including the Bureau of Prisons, the U.S. Marshal Service and Immigration and Customs Enforcement. The company’s recent contract renewals along with the reactivation of a previously idle facility in Louisiana have translated to increased guidance for 2019. With U.S Treasury yields still at an abysmally low level, the over 9% yield-to-maturity on Geo Group’s 2023 bonds makes these bonds an ideal addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.
Issuer: Geo Group Inc.
Ratings: B1 / B+
Yield to Maturity: ~ 9.12%
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Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services. Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured, or at Interactive Brokers. We have now started offering our highly successful FX2 service to clients of other Registered Investment Advisors through segregated accounts at TD Ameritrade. Please ask us to learn how this might work for you and your current advisor.
Disclosure: Durig Capital and certain clients may hold positions in Geo Group’s April 2023 bonds.
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