Shares of The GEO Group (NYSE:GEO) have plummeted to multi-decade low levels recently, potentially setting the stage for significant upside. Specifically, the stock has experienced a continuous and painful decline from its 2017 highs, currently trading at the same levels it did all the way back in 1996.
Don't Miss our Black Friday Offers:
- Unlock your investing potential with TipRanks Premium - Now At 40% OFF!
- Make smarter investments with weekly expert stock picks from the Smart Investor Newsletter
There are definitely multiple reasons that justify the market’s bearish stance toward GEO. These include the company’s heavily indebted balance sheet in a rising-rates environment, all major banks cutting ties with private prison operators, and the complete lack of capital returns following 2021’s dividend hiatus.
That said, GEO’s management has managed to navigate the challenges rather well. The company’s swift deleveraging efforts and strategic pursuit of growth opportunities have resulted in meaningful progress.
It is also evident that GEO is diligently progressing towards fulfilling management’s objectives, which instills confidence in a looming reinstatement of dividends. Adding to this promising scenario is that GEO stock trades at an exceptionally discounted valuation, reinforcing my bullish stance on its prospects.
Unshackling the Chains of Debt — GEO’s Deleveraging Story
The GEO Group is heavily indebted, as the company incurred significant amounts of debt before switching from a REIT to a corporation in 2021. In fact, reducing debt has been the main topic of GEO’s investment case for a long time.
To provide some perspective, at its peak in mid-2021, GEO’s total debt had soared to a staggering $3.1 billion. Adding to the challenge, major banks that had previously extended credit lines and term loans to the company had firmly committed to severing ties with the private prison and immigrant detention “industry” once all outstanding obligations came to an end.
This left GEO’s management with a daunting predicament, facing limited options for future refinancing due to rising interest rates and a dwindling pool of potential creditors as major banks closed their doors. In response to this emergency, GEO adopted a swift and strategic approach to deleveraging.
The company recognized that obtaining external financing would be nearly impossible and prohibitively expensive, leaving it with little choice but to rely on its very own operational cash flows to fund future capital expenditures. Consequently, GEO prioritized paying down its substantial debt burden above all else. In fact, since the second quarter of 2021, GEO has made admirable progress in reducing its debt, successfully driving it down by over one-third from its highs.
GEO’s management foresees an annual decline of around $25 million in interest expenses by 2024, driven by the ongoing debt reduction program. Notably, their plan is to drive GEO’s net leverage ratio below 3.5x adjusted EBITDA by the end of Fiscal 2023 (from 3.5x currently) and below 3.0x adjusted EBITDA by the end of Fiscal 2024. Once these targets are met, management “intends to explore capital return options for shareholders,” as stated during Q1’s earnings call.
Pursuing Growth Opportunities – Electronic Monitoring
In addition to GEO’s successful ongoing debt reduction efforts, which should enable the company to self-fund its CapEx going forward, its management has been actively pursuing growth opportunities to infuse fresh energy into the organization. The company seems to be finding great success in its Electronic Monitoring segment.
In Q1, Electronic Monitoring Services experienced a significant 51% increase in revenues and a 66.3% increase in operating income, reaching $132.6 million and $64.3 million, respectively. Besides the significant growth here, these numbers indicate that Electronic Monitoring is also a high-margin business. Therefore, as EM revenues as a percentage of total revenues grow over time (they did so from 15.9% to 21.8% year-over-year), GEO’s overall margins and profitability should also benefit.
GEO is Trading Near an All-Time Low Valuation
Ultimately, my bullish outlook for GEO stock stems from its heavy undervaluation, with shares currently trading near an all-time low valuation. Both the forward EV/EBITDA and forward P/E multiples stand at enticing levels – 5.3x and 7.5x, respectively – representing historical lows for the company.
To paint a more accurate picture, however, let’s consider GEO’s AFFO/share (a cash-flow metric) consensus estimate of $2.10 for this year, which accounts for the significant depreciation and amortization the company gets to record due to real estate assets. This figure points to a price/AFFO multiple of 3.5, which I find to be a very discounted multiple, especially when factoring in GEO’s ongoing deleveraging efforts, promising EM growth prospects, and the potential for a dividend reinstatement.
Is GEO Stock a Buy, According to Analysts?
Regarding Wall Street’s sentiment, The GEO Group features a Moderate Buy consensus rating based on two Buys assigned in the past three months. At $13.00, the average GEO stock price target implies 78.3% upside potential.
The Takeaway
Overall, while The GEO Group’s investment case doesn’t come without risks, management has shown resilience and determination in navigating the various challenges the company has faced thus far. Their aggressive deleveraging efforts and strategic pursuit of growth opportunities, particularly in the Electronic Monitoring segment, have yielded fruitful results.
With the potential for further debt reduction and a looming reinstatement of dividends, GEO’s current share price and discounted valuation may present an attractive entry point due to the strong prospects for a rebound.
