GEO - CoreCivic: Having Successfully Executed Its Balance Sheet Plan It May Be Time To Follow The Playbook Elsewhere

2023-08-31 12:10:15 ET

Summary

• CoreCivic is a provider of services to the government focused on incarceration and criminal rehabilitation.
• The macro environment has proven to be more supportive of its business than initially indicated when the Biden Administration took power.
• The company has successfully restructured its business, and the market has rewarded its shares with a premium multiple over its major competitor GEO Group in most major metrics.
• GEO Group is running the same playbook as CoreCivic did but has not yet been rewarded with a re-rating, making a swap a compelling option.

CoreCivic Inc. (CXW) is a provider of services to the government focused on incarceration and other alternatives to support criminal rehabilitation. They are most well known as a provider of outsourced correctional and detention management services, but also provide a growing network of residential and non-residential alternatives to incarceration.

This article looks at the overall market environment for the company administration, as there was to be a large philosophical change that was communicated by the Biden administration when it came to power. It also looks at where CoreCivic is at now considering this macro environment.

Out-Sourced Correctional Services Environment

In one of his first executive orders upon taking over the White House in January 2021, Joe Biden announced his goal to eliminate for-profit detention facilities, following up on a campaign promise. This initially provided a hangover to the stock price as investors understandably wondered whether this would be a permanent impairment to the business.

This did not totally come to pass. As detailed in this Reuters article , there was definitely steps taken to review the state of private prisons, which have numerous critics, including earmarking some that were underperforming for closure. However, the demand for space has proven too great that the original plan has been largely ignored.

This demand for prison space has come from several sources. The southern border immigration enforcement has been a hot button issue for all sides of the political debate, but the end of Title 42 has proven to be a boost for CoreCivic. Title 42 was originally brought in during the COVID pandemic to encourage quick return of immigrants at the border due to concerns about the spread of COVID-19 at the time; it also didn't really provide any manner with which to detain illegal immigrants. Its repeal brings in a more definitive immigration process which will require those that immigrate illegally to be more likely to require detention, which is another driver of demand.

A more socially concerning level is a general rise in crime throughout major cities. This report cites several trends that show despite a slight fall off from 2022, crime levels remain elevated from pre-COVID levels. Deteriorating economic conditions for the lower economic classes may also keep the crime rate elevated as the cost of living increases for basics like food, shelter, clothing, and energy. As detailed in the chart below, core inflation may be rising less than before, but its effects since the change in government have been substantial:

With inflation rising and the economy slowing, we see a very similar pattern to the 1970s, which saw a sharp escalation in the crime rate as shown in this table .

Overall, I believe that the current environment will be at a minimum a stable environment for private prisons as the sheer demand for their services make it untenable to remove them at this time. With the overhanging negative political view towards them, it may also provide a moat to competitors as well, much like the moats developed for cigarette companies.

CoreCivic as a Company

Back in 2020, CoreCivic made the decision to convert itself from a REIT to a C-corporation which gave it a much broader ability to operate without the dividend payout requirement. This understandably changed who the investor base was because, like its competitor GEO Group ( GEO ), both were favorites of income investors due to the payout as dividends of its previously stable cash flows. This change has allowed CoreCivic to drastically reduce its debt load over the last three years:

GEO Group took a similar step but well over a year later. This is reflected in the fact that CoreCivic has a larger market cap ($1.18B vs. $0.86B) but a smaller enterprise value ($2.25B vs. $2.80B); GEO is farther behind in its recapitalization efforts than CoreCivic is. CoreCivic is also returning money to shareholders through buybacks.

All is not necessarily rosy for CoreCivic. GEO Group's financial ratios are substantially cheaper than CoreCivic on almost all fronts, from price to book to EV to EBITDA to price to sales.

Source: Seeking Alpha

It appears the market has rewarded CoreCivic more for its efforts to recapitalize its books earlier than GEO Group did. GEO Group is making substantial headway on this front, dropping its net debt from $2.9B at the end of 2021 to $1.8B. There has been some lumpiness to both companies' revenues and earnings as they navigated COVID and a tricky macro environment.

The Takeaway

I believe the macro tailwinds make both CoreCivic and GEO Group good defensive plays. I have been a shareholder of CoreCivic since its conversion to a C-Corp in 2020 as I liked its plan to fix its balance sheet up at the time. At this point, I think GEO Group may give investors a second chance at the CoreCivic playbook since its metrics have it trading at a substantial discount with the larger EV switching from debt to equity to the benefit of shareholders.

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