GEO - GEO Group: Despite Uneven Results A Lot Of Upside Remains

2023-11-14 23:12:30 ET

Summary

• GEO Group's Q3 results were a bit lackluster, as the company continues to be hurt by lower ISAP revenue.
• A rebound in ISAP is a huge potential opportunity for the company.
• With a cheap valuation and ISAP potential upside, GEO is a "Strong Buy."

GEO Group ( GEO ) is up over 10% since I took the stock to "Strong Buy" in March , and up over 25% since I reiterated that stance at the end of August . With the company recently reporting its Q3 results, let's catch up on the name.

Company Profile

As a quick reminder, GEO owns, leases, and manages prisons, processing centers, and community reentry facilities. It primarily operates in the U.S., but it also serves detention centers in Australia and South Africa as well. The company also provides other services such as electric monitoring and post-release support.

GEO's largest customer is U.S. Immigration and Customs Enforcement ((ICE)), which accounted for about 44% of its revenue and 29% of its beds in 2022. Individual states represent nearly a quarter of GEO's revenue, with Arizona and Florida the biggest contributors.

Q3 Earnings

For the quarter, GEO posted a -2% decline in revenue to $602.8 million . That was ahead of the $595.3 million consensus.

Owned and Leased Secure Service revenue fell nearly -2% to $282.4 million, while the net operating income was $72.9 million, down -13%. Owned and Leased Reentry Service revenue rose 14% to $43.8 million, while its NOI also rose 54% to $15.2 million.

Managed Only revenue jumped 17% to $152.0 million, while its NOI surged 65% to $17.7 million. Electronic Monitoring and Supervision Service revenue sank -31% higher to $94.5 million, while its NOI dipped -30%. Non-residential service revenue rose 22% to $30.1 million, while its NOI jumped 62% to $7.6 million.

GEO said that it's seen a 30% increase in ICE processing center population since the start of July. The company noted that revenue from its discontinued Northlake facility was included in last year's revenue, which was generating $9-10 million in revenue.

Adjusted EBITDA fell -13% to $118.7 million. Adjusted EPS came in at 19 cents versus 33 cents a year earlier. That was in line with analyst expectations.

Despite seeing a nice jump in ICE processing center populations following the expiration of Title 42, GEO still hasn't fully benefited from the increase. Lower ISAP levels continue to weigh on the company's results, even though other areas of the business are showing strength.

The company is still generating solid free cash flow and was able to reduce debt by $109 million in the quarter, helped by the sale of a facility in NJ for $15 million. Given its variable interest rate debt, paying down debt and deleveraging is ultimately a key part of a bullish thesis.

Outlook

Looking ahead, GEO guided for Q4 revenue of between $590-600 million , down from a prior forecast of $595-610 million. The company said it now expects ISAP participation to be flat versus earlier expectations of a moderate increase.

The company forecast adjusted EBITDA to be between $117-122 million compared to the prior outlook of $115-130 million. It is looking for Q4 net income of between $19-24 million versus a previous forecast of $19-27 million.

For the full year, GEO now expects revenue of around $2.4 billion, in line with its prior outlook.

The company is looking for adjusted EBITDA of between $495-500 million versus a previous forecast of $490-520 million. It's looking for net income of between $100-105 million, compared to prior guidance of $95-$110 million.

GEO will look to reduce debt by between $175-200 million a year going forward.

Discussing its guidance on its Q3 earnings call, CFO Brian Evans said:

Our continued and steady performance is representative of the strength of our diversified services platform. We have been able to offset declines in our electronic monitoring and supervision services segment throughout 2023 with growth in revenues and earnings from several of our other diversified segments. Our guidance does not include the potential reactivation of any of our remaining idle secure services facilities, which total approximately 9000 beds and could provide meaningful upside to our annualized revenues and cash flows fully reactivated. Additionally, increases in the ISAP participant count or further increases in the utilization of our ICE detention beds could generate significant upside to our guidance. With respect to ISAP specifically, BI is the sole provider of electronic monitoring solutions to ICE and has provided these services with bipartisan support for over 20 years, successfully achieving high levels of compliance under the program. BI has all the necessary resources to assist ICE going forward, should the agency decide to increase the utilization of ISAP once appropriation bills are approved by Congress."

Congress is currently still fighting over its overall fiscal budget, and there are currently two versions of the Homeland Security appropriation bill that would impact GEO. The Senate version looks like a slight help by giving a small increase to detention alternatives (ISAP), while the House version increases the number of ICE beds and would require electronic monitoring for all non-detained individuals. The House version should be a big boost to the company if it is approved, and any compromise bill looks like it could also help GEO.

Thus, while guidance was disappointing, and reduced guidance was a theme throughout the year for GEO, there does appear to be some good potential upside for the firm with the ISAP program. That said, the program is controversial on both sides of the spectrum, with immigrant groups saying it is too invasive , while other groups say the program decreases public safety .

Valuation

GEO trades at a 5.9x EV/EBITDA multiple based on the 2023 EBITDA consensus of $498.7 million (down from $509.7 million when I last looked at it). Based on the 2024 EBITDA consensus of $527.0 million (was $541.4 million last time I looked at it), it trades at around 5.6x.

It trades at 11.2x forward EPS, with analysts projecting 2023 EPS of 83 cents (down from 88 cents when I last looked at it). Based on 2024 EPS of $1.13, it trades at 8.2x.

It's projected to grow revenue 1% in 2023, accelerating to 4% growth in 2024.

Fellow detention operator CoreCivic ( CXW ) trades at 7.6x 2024 EBITDA. CXW doesn't have the ISAP exposure of GEO and carries a bit less leverage, which can help explain its premium.

Conclusion

GEO's stock has performed well lately but not really due to its operational performance, which has been a bit unsteady. However, investors are beginning to see a cheap stock that has the ability to nicely delever. And even more importantly, they see the potential for a huge rebound in its ISAP business.

If the House version of the Homeland Security appropriation bill were to pass, GEO's stock would likely skyrocket. Now the odds of that are likely low, but a compromise bill that benefits the company seems more likely at this point. Given its current valuation, GEO looks like a bit of asymmetrical bet, where the upside way outweighs the down at this point. As such, I continue to rate the stock a "Strong Buy."

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