2024-01-12 07:56:11 ET
Summary
- CXW may achieve FFO between $220 to $260 million by 2028, assuming 23% gross margins and around $1.8 billion in revenue.
- Its real estate value exceeds $4.6 billion versus a market cap of $1.6 billion.
- The company's bond yields around 6.5% annually with maturity in 2026.
Investment Thesis
CoreCivic (CXW) could be an attractive opportunity, where, if the Democrat party wins in 2024, the downsides are restrained, and one might exploit market fear and buy the stock with a great discount compared to its intrinsic value. If instead the Republicans prevail in the election, the stock may experience new highs in the stock price. What I really like of the company and what got me interested is the value of its assets. In fact, CoreCivic shows a significant hidden value in its balance sheet, providing a sense of security against concerns about debt or potential government crackdowns. I also really appreciate the attitude of the management in prioritizing the repayment of long term debts, rather than buying back shares to push the stock higher and get better compensations. This approach should improve CXW's profitability over the long term. If the price of the stock had to drop around $8 to $9, I am prepared to initiate a position.
Business Model
CoreCivic is a diversified government solutions company that manages private prisons, detention centers, and various correctional facilities. The essence of CoreCivic's business model lies in delivering correctional and detention services to government entities, predominantly at federal, state, and local levels. Here are the key components of CoreCivic's business model:
- CoreCivic Safety
- CoreCivic Community
- CoreCivic Properties
As of September 30, 2023, CoreCivic owned and managed 15.8 million square feet of real estate substantially all used by the government. Through its CoreCivic Safety segment, the Company operated 44 correctional and detention facilities, 40 of which the Company owned, with a total design capacity of approximately 66,000 beds. Through its CoreCivic Community segment, the Company owned and operated 23 residential reentry centers with a total design capacity of approximately 5,000 beds. In addition, through its CoreCivic Properties segment, the Company owned 6 properties, with a total design capacity of approximately 9,000 beds, leased to government agencies.
Financials
Income Statement
When examining the company's Income statement, there are two important items to consider in the top line: revenue and gross margins.
Revenue has remained relatively stable over the past decade, fluctuating within the $1.7-1.9 billion range. Gross margins have been on a downward trend for a few years. The company is expected to have Gross margins around 23% for FY23, and I expect they will remain within that range in the years to come.
One possible explanation for this decline could be attributed to the diminishing average compensated occupancy of both CoreCivic Safety and CoreCivic Community facilities. Since 2019, CXW's occupancy rates have experienced a decline, primarily due to the impacts of COVID-19. The average compensated occupancy of the correctional, detention, and residential reentry facilities, based on rated capacity was as follows:
As for the Properties segment, they possess properties leased to government agencies, with the occupancy percentage determined by leased square feet rather than bed capacity. As of December 31, 2022, the average occupancy for the 8 properties within the CoreCivic Properties segment portfolio was 100%.
Looking at the first 9 months of 2023, the average compensated occupancy for the facilities stood at 72%, showing a slight improvement compared to the year prior.
Balance Sheet
While CoreCivic's balance sheet may not appear extraordinary at first glance, it conceals a broader value in its assets compared to what is reported in the financial statements. Let's start with the cash line.
They currently hold approximately $118 million in cash, equivalents, and restricted cash. The majority of their asset value is attributed to the actual facilities they own. CoreCivic oversees facilities with a total capacity of around 80,000 beds, of which 70,000 are owned by the company. The reported value for these facilities is approximately $2.1 billion. Despite this amount seeming significant compared to the market capitalization of $1.6 billion, the true value of these assets is much higher.
For instance, in 2022, CXW successfully sold its McRae Correctional Facility , consisting of 1,978 beds, for $130.0 million. This transaction resulted in a gain on sale of about $80.0 million. With a sale price per bed at approximately $66,000. If we roughly multiply that value to the 70,000 beds owned, we would get a real estate value that exceeds $4.6 billion. This substantial difference from the value stated in the balance sheet is mainly due to annual depreciation for accounting purposes, which creates a significant gap.
Moving on to their obligations, they carry long-term debts amounting to $1.055 billion, structured as follows:
The interest payments incurred by the company are somewhat elevated, fluctuating within the range of 4% to 8.5%, but manageable. For the fiscal year 2023, the company is expected to have paid approximately $80 million in interest.
Cash Flow Statement
Here, we can also discern the appealing aspects of CXW and acknowledge the effectiveness of the management. However, let's begin by examining the cash flows for the first nine months of 2023.
The net cash provided by operating activities for the nine months ended September 30, 2023, was $209.6 million, compared with $118.2 million for the same period in the prior year. The increase in cash provided by operating activities resulted primarily from positive fluctuations in working capital accounts relative to the prior year's nine-month period.
The net cash flow used in investing activities instead was $39.2 million and was primarily attributable to capital expenditures for facility development and expansions of $5.0 million and $39.3 million for facility maintenance and information technology capital expenditures, partially offset by $6.4 million in net proceeds from the sale of assets.
The net cash flow used in financing activities was $214.6 million and was primarily attributable to debt repayments related to the $153.8 million redemption of the 4.625% Senior Notes and the $21.0 million purchase of the 8.25% Senior Notes in the second quarter of 2023. In addition, the net cash flow used in financing activities also included $30.5 million for the share repurchase program.
The cash flow movements reveal a consistent focus from the management on utilizing generated cash to reduce debts, a trend that has been observed over an extended period, as illustrated in the chart below.
Moreover, shareholders have been rewarded with several share repurchase programs announced in 2022, totaling an aggregate amount of up to $225 million. By September 30, 2023, the Company had successfully repurchased a total of 9.2 million common shares at an aggregate cost of approximately $100.1 million. According to my evaluations, the average price cost was around $10,8 per share. A much lower price compared to the current one.
Competitors
CXW's primary competitor is The GEO Group (GEO), a Florida-based corporation specializing in the ownership, leasing, and management of secure facilities, processing centers, and community reentry centers in the United States, Australia, and South Africa. As of September 30, 2023, The GEO Group's global operations encompass the management and/or ownership of approximately 81,000 beds across 100 facilities, inclusive of idle facilities. Additionally, they provide community supervision services for an average of over 400,000 individuals.
GEO surpasses CoreCivic in terms of revenue and displays better gross margins. However, a significant concern lies in its elevated level of indebtedness. The company carries a total debt of approximately $1.9 billion, nearly 80% higher than CXW. In 2023, GEO is projected to pay around $220 million in interest, a stark contrast to CoreCivic's $80 million. Despite trading with a market capitalization of about $1.3 billion, the risk is too high for me. If the circumstances take a downturn, GEO might go bankrupt.
Valuations
In my initial assessment, I aim to project the future cash flows that CoreCivic is likely to generate for its shareholders, spanning from 2027 onward. Subsequently, in the second evaluation, I adopt a more cautious approach, focusing on determining a fair Net Asset Value ((NAV)) for CXW.
Assuming the company's performance remains consistent over the next three years, mirroring the anticipated results for 2023, we could expect a potential generation of approximately $140 million in free cash flow annually. This estimate doesn't account for potential changes in accounts payables/receivables and other minor items. Consequently, the overall cash flow generation could amount to around $400 million over the next three years. If the management chooses to allocate this sum, along with some of the available liquidity, towards reducing a portion of the debts, CoreCivic could potentially cut nearly half of its current debt by 2027. This, in turn, would result in a reduction of more than half of the interest payments. The extent of this reduction depends on the terms under which the company refinances some of its debt. Additionally, if the company decides to sell some of its assets, as observed in previous years, it may achieve a debt-free status by 2028.
If the outlined scenario materializes, we could expect CXW to have FFO (Funds-From-Operations) between $220 to $260 million, supposing they would have gross margins of 23% and revenue of around 1.8 billion.
Regarding the Capital Expenditures, I expect them to be around $60 to 70 million in the years to come. That should lead to $200 million in free cash flow. With the current market capitalization standing at $1.6 billion, we could achieve a return of approximately 12.5% by 2027-28.
The data presented in the image above are rough expectations made by myself.
Coming to the second type of evaluation, I tried to estimate the value of the facilities that they own by using a square foot parameter. CoreCivic manages 15.7 million square feet, with 87.5% being company-owned (13.8 million square feet). The percentage is calculated by dividing the 70,000 company-owned beds by the 80,000 beds managed, (multiplied by 100).
Now, we have to estimate an appropriate price per square foot. One way to do so is by looking at the recent costs of construction for new prisons in the U.S. The State of Indiana is building a $1.2 billion Correctional Facility in Westville . The facility will be completed in 2027 and is set to incarcerate 4,200 men, spanning a total of 1.4 million square feet. This translate to a construction cost of around $860 per square foot or $285,000 per bed. The State of Alabama has recently approved a final price of $1.08 billion for a 4,000- bed facility . It is expected to be completed by May 2026 and it will encompass 300 acres of space, resulting in a construction cost of $830 per square foot. The States of Nebraska and Georgia also have correctional facilities in construction, with a comparable cost per square foot to the above-mentioned facilities.
Therefore, if we take for instance the $335 per square foot price at which CXW sold its facility in 2022, we can then state that is a pretty fair value for an old prison (deterioration and depreciation in value over time considered). Taking for granted that CoreCivic spends $70 million in Capital Expenditures annually, $50 million of which just for maintenance, ensuring the proper upkeep of the facilities.
If we multiply the total sq ft owned by CXW by $335, we get to a total value of $4.6 billion. If we subtract from that the total debt (long-term debt + capital leases) which amounts to $1.08 billion, we get to a NAV of approximately $3.6 billion or $31 per share.
Risks
Certainly, it's important to acknowledge the inherent risks associated with the private prison industry. CoreCivic and similar entities have faced criticism and scrutiny concerning concerns about the profit motive within the criminal justice system, the treatment of inmates, and potential conflicts of interest. A notable development is the Executive Order issued by President Biden on January 26, 2021, which directs the Attorney General to refrain from renewing Department of Justice (DOJ) contracts with privately operated criminal detention facilities. It's noteworthy that CoreCivic has two detention facilities with direct contracts with the DOJ, with one contract renewed in September 2023 and expiring in September 2028, and the second contract expiring in September 2025.
While it's true that CXW relies on government contracts, it's crucial to recognize that the government or states may, in certain instances, depend on CoreCivic more than the company relies on them. Many public prisons in the U.S. face challenges such as overcrowding and substandard conditions for inmates.
Conclusions
CoreCivic presents itself as a highly controversial stock, where the value of the company is highly influenced by the outcome of political elections. Regardless of that, my suggestion is to wait patiently and consider acquiring shares If the price declines to around $8 to $9. This would provide a substantial margin of safety, around 20-30%, particularly if we opt for a stock purchase at a free cash flow multiple of 10, with an estimated FCF of $130-140 million based on my previous estimations. If Democrats secure victory, the stock may trade again below $6, as was the case in 2020. That would represent a great opportunity to buy more shares and hold the stock until it reaches a more fair valuation. Conversely, if Republicans win, the stock might probably reach higher valuations than current ones. In that scenario, I would sell the stock.
For investors perceiving the stock as too risky, an alternative to consider is investing in CoreCivic's bonds , which currently yield around 6.5% grossed. I believe that the company will have the financial capability to refinance and pay down its debt.
For further details see:
CoreCivic: High FFO May Lead To A Debt-Free Status By 2028