Summary
- Iron Mountain insider transactions have been dominated completely by selling activities in the past 6 months.
- The investment now indeed faces limited upside (about 4% per year) while issues begin to accumulate.
- These issues include heavy capital requirements under rising rates, FX exchange rates, and geopolitical disruptions.
- At the same time, the stock has reached its full valuation and leaves no margin of safety.
Thesis
I first published my bull thesis on Iron Mountain ( IRM ) back in July 2021. At that time, the stock was priced at $42.8. The stock price has appreciated by more than 25% since then. With the dividends, it has delivered a total return of about 33.5, compared to an 8.9% loss in the S&P 500 index.
Business fundamentals are healthy and organic growth remained throughout the first half of the year. The growth has been driven by improved storage volumes and a strong pricing environment. Several customer wins and expansion of existing relationships have also helped boost business. Overall, its recent data center initiative has also been expanding more quickly than the shrinkage of its traditional paper document storage segment. The acquisition of IT Renew further added to the growth.
However, the large price rally has thinned the margin of safety substantially. And as you will see later, the stock is now fully valued or even overvalued. In the meantime, other issues begin to accumulate, ranging from muted growth prospects, FX exchange rates, and geopolitical disruptions. Heavily capital investments are required to keep building its data center hosting business, while its balance sheet is a bit leveraged, especially relative to its historical average and its peers. As a result, I am seeing more downside potential while the upside is limited (to about an annual return of 4% in the next few years). As such, I've changed my thesis from buy to hold recently, as you can see from the chart above.
Investors should also take notice of insider activities, as elaborated next.
Insider activities
When it comes to insider activities, usually I pay more attention to buying activities than selling activities. The reason is that selling activities can be triggered by a range of factors irrelevant to business fundamentals (such as divorce or buying a new house). In contrast, insider buying activities usually have only one explanation - the insiders think the stock is undervalued.
However, in IRM's case, its insider transactions have been dominated completely by selling activities in the past 6 months, as you can see from the following charts provided by Dataroma.com. When such a completely one-sided picture shows up, investors should pay attention. To wit, over the past six months, there were a total of 7 insider transactions, all from its directors. And as seen, all 7 transactions have been selling activities. And all combined, these insiders sold a total of almost $2.5 million of IRM shares.
Next, we will see that these insider sales are probably for good reasons.
Weakening capital allocation flexibility
Its financial strength is currently OK, as you can see from the following interest coverage ratio. Its interest coverage ratio has fluctuated from about a low of 1.4x to as high as 2.9x in the past decade. It currently earns 2.04x of its interest expenses, close to the average, and slightly above its own historical average.
However, its capital allocation flexibility is definitely not at its peak and the weakening can continue for several reasons. First, when its financials are holistically considered such as by the Altman Z-score, its financial strength has deteriorated substantially over the years as shown in the bottom panel of the chart below. Note that as a general rule of thumb , for nonmanufacturing businesses, a Z-score above 2.9 is deemed safe. And as a REIT business, the absolute score probably does not mean too much, and the weakening trend is more meaningful.
Secondly, compared to other comparable peers such as CubeSmart ( CUBE ) and EPR Properties ( EPR ), it sits on a relatively high level of debt as seen from the chart below. Its net debt of $12.7B is significantly higher than its peers (more than 4x higher than both CUBE and EPR), and even higher when adjusted for its equity. Its debt-to-equity ratio of 1704% is more than 10x higher than both CUBE and EPR.
Next, we will discuss the implications for growth and valuation.
Growth prospects and projected returns
As mentioned above, to keep building its data center hosting business, heavy spending is required for the years to come. And management does not have too much of a choice here given that its mature paper document storage business faces a secular decline. For 2022, the capital spending in the data center alone is expected to reach $625 million. Its relatively high debt, stretched leverage, currency exchange headwinds, and rising borrowing rates could all lead to dampened capital investments and muted growth.
At the same time, the stock has reached full valuation or is even overvalued as you can see from the chart below. In terms of FFO multiples, as you can see from the second chart below, the valuation for IRM has fluctuated in the past decade between as low as 6.35x and as high as 23x. The long-term average is 13x. Therefore, its current valuation of 22x is substantially above its historical, by almost 70%.
In terms of its dividend yield, IRM is overvalued by about 21%. It is currently yielding 4.56% while its historical average has been 5.8% as shown in the chart below.
Looking forward, management expects adjusted EBITDA of ~$465 million in Q3 of 2022 and AFFO to be approximately ~$280 million. Based on this guidance, my estimate of its current P/AFFO multiple is about 18.6x, slightly above its historical average of 18.0x by 3%. So the overvaluation may not be as dramatic as indicated by the above assessment from dividend yield or P/FFO multiples. But I have no doubt that the stock is at a full valuation, or overvalued by any standard under current conditions.
With the lack of margin of safety, the project return profile is quite tepid as shown. Even under a healthy growth rate of 5% (to put it in perspective, its FFO growth rate has been about 3% CAGR in the past decade), the total return is projected to be in a range of a small loss of 4% (about -1.1% annually) to about 18% (an annual return of 4.1%).
Other risks and final thoughts
My view is that such a limited upside does not properly compensate for the risks that investors are undertaking at this point. As aforementioned, these risks include slower growth in corporate storage spending, the uncertainties of the growth in its digital storage initiative, the heavy capital requirement involved, and the valuation risks. Besides these risks, it could suffer from deterioration in overseas markets given the current geopolitical tensions. FX headwinds and also supply chain issues could also negatively impact its bottom line and lead to facility development delays.
To conclude, I am downgrading my IRM thesis from buy to hold based on these considerations. Its insider transactions have been dominated completely by selling activities in the past 6 months. I usually pay more attention to insider buying than selling. But in this case, I think the insider sells are for good fundamental reasons.
For further details see:
Iron Mountain: The Insiders Are All Selling