Now and then, you have to make a choice as an investor.
Will you go with the growing narrative and follow Wall Street's departure from a specific asset due to public pressure, or will you swim directly where the money is and pick it up?
In this case, I'm talking about the U.S. prison industry.
The last few years have cast operators of private prisons as willing conspirators in a massive "prison complex" across the United States. The primary accusation is that operators of border detention centers and private prisons are profiting off mass incarceration.
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This narrative from more liberal activists has fueled a divesting of prison real estate investment trusts (REITs), the companies that operate private prisons.
The recent sell-off has pushed firms like the one I'll discuss today to an incredible discount and a hefty dividend that is hard to ignore (10.6%).
Today, I want to approach this subject by looking at the numbers. I'm not an advocate, and I'm not planning on owning this REIT in the future.
But I will make the case that this REIT is sharply undervalued due to a misplaced narrative driven by emotion over reason.
And you can decide for yourself if it's worth buying or not...
A Controversial - but Possibly Brilliant - Buy
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To identify the best REITs, I use several metrics, including our proprietary Money Morning Stock VQScore™ system.
This week, I was intrigued when I saw CoreCivic Inc. (NYSE: CXW) on the VQScore list. So I dug into the numbers...
CoreCivic is an owner and operator of private prisons across the United States. The firm manages 65 state and federal correctional facilities in the United States. More than half of its revenue comes from federal agencies. It operates as a real estate investment trust.
The more one digs into the companies that operate private prisons, the more one uncovers a controversial, yet overly simplistic, narrative. So let's dig a little into what is actually happening...
The United States has the largest prison population on the planet by a wide margin. The U.S. accounts for roughly 25% of the world's incarcerated, despite having just 5% of the world population.
Since the 1970s, the number of incarcerated Americans has quadrupled.
The talking points suggest that mandatory sentence laws combined with the failed war on drugs fueled the swell in prison population.
Of the people who are in state prisons, however, 55% have been convicted of violent crime. Just 15%, comparably, have engaged in drug crimes. While that latter figure is too high, in my opinion, it is the first number that warrants the existence of a prison system.
And despite the narrative, the bulk of prisons in the United States are not private.
While the U.S. prison population sits at 2.2 million people, just 150,000 to 175,000 inmates reside in private prisons. Also, prison REITs make up 90% of that private prison population (or 6.3% of the entire U.S. prison population).
There is a debate about how public and private prisons use their money, but it's usually one-sided and directed negatively at the for-profit model.
That said, some evidence shows that these prisons operate at a lower cost to taxpayers, despite their tight margins. However - given that private prisons can choose their prisoners in certain contracts (typically less violent offenders or ones without mental health conditions), they can reduce security costs.
Still, one number about the differences between the two should enter the broader debate. Roughly 60% of the $50 billion spent on public prisons goes to the wages and benefits of public-sector employees.
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The call for bans to private prisons won't reduce crime, stop mass immigration, or reduce costs to taxpayers. And the charge that for-profit prisons incentivize more prisons is mostly confusing given the significantly smaller number of private prisons.
This is mostly a political talking point taken to appease a smaller base. Mass incarceration would still exist, just this time at the full hand of the state (government agencies at the state and federal level already oversee 94% of the prison population).
Prison REITs took a big hit several years ago after the Obama administration ordered the federal government to reduce the use of private prisons. The Trump administration, however, has reversed that order and sought the assistance of the private sector in detention of immigrants crossing the border without authorization.
The REITs now face pressure as various financial institutions cut funding and pension schemes and other institutional investors slashed their exposure due to divesting pressure from shareholders. The probability that the federal government will outright ban the practice of private prisons (the goal of Sen. Bernie Sanders (D-VT) but not independents) is very low.
That has led to a massive discount for a company like CoreCivic. A conservative analysis of cash flow puts the stock's net asset value at about $30 per share. That would represent an 82% discount to the REIT's NAV (the stock is currently trading for $16.50).
CoreCivic's assets are real assets primarily tied to land and buildings, and its contracts ensure a very positive future cash flow that should easily allow it to pay and protect its dividend. At a 10.6% dividend, investors who can hold their noses at the prison system could see a significant payday in the future.
The Bottom Line
CoreCivic isn't a popular company, and it operates outside the bounds of traditional ESG investing.
It's certainly generating controversy, but the narrative against it appears to be built on more hyperbole. Prison reform may improve both the industry and improve the company's operating numbers.
The company has a VQScore of 4.3 and a 10.6% dividend backed by contracts tied to the federal government.
CXW stock might see an uptick of investment as the 2020 election approaches. Should Trump become the likely winner of next year's election, it would reduce pressure on the private prison industry and fuel an uptick of buying from income-starved investors.
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About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.