Corrections Corp Of America (CXW), Iron Mountain Incorporated (IRM): Conversion to REIT Status Could Mean Big Gains for This Little Known Stock

Income taxes will fall to nearly zero from $98 million, while the cost of debt for the company has declined substantially. In April 2013, two new debt issuances were completed for $675 million at an average rate of 4.375%.  Prior to the issuance, CCA was paying an effective interest rate of 6.70% ($75 million in interest expense on $1.112 billion in long-term debt). With 60% of its long-term debt at this lower rate, CCA will save 23% on its debt servicing costs . Therefore, the REIT conversion has lowered the cost of debt by $17 million per year while decreasing income taxes by $98 million per year, increasing the earnings power of the company .  Since the REIT application became public knowledge, CCA’s price/sales multiple has expanded by 11% indicating that the significance of the REIT conversion may not yet be fully discounted.

The consensus earnings expectation for CCA is $2.01 per share for the upcoming 12 months. As shown above, when considering the effect of lower tax and debt costs and expecting flat revenue growth there appears to be substantial upside to the current analyst expectations. The top range of the company guidance is $2.16 per share, which also seems quite conservative.  Costs have risen and narrowing margins could be a concern, however, the company seems well situated to outperform expectations moving forward.

The dividend will also be raised as a result of the REIT conversion. CCA is required to pay a minimum of 90% of its net income as dividends and Todd Mullenger stated on the most recent earnings call that $2.12 per share will be paid in dividends over the next year.  This corresponds to a 6.3% yield at the current market price and a 10% raise in the trailing dividend yield.

Conclusions

Over the past several months all income-producing assets have been under considerable pressure as the market has become concerned about the threat of rising interest rates. Corrections Corp Of America (NYSE:CXW) has pulled back as well, however this most likely represents a buying opportunity. Assuming fairly conservative earnings expectations of $2.20 per share CCA should have upside to $40 per share within the next 12 months by assigning the average multiple the company has received over the past 5 years.  If CCA receives a valuation even close to the average REIT the upside would be considerably greater.

Brendan O’Boyle is short CXW Jul-2013 $34 puts. The Motley Fool recommends American Tower  and Corrections of America. The Motley Fool owns shares of American Tower . Brendan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article Conversion to REIT Status Could Mean Big Gains for This Little Known Stock originally appeared on Fool.com is written by Brendan O’Boyle.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.