Because of COVID-19, iREIT on Alpha is now tracking 58 equity REIT dividend cuts and/or suspensions. Of them, some were expected, such as:
- New Senior (SNR)
- Outfront Media (OUT)
- Armada Hoffler (AHH)
- EPR Properties (EPR)
- Global Net Lease (GNL)
- Preferred Apartments (APTS)
- Whitestone REIT (WSR)
- Washington Prime (WPG).
Other weren’t, including:
By now, we all know – or should know – that this is a global pandemic. No REIT is immune from turbulence, but certain property sectors do appear more defensive than others.
Farthest from COVID-19 risks are the “technology trifecta”: cell towers, data centers, and logistics. Fortunately, we’ve been overweight in all these sectors since before the shutdowns. That’s enabled us to maintain some truly impressive returns.
According to Cohen & Steers, “These three sectors, which constitute over 40% of the U.S. REIT market, provide critical infrastructure for many of the technology services upon which the world increasingly depends. Notably, each delivered positive returns during the market downturn of the first half of 2020.”
And we have the proof-positive down below.
Durable Income Opportunities for All
Take three of our top performers in the Durable Income Portfolio. They’ve returned an average of 20% year-to-date:
They’ve actually been worthwhile additions since the portfolio’s inception in 2013, returning an annual average of 23%. (Note: The larger Durable Income collection has returned 12% annually since inception.)
- Cyrus One – 28.4% per year
- Digital Realty – 22.6% per year
- Crown Castle – 22.5% per year.
It’s no fluke that the Durable Income Portfolio has generated rock-solid results. And we can credit that success to rock-solid dividends.
We consider dividend safety paramount to successful REIT investing. That’s allowed us to overall avoid catastrophic dividend blowups, both this year and in the past.
Occasionally, we will recommend an outlier: A REIT that generates an above-average yield with exceptional total return potential. We do own a few of those right now. But we always analyze their risk profiles and publish their possible downsides accordingly.
That’s what we’re doing today by taking a closer look at Iron Mountain (IRM). As its website says, it’s “the world leader in storage and information management services.”
And it’s been a singular stock in the past, leading us to wonder if it’s still got what it takes.
The Business Model
I purposely included the picture above. It’s of Iron Mountain’s racking system, which were designed to “withstand the 8.8 magnitude earthquake in 2010 that devastated the Chilean regions of Maule and Bio Bio.”
That kind of attention to detail is how Iron Mountain was able to convert from a C-Corporation to a REIT.
Specifically, just over four years ago, Iron Mountain obtained a Private Letter Ruling (PLR) from the IRS. It was regarding the characterization of the company’s steel racking structures as real estate. This was an important milestone because it allowed IRM to follow the steps of Equinix (NASDAQ:EQIX) and other data center REITs.
By converting to a REIT in the first place – on the back of its racking system – Iron Mountain pays out a larger dividend. However, since the PLR, IRM shares have underperformed the broader REIT market as compared with VNQ:
Source: Yahoo Finance
Keep in mind, however, that Iron Mountain has a diverse business model and more than 70 years of experience. Plus, it’s real estate network involves:
- More than 85 million square feet
- Across more than 1,400 facilities
- In over 50 countries.
The company has an equity market cap of around $7 billion with a total enterprise value of over $16 billion.
Iron Mountain considers itself a “trusted guardian” of “assets most important” to its customers by “securing their past, present, and future value.” It “stores and protects billions of valued assets, including critical business information, highly sensitive data, and cultural and historical artifacts.”
The company essentially “looks after the information of some 225,000 customers, including 95% of the Fortune 1000.”
More About the Iron Mountain Way of Doing Business
Iron Mountain serves mission-critical storage to these diverse industries:
- Healthcare – 16%
- Federal – 2%
- Legal – 8%
- Financial – 12%
- Insurance – 6%
- Life sciences – 3%
- Energy – 3%
- Business services – 1%
- Other – 50%.
As viewed below, the storage segment represents around 64% of its total revenue. You can also break it down as:
- Records management (including storage) – 72%
- Data management – 13%
- Data centers – 9%
- Adjacent business – 3%
The service sector represents 36% of Iron Mountain’s revenue. This includes records management (45%), secure shred (25%), digital solutions (13%), data management (11%), adjacent business (4%), and other.
Records management is clearly Iron Mountain’s “core business” then, with 72% of storage revenue and 45% of service revenue. This pillar is marked by:
- 720 million cubic feet of archived hard-copy records
- 98% customer retention rate
- Steady organic revenue growth supported by revenue management
- 50% or more of boxes that stay in its facilities an average of 15 years
In a recent virtual conference call, Iron Mountain CEO Bill Meaney explained that last stat means “it’s a 75% gross margin business.”
He calls this business the “financial beast” because “it drives so much profitability and cash that we both use it to pay our dividend and invest in the growth of the business.”
It certainly has some claims to fame to work off of in those growth pursuits. Iron Mountain just so happens to store the wills of famous faces like Princess Diana, Charles Dickens, and Charles Darwin. It also preserves the original recordings of Frank Sinatra and Prince.
Better yet, as viewed below, more than 96% of its facilities “are open at varying levels of operations.” And “over 97% of annual storage rental revenue was inbounded in prior years.”
An Expansive Reach
Iron Mountain has relationships with 950 of the Fortune 1000. Or, as Meaney explained, “950 of the largest global companies are our customers and we have built that on a level of trust.”
One of the reasons I’ve been so bullish about its business model is IRM’s ability to cross-sell its customers to the cloud. It’s made significant progress in shifting its revenue mix to faster-growing businesses. This includes emerging markets, data centers, and adjacent business segments.
In total, five of the top 10 cloud providers utilize Iron Mountain’s data centers.
Currently, the company owns 14 of these (operating) facilities across the U.S., Europe, and Asia, and it continues to bring in new business. IRM recently signed a 3MW lease with a Fortune Global 200 company in Singapore at its SIN-1 datacenter. That’s for utilization of its colocation space and network services, as well as storage and office space.
Iron Mountain also has expanded its data center footprint globally via Fortrust, I/O, Credit Suisse, and EvoSwitch acquisitions. It’s targeting these business to be 10% of its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by the end of 2020.
As viewed below, this shift to has enhanced EBITDA margins:
And it has significant expansion opportunities left in this regard:
Right From the Iron Mountain’s Mouth
In a white paper, Iron Mountain explains (emphasis added throughout):
“The amount of data stored in large data centers in the core will be more than double the amount stored in the endpoint, reversing earlier trends, where data storage was growing fastest at the edge or with the end user.
“According to IDC, 49% of data will be stored in public cloud environments by 2025. And nearly 30% will be consumed in real time.”
Every business involves unstructured data, the report states. It’s only a matter of knowing what to do with it and how to most positively affect everyone involved.
“… the key is knowing how to use and process it to the greatest business advantage, which data to store and which to discard. It is very expensive to store and maintain unstructured data because of its size, the processing power it requires, and the fact that not all of it is useful.
“According to a recent survey by the Economist Intelligence Unit, employees spend over (25%) of their time simply tracking down data. In most companies, data is created and accessed ad hoc, and it is not organized to encourage accessibility. Without clearly-defined pathways for the vast majority of the data companies are generating, end users cannot massage it, visualize it, secure it, or manipulate it in any meaningful way
“The growth in data and the growing need to automate management of this data is driving both reactive (compliance and security-driven) and proactive (competitive advantage, transactional) business cases for the deployment of machine learning.”
Iron Mountain says there’s a lot of hype around digital transformation strategies. But really, most businesses haven’t embraced its full capabilities. They still greatly require automated analytical tools to manage what they do have.
The Balance Sheet
To be clear, we’re reluctant to recommend outsized positions in Iron Mountain because of its balance sheet.
Some analysts call it a “blue chip.” But I can’t get my arms around that designation for a company S&P rates as BB-.
That indicates concern about deteriorating economic conditions and/or company-specific possibilities that could hurt its cash flow. It also means Iron Mountain is one step closer to being downgraded to B+.
As The Balance writes, a B rating means a company, “can meet their current financial commitments. But their future outlook is more vulnerable to adverse developments.”
Still, Iron Mountain operates a unique business model that derives revenue from multiple sources – primarily storage, with every box essentially acting as a revenue driver.
I also would argue that the business model is somewhat recession proof and seemingly pandemic proof. Trusted assets such as tax returns, wills, and artwork are essential, after all, and customers want security and privacy for that storage.
Thus, I make the case that there’s “brand equity” given its wider moat advantages. And keep in mind that the pricing model is advantageous for Iron Mountain, much like Orange Door is for Public Storage (PSA) – in which consumers feel safe with a trusted global brand.
As for leverage, it does run higher with a target of 4.5x-5.5x.
But it’s driving that down, in part by simplifying its business model via its “Project Summit.” That’s its process of consolidating external reporting segments and streamlining the management structure.
Prior to COVID-19, the company reduced the number of its layers and reporting levels. This has reduced its VP count by approximately 45% so far. And it plans to cut around 700 positions in all this year and next.
Silver Bullets at Its Disposal
As viewed below, the financial impact should add $375 million of EBITDA benefits through 2021 that could add meaningful value to Iron Mountain’s bottom line. As of Q1-20, it had a cash balance of $150 million and $1 billion remaining on its revolver.
There are no significant debt maturities on its horizon.
Another “silver bullet” at its disposal has to do with its owned real estate. Although the company was successful in using its “racking” assets to form the REIT, it still has around $2.5 billion of “owned” real estate at its disposal.
So Iron Mountain could – theoretically – sell all of its “owned” real estate and lease it back to a REIT like W.P. Carey (WPC). Again, to qualify as a REIT, a company must either invest a minimum 75% of assets in real estate or generate 75% of gross income in rents, sales or interest in real estate.
I’m not predicting it will go that route. But for the sake of discussion, assume it sold $2.5 billion of “owned” real estate to WPC at a 6.5% cap rate.
I estimate its weighted average cost of capital at around 7% – meaning that a large sale-leaseback transaction could “move the needle” considerably.
In other words, Iron Mountain could generate enhanced margins by reducing debt and reinvesting proceeds back into its “financial beast” that generates superior returns compared to its cost of capital.
As far as I’m concerned – given the global demand for data storage – Iron Mountain should take a much closer look at monetizing its owned real estate to drive shareholder value.
But to be clear, I’m not an activist, merely a suggestivist!
Can the Dividend be Trusted?
A few weeks ago, I interviewed Iron Mountain’s Meaney, where he explained:
“I don’t think it should be lost on folks that during the darkest point of this thing, we issued our earnings… we also declared our dividend and kept the dividend flat, and reaffirmed our confidence in being able to – in the 2022, 2023 timeframe – to get into that mid-60s (adjusted funds from operations) AFFO payout ratio without cutting the dividend.
“So we feel really good about where we are. Yeah, it’s hit… first of all, 40% of our revenue is service… that’s about 20% of our profits. And of that profit pool, about 70% of the activities are down 40%.”
Meaney calls that “impactful” but “not major,” especially with the resources it has to reduce costs. And he added that, comparatively speaking, the company is looking good.
“… I’d rather have my chair than a lot of chairs navigating through this thing – and I think dividends, when you’re an income-oriented stock, that’s an important trust bond that you have with your investors. And it’s one that, luckily, with our business model, we’re able to honor.”
To better understand the dividend risk, I put together an updated AFFO-per-share model with analyst estimates for 2020-2023:
In full disclosure, that’s based on this many analysts:
Still, let’s examine the dividend per share model as well:
Clearly, Iron Mountain’s dividend growth engine has slowed, an issue iREIT takes seriously. And, in terms of the payout ratio, its dividend safety score isn’t as good as it was before.
However, consensus AFFO per share looks strong, especially in 2021 as “project summit” delivers its full potential. Assuming analysts are right about Iron Mountain delivering 15% growth in 2021, its payout ratio could improve to 75%.
All things considered, we consider Iron Mountain attractive based on a valuation basis. Shares now trade at $27.27 with a P/AFFO multiple of 9.3x (it’s norm is 11.8x) and dividend yield of 9.07%.
Source: FAST Graphs
Project Summit serves as a catalyst to drive profitability, and I consider the company’s “owned” real estate as an essential part of its value creation thesis.
Iron Mountain is targeting AFFO per share of 4% annually. But it could deliver stronger margins if it deployed sale/leaseback capital into more accretive hyperscale deals (10%-14% cash on cash returns).
Meaney says (emphasis added), “A good portion of the digital economy will be founded on the hyper-connected data center.” And, to date, Iron Mountain has already “invested over $2 billion in cutting-edge global data center infrastructure.”
The key to unlocking value is to exploit its digital and data center assets so customers can migrate to cloud storage, workflow automation, imaging and data restoration, and AI-powered SaaS (software as a service). And Meaney seems to very well understand that.
That’s why we’re maintaining a Strong Spec Buy.
Source: FAST Graphs
Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
WHO PAID RENT? WHO CUT DIVIDENDS?
We just launched iREIT Earnings Headquarters:
- Revamped Dividend Cut Tracker
- Real-Time Rent Collection Tool
- Real Estate Earnings Calendar (with 200+ companies)
- Quick Take commentaries.
Disclosure: I am/we are long IRM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha