CoreCivic’s Plunge Does Not Constitute A Buying Opportunity (NYSE:CXW)

Pgiam/E+ via Getty Images June 11th was a very painful day for shareholders of the publicly traded prison operators. Shares of CoreCivic, Inc. (NYSE:CXW) plummeted, declining by roughly 21.3% in midday trading. Even worse was the performance of Target Hospitality Corp. (TH). Its shares plummeted roughly 32.4%. At issue is the news that, in about 60 days, the U.S. government will no longer be paying for the detention of undocumented immigrants at the South Texas Family Residential Center in Dilley, Texas. Both companies generate revenue from providing these services at that facility. And clearly, this will have a negative impact on both firms. From a revenue perspective, the company that will be most impacted will be CoreCivic. It looks as though its bottom line will also be decimated by this development. When it comes to percent of revenue exposure, the real pain will befall Target Hospitality. But according to third-party estimates, the impact on the company’s profitability should be far smaller. The purpose of this article is to focus more on CoreCivic and what this might mean for investors moving forward. But I do think that Target Hospitality does deserve some attention, especially in light of the impact this might have on a potential buyout of the business. A look at CoreCivic In the publicly traded prison space, CoreCivic is a behemoth. According to management, the company is the largest owner of partnership correctional, detention, and residential re-entry facilities in the country. It’s also one of the largest prison operators as well. Operationally speaking, the enterprise has three different segments. The first of these, CoreCivic Safety, operates 43 correctional and detention facilities, 39 of which it owns. All combined, these facilities have around 65,000 beds. The second segment, CoreCivic Community, operates 23 residential re-entry centers that have a capacity of about 5,000 beds. And lastly, you have CoreCivic Properties, which owns 6 properties with a combined 10,000 beds. These are correctional facilities owned by the company that are held for lease to 3rd party operators. Using data from 2023, about 84.7% of the company’s net operating income came from its CoreCivic Safety segment, making it the most significant part of the business as far as investors are concerned. By comparison, CoreCivic Community and CoreCivic Properties are far smaller, accounting for only 5.2% and 10.1%, respectively, of net operating income. Author – SEC EDGAR Data Over the past few years, revenue for the company has not changed all that much. From 2021 to 2023, sales ticked up modestly from $1.86 billion to nearly $1.90 billion. Having said that, results for the 2024 fiscal year are looking up. In the first quarter of 2024, revenue for the business came in at $500.7 million. That’s up 9.3% compared to the $458 million reported for the same time one year earlier. A good portion of this increase can be attributed to a rise in revenue per compensated man-day. This represents the average revenue that the company generates for each offender on each day served. This metric totaled $100.85 in the first quarter of this year. That’s up from the $96.87 reported one year earlier. In addition to this, the company also benefited from a rise in the average compensated population from 49,844 to 52,176. I wish I could say that things on the bottom line were looking better. But that’s not the case, either. As the first chart in this article illustrates, revenue, profits, and cash flows, have been all over the map. The only real consistency has involved EBITDA, with the metric falling from $402 million in 2021 to $311 million last year. Even when you look at the current fiscal year, results have been mixed. Net income of $9.5 million fell short of the $12.4 million reported one year earlier. In addition to this, operating cash flow dropped from $89.8 million to $70.5 million. Other profitability metrics fared better. If we adjust for changes in working capital, for instance, we would have seen a rise in operating cash flow from $52.2 million to $71 million. Adjusted net profits nearly doubled from $14.7 million to $27.9 million. And lastly, EBITDA for the company expanded from $73.7 million to $500.7 million. Management had previously expected some rather impressive results for this year as a whole. They were forecasting adjusted net profits of between $74 million and $85 million. That’s up from the $70.4 million reported in 2023. Meanwhile, EBITDA was expected to be somewhere between $312 million and $321 million. This is a modest improvement over the $311 million reported for last year. No estimates were given when it came to operating cash flow. But if we assume that it will increase at the same rate, we would expect it to climb to approximately $227.5 million. Unfortunately, this no longer appears to be a possibility for the company. On June 10th, management received a notification from US Immigration and Customs Enforcement (known as ICE) wherein the agency made clear that it is planning to terminate its agreement with CoreCivic whereby CoreCivic has agreed to house up to 2,400 undocumented immigrants at a time. As of June 9th, however, the company housed only 1,561 individuals. From a revenue perspective, this does not appear to be all that awful a situation. Even though the company’s annual report states that it generated $156.1 million in sales associated with these operations during 2023, the press release announcing this problem pegged that number a bit higher at $156.6 million. My guess is that this is a typo. But at the end of the day, the size of this difference is immaterial. Even in the worst case, it’s responsible for only 8.3% of the firm’s overall revenue. On the bottom line, however, the picture is far more devastating. In response to this development, management said that they are suspending financial guidance for 2024. The good news is that the company will continue to generate revenue and cash flows from this contract until early August. So that means that it will benefit from this arrangement for most of this year. But in its press release regarding the matter, management said that the estimated annualized financial impact will be a reduction to earnings per share of between $0.38 and $0.41. To put this in perspective, when the company announced financial results for the first quarter of this year, it said that adjusted earnings per share this year should be between $0.66 and $0.76. If we take the midpoint here, this should mean that, instead of generating adjusted net profits this year of $79.5 million, the company should generate closer to $35.3 million on an annualized basis. This is a substantial reduction in profitability. Because we don’t have more details from management, it’s impossible to know the impact on other profitability metrics. But as an example, if we assume a proportional impact on those, we would see EBITDA on an annualized basis of around $140.4 million. That’s down from the $316.5 million previously anticipated by management. Adjusted operating cash flow, by comparison, would be around $108.9 million. That compares to the $227.5 million that guidance suggested the company would see. Author – SEC EDGAR Data In the chart above, you can see what this does for the company’s valuation on a pro forma basis. The 2024 figures are based on guidance for 2024 and do not factor in the period from early August through the end of this year without the contract in play. But even if you look at the 2023 figures, shares of the business as they stand today look very cheap. But that picture changes on a pro forma basis. The firm goes from low to mid-single digit trading multiples to low to mid double-digit multiples. I do think that it would be helpful to understand exactly why this is occurring. In a press release issued on June 10th, ICE stated that its goal is to increase its overall capacity for dealing with the immigration crisis in this nation. You see, on June 4th of this year, the Biden Administration issued a Presidential Proclamation aimed at streamlining the expedited removal process for those no longer allowed to remain in the country, and to speed removals for those individuals who qualify for this. This includes changing the company’s air charter contracts to increase the number of repatriation flights that the agency is capable of handling each week. Over the past year, it has averaged about 29 such flights each week. House.gov While it may seem counterproductive to end a contract that is capable of housing thousands of undocumented immigrants, ICE pointed out that the cost of this existing contract is incredibly high. The first indication that this might come to pass came out in August 2022. But in February of this year, the data in the memo in question was republished as a letter to Homeland Security Secretary Mayorkas signed by multiple members of Congress. According to the data provided, closing the facility in question would bring potential cost savings of up to $129 million annually. Throughout that letter, it was stated that for-profit private prisons are incentivized to cut costs. This includes by reducing staffing, and health care, as well as other things, to boost their profits. In fact, the letter even went on to say that the facilities are unsafe and that detained individuals are regularly denied medical care and other resources. And over 90% of detained immigrants are held in facilities owned or operated by such firms. By making certain proposed changes, including by expanding its own network and revisiting contracts regarding other facilities, ICE thinks that this maneuver can increase its bed capacity by roughly 1,600. If it seems unlikely that the government could save money from this maneuver while also expanding its bed capacity, consider that, based on the number of occupants that CoreCivic handled as of June of this year, the company generated about $100,320 annually in revenue from each occupant. Even though we are in a sense comparing apples to oranges, this is far above the $28,284 per year that the state of Texas spends for each of its prisoners. Even though I don’t expect these numbers to be at parity, I don’t think anybody would argue that there is a lot of space between these two figures where waste can exist. A look at Target Hospitality Author – SEC EDGAR Data If the analysis that I have conducted here ends up being correct, this move will be absolutely devastating for CoreCivic from a profitability perspective. However, this is not necessarily the case when it comes to Target Hospitality. Although much smaller than CoreCivic, Target Hospitality has a nice track record of growth recently, as shown by the chart above. And if we use original guidance provided by management for 2024 and historical results for 2023, shares of the business are trading at very low multiples. Unfortunately, it will also be impacted by this maneuver. Management has not provided significant details as to what this impact will be. Though they did say that they will come out with estimates before June 30th of this year. Author – SEC EDGAR Data This is not to imply that we can’t get some idea ahead of time. One analyst, Stephen Gengaro at Stifel, estimated that the facility in Dilley generates around $55 million in revenue for Target Hospitality each year. The estimate for gross profit is between $35 million and $37 million. At the midpoint, this translates to only 11.5% of the company’s gross profit. However, some of the firm’s revenue last year was irregular. A more appropriate estimate, according to the same analyst, is for an impact on profits of around 15%. Even if profitability were to drop by half, shares would still be trading at attractive multiples. In fact, even if adjusted operating cash flow fell by 75%, the company would still be trading at a price to adjusted operating cash flow multiple of 8.9. The EV to EBITDA multiple would be only marginally higher at 9.1. Another element to this, however, is the impact this might have on the potential buyout of the firm. Earlier this year, another party stepped up, offering to acquire the company for $10.80 per share. In response to this, the management team at Target Hospitality set up, in late April of this year, a special committee to explore the possibility of this deal occurring. I doubt that anybody would disagree with me when I say that this development that we are now seeing will drastically reduce the probability of this transaction occurring. Or if it does occur, it very likely would be at a lower price. Takeaway The way I see things, the picture is not looking positive for CoreCivic, Inc. at this time. Unless something changes, the company’s bottom line will probably be devastated. The picture is far opaquer when it comes to Target Hospitality, given the lack of data that management provided and how much we have to rely on third-party estimates for the impact this will have. Given my own estimates for CoreCivic, I think that the best rating that I can assign this stock would be a “hold” at this time. But I would argue that, with a possibility of a buyout and the margin of safety that seems to exist for Target Holdings, that it deserves a “strong buy” rating.

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