When one thinks of battleground stocks in the REIT space, retail and mall owners often come to mind. Outside of retail, I see Iron Mountain (IRM) as being another battleground stock, with bulls pointing to the durability of physical storage, and bears pointing to the threat from digitization.
While I see valid points from both sides, I believe the answer lies somewhere in the middle, with Iron Mountain straddling both sides of the equation. At the current price of $27.63, IRM is back to a 9% yield. In this article, I evaluate what makes Iron Mountain an attractive investment at the current valuation; so let’s get started.
(Source: Company website)
A Look Into Iron Mountain
Iron Mountain is a leader in information storage and management, and is used by over 225,000 organizations around the world. Its global real estate network covers more than 85 million square feet, across 1,400 facilities in over 50 countries. Its leadership position is further supported by the fact that it has a business relationship with nearly all of the Fortune 1000.
Physical storage continues to be the bread and butter of the business. As seen below, the company continued to grow its storage revenue, by 1.1% YoY, during the second quarter despite the uniquely challenging economic environment.
(Source: Company Earnings Presentation)
It should be noted, however, that the storage revenue growth was driven by pricing increases, as the total organic volume declined by 1.8M cubic feet compared to the first quarter. In addition, the Services segment saw a 23% revenue decline, as business activity slowed dramatically during the second quarter. I expect the Services segment to have continued challenges into Q3/Q4, as many companies are still adopting work-from-home practices, with the potential for a meaningful recovery in 2021.
Before investors start running for the hills, however, I’m not too concerned about the drop in physical storage volume, as it was largely expected due to the effects of COVID. In addition, the overall decline was partially offset by strength in the consumer business, which saw a 2M cubic feet sequential QoQ increase.
Looking forward, I expect to see a recovery in demand for the records management business in Q3 and for the remainder of the year. This is supported by the general normalization of economic activity, as social distancing measures have been relaxed, and by management’s expectation of a 0.5% annual volume growth in physical storage in a post-COVID world.
In the meantime, I see Iron Mountain’s digital transformation efforts as ramping up well. Earlier this month, they announced the formation of a joint venture to develop a 27 megawatt hyperscale data center in Frankfurt, Germany. IRM will earn fees, including property management, construction, and development fees for services provided to the venture.
Looking forward to the remainder of the year (Q3 and Q4), management expects to lease an additional 10+ megawatts. This would bring the full year 2020 total in new and expansion leases signed to 45-50 megawatts. I find this to be impressive, as this is substantially higher than the 17MW of leases that IRM signed in all of 2019. Longer-term, I expect data centers to be a key growth driver for IRM, as it is able to leverage its existing relationships and reputation as a trusted data steward, whether it be in physical or digital form.
In addition, I see the cost reduction efforts resulting from IRM’s Project Summit as bearing fruit. This is demonstrated by the YoY increase in the Gross Profit Margin, which increased by 210 bps, to 58.6% during the second quarter. I see this as being a net positive for the company not only financially, but also operationally, as the reduction in the number of VPs at the company enables more nimble decision making, and better cost matching with revenues in a changing demand environment.
Turning to the balance sheet, IRM maintains a steady leverage profile, with a net lease adjusted leverage of 5.4x, which is in-line with the company’s long-term target leverage ratio of 4.5x to 5.5x. In addition, IRM was able to extend its weighted average debt maturity by 2 years, to 7 years, with a 4.6% weighted average interest rate. Going forward, I expect to IRM to benefit from the current low-interest rate environment, which is expect to last at least until 2023, as it looks to refinance additional debt at opportune times.
Lastly, I find the 9% dividend yield to be attractive, especially in the current low-yield environment. The payout remains safe from an AFFO standpoint. Based on the $249M in AFFO that the company generated during Q2, and the 288M in fully diluted shares outstanding, I arrive at an AFFO/share of $0.86, which more than covers the $0.6185 dividend.
It should be noted that IRM received a tax refund in Q2, which helped its AFFO. Nonetheless, IRM still would have covered its dividend if it achieved zero YoY growth, at the Q2’19-level AFFO/share of $0.73 (based on Q2’19 AFFO of $210M, and 287M shares outstanding).
Iron Mountain is somewhat of a battleground stock, with most of its business still attached to physical storage. However, I don’t see this as a negative, as physical storage continues to provide substantial revenues. Although physical storage volume is expected to grow at just 0.5% annually in a post-COVID world, I see IRM as having continued pricing power through its moat-worthy relationships, as demonstrated during Q2. This should help drive higher revenue growth than volume growth.
In the meantime, IRM is rapidly evolving in data centers and has seen very strong YoY growth in new and expansion leases signed. I see IRM as having a differentiated business model in the data center segment, as it is able to leverage its existing relationships with many of the world’s leading businesses.
I also find the 9% dividend yield to be safe and attractive, and at the current blended P/AFFO of 9.1, the shares are trading at a 23% discount to their normal P/AFFO of 11.8. Based on this and the reasons stated above, I have a favorable view of the stock and see upside potential from the current price.
(Source: F.A.S.T. Graphs)
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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.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.