Undervalued Dividend Growth Stock of the Week: Iron Mountain Inc. (IRM)

High-yielding and high-quality dividend growth stocks can be fantastic income generators.

This income can be used to reinvest and buy more stocks, or it can be used to pay bills in retirement.

Either way, I’ve never heard anyone complain about receiving more money.

But yield can often be a proxy for risk.

That’s why it’s imperative to focus on quality businesses at appealing valuations.

Buying equity in high-quality companies that reward you with a healthy share of profit is a straightforward path to riches.

Even better if equity is purchased at appealing valuations.

And better yet if the profit and dividends are both regularly and reliably growing.

That’s dividend growth investing in a nutshell.

As I lay out in my Early Retirement Blueprint, I used this simple strategy to retire in my early 30s.

I now live off of dividend income, in exotic Thailand.

Higher-yielding stocks have certainly helped me get here.

However, I don’t sacrifice quality in the name of yield.

A big yield might dazzle new investors. But don’t let a big yield fool you into investing in a low-quality company. A big dividend that’s unsustainable will often lead to dividend cuts and lost capital.

That’s no good.

Take a look at my FIRE Fund, for example.

This is my real-life, real-money early retirement stock portfolio.

It generates the five-figure and growing passive dividend income I need to live off of.

There are numerous high-yield stocks in the Fund.

But they’re not low-quality businesses.

Jason Fieber's Dividend Growth PortfolioAlmost all of them have lengthy track records for rising dividend payments.

That’s a great initial quality indicator.

After all, it’s almost impossible to run a low-quality company while simultaneously paying out ever-rising cash dividends to your shareholders.

That’s why the Dividend Champions, Contenders, and Challengers list is such a great resource for dividend growth investors.

It contains information on more than 800 US-listed stocks. All of them have paid rising dividends each year for at least the last five consecutive years.

It shouldn’t be a surprise that many stocks on that list are blue-chip stocks.

Moreover, quite a few stocks on that list offer yields in excess of 4%.

So you can have your cake and eat it, too.

Quality and yield are great.

Valuation is also extremely important, however.

“Price is what you pay. Value is what you get.” – Warren Buffett

An undervalued dividend growth stock should present a higher yield, greater long-term total return potential, and reduced risk.

That’s all relative to what the same stock would otherwise offer if it were fairly valued or overvalued.

The higher yield comes about because of the inverse relationship between price and yield.

All else equal, a lower price will result in a higher yield.

More passive investment income is great. But it gets better.

A higher yield should lead to greater long-term total return potential.

Total return is simply comprised of investment income and capital gain.

Well, investment income is given a boost via the higher yield.

But capital gain also stands to benefit via the “upside” between price and value.

Stock prices gyrate every day because of investor emotions. Value, however, far less volatile.

Buying when there’s a favorable mismatch between price and value sets you up with that upside.

That’s on top of whatever capital gain would be available as a high-quality company naturally becomes worth more over time.

These dynamics should also reduce risk.

Paying a price well below estimated intrinsic value introduces a margin of safety.

That’s a “buffer” that protects the investor against unforeseen events that can diminish the value of a business.

Fortunately, undervaluation isn’t terribly difficult to spot and take advantage of.

Fellow contributor Dave Van Knapp has made it even easier to do so by way of his “lesson” on valuation.

Part of a series of lessons on the entire DGI strategy, Lesson 11: Valuation lays out a valuation system that can be applied to almost any dividend growth stock out there.

This is an awesome tool that you can use to put yourself in the driver’s seat.

With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…

Iron Mountain Inc. (IRM)

Iron Mountain Inc. (IRM) is a real estate investment trust that operates as a global leader in documents storage.

A real estate investment trust is required by law to return at least 90% of its taxable income to shareholders in the form of dividends. This makes REITs very attractive for income seekers.

With more than 1,400 secure storage facilities across more than 50 countries, Iron Mountain has no peer.

The company uses its combined 85 million square feet of facilities to store and protect billions of valued assets, including critical business information, highly sensitive data, and cultural and historical artifacts.

Revenue is broken out across two primary business segments: Storage Rental, 62% of FY 2018 revenue; and Service, 38%.

Approximately 67% of revenue is from North American operations, with the remaining revenue generated from Europe (19%), Latin America (7%), and Asia (7%).

Iron Mountain currently serves ~95% of Fortune 500 companies. They have over 225,000 customers.

This is a highly durable business model, with a 98% customer retention rate. Indeed, with no major peer, Iron Mountain has a very captive customer base. Low cost of storage (relative to a company’s overall spending) is more than worth the security of assets. Switching costs are thus irrelevant.

Document storage might be boring, but boring investing is often the best investing.

That said, there’s nothing boring about this company’s iron mountain (pun intended) of a dividend.

It’s a massive dividend.

In fact, the stock yields 6.84%.

That’s more than three times the broader market’s yield.

It’s also more than 70 basis points higher than the stock’s own five-year average yield.

If that dividend were just big, it’d be great. But it’s also growing.

Iron Mountain has increased its dividend for nine consecutive years.

The five-year dividend growth rate is 7.2%, which is silly high for a stock that’s already yielding almost 7%.

There are very few instances in which you’re going to get this kind of yield in conjunction with a DGR this high.

Now, there’s been some slowing of the dividend growth. The most recent raise was 4%.

But a 7% yield that’s growing in the low single digits sets you up very nicely moving forward. That’s in terms of both aggregate income and total return.

This is assuming, of course, the dividend isn’t in danger. As I noted earlier, yield can often be a proxy for risk.

However, Iron Mountain’s dividend appears to be sustainable.

With a REIT, it’s important to look at FFO or AFFO – funds from operations or adjusted funds from operations.

Because of the way real estate investment trusts are structured and earn money, earnings per share can’t be used to determine profitability.

FFO adds depreciation and amortization back to earnings, while subtracting gains on sales. It’s a more accurate look at profit because the value of real estate is usually not depreciating in the way that GAAP financial reports would indicate.

The payout ratio, using FY 2018 AFFO/share, is 80.4%.

It’s tight coverage, which isn’t surprising for a REIT. But there doesn’t appear to be any risk of a near-term dividend cut.

I wouldn’t expect massive dividend growth, but the high starting yield doesn’t require it.

We do want growth, though. Investors invest for growth. This stock might not require a lot of it, but determining the amount of growth to expect moving forward will tell us a lot about what the business might be worth.

I’ll first take a look at what Iron Mountain has done in terms of top-line and bottom-line growth since FY 2015. And then I’ll compare that to a near-term professional forecast for growth.

I usually look at a 10-year track record for growth. However, Iron Mountain reorganized as a REIT in 2014. So I’m only looking at the results with the current entity.

Combining the results thus far with a professional estimate for go-forward numbers should give us plenty to work with.

Iron Mountain grew its revenue from $3.008 billion in FY 2015 to $4.226 billion in FY 2018. That’s a compound annual growth rate of 12.0%.

Outstanding top-line growth here. But it’s not all organic.

While the underlying physical asset storage business is boring and predictable, Iron Mountain has been busy diversifying itself and protecting its interests.

A major aspect of that has been the diversification into data centers, which is an obvious move for this company. As storage and data becomes increasingly cloud-based and digital, data centers are growing like crazy. This threatens physical storage.

In fact, the bear case here is based around the existential crisis of the business model itself. There could be a future in which document storage is mostly obsolete.

The move to data centers seems very prudent on management’s part, in my view.

Furthermore, Iron Mountain already has a massive built-in customer base to tap. This makes it easy to transition relevant customers right over to their data centers.

A recent move in this department was the acquisition of the US operations of IO Data Centers in 2017 for $1.32 billion. This scaled them right up, as IO Data Centers was a leading colocation data center services provider.

However, the move into data centers is also fraught with possible pitfalls, as Iron Mountain lacks any experience in this space. And the company, organized as a REIT, has to fund these moves by issuing debt and equity.

If we factor in the issuance of equity as it pertains to dilution, and get our best look at true profit growth, FFO/share grew from $1.43 to $2.22 over this period. That’s a CAGR of 15.79%.

Fantastic stuff here, really.

I wouldn’t expect it to continue indefinitely, however. But I don’t see why anyone would. This company has a very low bar to clear. And that’s why it’s so appealing here. As long as it doesn’t go bust, they don’t have to do much to be a very good investment.

Looking forward, CFRA is predicting that Iron Mountain will compound its FFO/share at an annual rate of 3% over the next three years.

Iron Mountain has already provided guidance for FY 2019. And this 3% forecast is right in line with what Iron Mountain put out.

Indeed, the midpoint of FY 2019 AFFO guidance, at $900 million, would represent 3% YOY growth compared to the $874 million of AFFO Iron Mountain generated for FY 2018.

But there is an opportunity for acceleration.

Primarily, we can look at how Iron Mountain sees its revenue mix changing.

It states that 75% of revenue is generated from its “developed portfolio”, including developed markets of North America and Western Europe. This portfolio features ~3% revenue growth.

The remaining 25% of revenue comes from the “growth portfolio”, which includes emerging markets, data center business, and adjacent businesses. This portfolio sports ~6% revenue growth.

Combined, it’s 3.6% revenue growth.

The plan is for this to move to a 70/30 split by 2010, along with margin expansion in the interim, with overall revenue growth of ~5% as a result.

Again, it’s a low bar to clear. Iron Mountain need not, well, move iron mountains in order to do well for its shareholders. It simply has to avoid doing anything terribly wrong.

Looking at the balance sheet, we can see that the company has a substantial amount of debt.

However, almost all REITs carry quite a bit of debt. Because they must return most of their earnings to shareholders in the form of dividends, they typically fund growth by issuing debt and equity. It’s the name of the game.

Furthermore, Iron Mountain has operated with a heavy debt load for years. The only problem I see here is that interest rates are rising, making that more of a burden moving forward.

The long-term debt/equity ratio is 4.25.

Total assets of $11.852 billion lines up against 9.967 billion of total liabilities.

The current fixed charge ratio of 2.2 is well over the firm’s covenant limit of 1.5. Fixed rate debt makes up 73% of total debt. And there are no significant maturities until 2023.

It’s difficult to measure profitability for a REIT. GAAP income numbers don’t really tell the whole story.

But Iron Mountain is clearly growing at a nice clip, and it’s hedging its bets with its encroachment into data centers.

When I think about risks, it’s pretty clear.

The primary risk is the very business model.

There’s a risk of obsolescence. While not all of that which it stores can just be moved right over to the cloud, basic paperwork and data could be.

In addition, the balance sheet is stretched.

Iron Mountain is carrying a heavy amount of debt. It’s not something to be immediately concerned by, but I think it does limit their ability to pivot aggressively. And that could pressure dilution as the company seeks to raise capital through stock issuance.

That pivot, by the way, is into an area in which Iron Mountain hasn’t yet developed expertise or scale. So it might be a tough road ahead.

Even with those risks, there’s a lot to like about this stock. I wouldn’t want to bet the farm on it, but a ~7% yield goes very far, even with only a little exposure.

At the right valuation, it could be a particularly fantastic investment.

Well, the valuation looks appealing right now…

If we use NAREIT FFO, the stock is trading hands for a P/FFO ratio of 16.09.

That would be the closest equivalent to a P/E ratio, and you can see how much lower than that is than the broader market.

If we use AFFO, the stock is available for a P/AFFO ratio of 11.75.

Either you slice it, it looks cheap.

We can also cut right through the fog and get to cash flow.

The P/CF ratio, at 10.8, is substantially below the stock’s own three-year average P/CF ratio of 13.6.

And the yield, as noted earlier, is quite a bit higher than its own recent historical average.

So the stock does look like it’s on sale. But how cheap might it be? What would a reasonable estimate of intrinsic value look like?

I valued shares using a dividend discount model analysis.

I factored in an 8% discount rate (accounting for the high yield) and a long-term dividend growth rate of 2%.

I’m clearly assuming the DGR will radically slow.

That’s because the debt has to be reckoned with. In addition, the near-term go-forward estimate of FFO/share growth is only 3%.

And with the payout ratio (using AFFO) at roughly 80%, I don’t think there’s room for payout ratio expansion.

If anything, the dividend should grow slightly slower than profit over the near term in order to bring that down a tad.

However, the aforementioned growth catalysts (the changing revenue mix) offer an opportunity for more growth than that 3% forecast.

And the stability of the storage business is a floor on the business and its growth profile.

I believe this is a conservative look at the valuation. But I think the makeup of this business deserves caution.

The DDM analysis gives me a fair value of $41.48.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

Even with a conservative valuation, the stock still looks to be very undervalued.

But we’ll now compare that valuation with where two professional stock analysis firms have come out at.

This adds balance, depth, and perspective to our conclusion.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates IRM as a 3-star stock, with a fair value estimate of $36.50.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates IRM as a 3-star “HOLD”, with a 12-month target price of $39.00.

Averaging the three numbers out gives us a final valuation of $38.99, which would indicate the stock is possibly 9% undervalued.

Bottom line: Iron Mountain Inc. (IRM) is a dominant company that serves 95% of the Fortune 500. Its legacy business offers recurring cash flow, which allows it to invest in and adapt to new technologies to ensure its long-term survival. With a yield near 7%, almost a decade of dividend raises, significant growth catalysts, and the potential that shares are 9% undervalued, this high-yield stock in a low-yield market should be strongly considered for income seekers.

— Jason Fieber

Note from DTA: How safe is IRM’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 52. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, IRM’s dividend appears borderline safe with a low risk of being cut. Learn more about Dividend Safety Scores here.

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