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

If getting rich were easy, everyone would be doing it.

Or so you’ve probably been told.

Well, getting rich is actually a simple process, yet so few are doing it.

What gives? 

I’ll tell you.

Most people are not taking advantage of capitalism as investors. 

If you have $100, you can do a lot of things with that money.

You could spend it. Be a consumer. Buy something that might be gone or useless tomorrow.

Or you could invest it. Be an investor. Buy stock that’ll likely compound for the rest of your life.

I used to spend my money frivolously and waste it away.

And I was broke because of it.

Then I decided to wake up and stop being foolish with my money.

By making that pivot in my life, I went from broke to financially free in just six years.

I lay out exactly how that process unfolded – and how you can do the same – in my Early Retirement Blueprint.

Suffice to say, I took full advantage of capitalism as an investor.

Now I own and control the FIRE Fund.

This real-money stock portfolio generates the five-figure passive dividend income I need to pay my bills.

I’m in my 30s.

Retired.

And living off of passive income.

It’s a dream come true.

But I had to take advantage of capitalism in order to make this happen.

I’ve followed the tenets of dividend growth investing as I’ve gone about building my wealth.

This is an amazing long-term investment strategy.

Jason Fieber's Dividend Growth PortfolioIt basically involves buying shares in world-class enterprises that are highly profitable and sending their shareholders rising cash dividend payments.

You can find more than 800 US-listed dividend growth stocks by checking out the Dividend Champions, Contenders, and Challengers list.

Does all of this sound simple? 

That’s because it is!

Like I said earlier, getting rich actually is a simple process.

But you have to make the proper choices.

Now, the investing portion is clearly a bit more complicated than randomly buying stocks.

I’ve always tried to invest in the highest-quality companies at the lowest valuations.

A quality company stands to do better over the long term than a mediocre company.

And valuation plays a critical role in an investment’s performance.

While price is what a stock costs, value is what a stock is worth.

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

That’s relative to what the same stock might otherwise provide if it were fairly valued or overvalued.

Price and yield are inversely correlated. All else equal, a lower price results in a higher yield.

This higher yield leads to greater long-term total return potential.

That’s because total return is the sum of investment income and capital gain.

The possible investment income given a boost by a higher yield.

In addition, possible capital gain is given a boost via the “upside” between price and value.

If/when the market realizes a stock mispricing, when undervaluation is present, that results in capital gain.

These favorable dynamics should also reduce risk.

An investor introduces a margin of safety, or “buffer”, with undervaluation.

This protects the investor’s downside against unforeseen circumstances that could erode the value of a business.

All well and good to understand this, but one still has to be able to spot undervaluation and execute.

Fortunately, we’ve got you covered.

Fellow contributor Dave Van Knapp penned a great piece on valuation, which is part of an overarching series of “lessons” on the dividend growth investing strategy.

See Lesson 11: Valuation for more.

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) 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 appealing for investors in need of income.

REITs usually focus on real estate, as their legal structure implies.

What’s great about REITs is, investors get to participate in the wondrous nature of investing in real estate without directly getting their hands dirty and dealing with all of the drawbacks of owning physical properties.

Iron Mountain is a great example of that kind of opportunity.

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.

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

Obviously, it would be impossible for an individual investor to go out and accumulate these properties. One can instead buy Iron Mountain stock and get that real estate exposure instantly.

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. The remaining revenue is 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. 50%+ of boxes stay in facilities for 15 years on average.

With no major competitor in sight, Iron Mountain has a very captive customer base. The low cost of storage (relative to a company’s overall spending) is more than worth the security of assets. Switching costs are thus irrelevant.

This unique and durable business model operating in a niche industry sets them up with inherent competitive advantages.

And that sets investors up with great conditions for durable, growing dividends.

Iron Mountain has increased its dividend for nine consecutive years already.

A solid track record, but I think it’s short length belies the potential. Iron Mountain converted to a REIT in 2014, which put the legal framework in place for bigger, growing dividends.

Speaking of bigger, the stock yields a massive 8.18% right now.

That’s more than four times the yield of the broader market.

This yield is also more than 200 basis points higher than the stock’s own five-year average yield.

That speaks to what I noted earlier about undervaluation and higher yield.

A gigantic yield like this is usually only present when there’s a wobbly dividend at risk of being cut.

Well, that doesn’t appear to be the case here at all.

Again, it’s a REIT. So there’s some dividend protection built in, assuming they’re not losing money.

Also, as a REIT, we have to look at funds from operations (FFO) or adjusted funds from operations (AFFO) to determine the extent of profit.

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.

Based on 2019 guidance of AFFO/share of $3.14 at the midpoint, the payout ratio is currently sitting at 77.8% on a forward-looking basis.

A payout ratio near 80% is not uncommon for a REIT. So the dividend doesn’t appear to be in any danger.

If anything, it’s the opposite.

It’s a dividend that continues to grow like clockwork – the three-year dividend growth rate is 7.2%.

This is one of those rare scenarios in which a dividend has a great combination of sustainability, high yield, and even high growth.

Of course, we invest in where a company and its dividend is going, not where it’s been.

I’ll now try to build out a future trajectory, which will give us a lot of information to work with when it comes time to estimate the intrinsic value of the stock.

I will rely first on what Iron Mountain has done thus far. Then I’ll add in a professional forecast for near-term growth.

Combining the known past with a good look at what might come to pass should tell us a lot about this company’s track.

I typically like to show you what a company has done over the last decade, using that as a proxy for the long haul.

However, since Iron Mountain reorganized as a REIT in 2014, I’m only going to use numbers that are relevant to the current entity.

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%.

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

While the underlying physical asset storage business is durable, it’s not totally future-proof.

Iron Mountain recognizes that the move away from paper assets and toward digital assets is a threat. Perhaps not an immediate threat, but management is trying to make sure it protects the business.

Management has starting diversifying Iron Mountain’s interests into data centers.

It’s an obvious and natural transition.

As storage and data becomes increasingly cloud-based and digital, data centers are growing like crazy. This endangers physical storage.

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.

The bear case here is based around the existential threat 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.

As part of this transition, Iron Mountain acquired the US operations of IO Data Centers in 2017 for $1.32 billion.

This immediately scaled them, as IO Data Centers was a leading colocation data center services provider.

However, the move into data centers is also fraught with possible pitfalls.

Specifically, 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.

Let’s now look at that profit growth after factoring in dilution.

If we factor in the issuance of equity as it pertains to dilution, getting 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%.

Even with the dilution, the company is growing at a very strong rate.

We can now see how they’ve been able to hand out such big dividend raises on top of such a high yield.

Now, I wouldn’t expect this kind of growth to continue.

Moreover, it’s a very short period of time we’re looking at.

Thus, it’s difficult to glean too much from this.

But the stock doesn’t have to do a lot to be a great investment. As Warren Buffett would put it, they really only have to clear one-foot bars. You need almost no growth when the stock is already yielding over 8%.

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

This is clearly a substantial slowdown compared to what’s transpired since FY 2015.

Again, though, it’s difficult to put too much weight on the results we see above because of the REIT conversion and messy nature of the numbers since then.

Still, 3% FFO/share growth would provide the fuel for similar dividend growth.

And if you can get 3% dividend growth on an 8% yield, you could be looking at 10%+ annual returns moving forward – with almost all of that return coming in the form of big cash dividend payments.

I think this 3% call is accurate.

Iron Mountain’s own guidance for FY 2019 calls for $900 million in AFFO at the midpoint. This would represent exactly 3% YOY growth compared to the $874 million in AFFO Iron Mountain generated for FY 2018.

That said, I think there’s room for Iron Mountain to pleasantly surprise us.

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 2020, 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 mountains in order to do well for its shareholders. It only has to avoid doing anything terribly wrong.

Moving over to the balance sheet, Iron Mountain’s, well, mountain of debt is my biggest concern.

But we have to keep in mind that REITs typically carry a lot of debt.

Because a REIT 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 nature of the structure.

Offering some appeasement, Iron Mountain has operated with a heavy debt load for years.

The high retention rate, stable cash flows, and overall visibility of the business model has created an environment in which a high debt load isn’t as disastrous as it might ordinarily be for another company.

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. The possibility of falling rates over the near term could be a boon to the balance sheet.

Adding further color, S&P rates their senior long-term debt at a BB-. This is non-investment grade.

I’d ordinarily shy away from a balance sheet like this. But I think this is one of those rare cases in which an exception can be made, keeping in mind that it would be shrewd to see this as more of a speculative and smaller holding within a larger, high-quality portfolio of dividend growth stocks.

It’s difficult to measure profitability for a REIT. GAAP income numbers don’t 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.

I don’t know of too many places where you can get a sustainable and growing 8% yield in this market.

There are risks to consider, however.

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.

As noted, the balance sheet is very stretched.

This could reduce the company’s ability to opportunistically and properly transition itself into data centers.

There’s not an ability to aggressively pivot.

That pivot, by the way, is toward an arena in which Iron Mountain hasn’t yet developed expertise or scale.

And this arena doesn’t confer the natural benefits (like lack of switching costs) that the legacy business model does. So it might be a tough road ahead.

Even with these risks, there’s a lot to like about the stock here.

I most certainly wouldn’t bet the farm on it, but an 8%+ 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…

Based on that aforementioned guidance for AFFO, the stock is trading hands for a forward P/AFFO of only 9.51.

This would be the closest equivalent you have to a P/E ratio on a REIT.

That’s half of the broader market’s forward earnings multiple.

Additionally, the P/CF ratio, at just 8.9, is significantly lower than its own three-year average of 13.6.

And the yield, as shown earlier, is substantially higher than its own recent historical average.

So the stock does look cheap. 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 (due to the high yield) and a long-term dividend growth rate of 2%.

That’s obviously quite a bit lower than the dividend growth that Iron Mountain has delivered over the last few years.

But I believe it’s wise to be cautious here.

The questions regarding the viability of the business model, the debt load, and a lot of moving parts regarding the transition toward data centers all add up to uncertainty.

With the forecast for 3% growth in the company’s FFO over the next three years, I wouldn’t be surprised to see the dividend grow at a slightly lower rate. This would give the company flexibility regarding the debt.

I’d be surprised if the company grew its dividend at a rate markedly higher than this over the long term.

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.

I believe I erred on the side of caution with my valuation, yet the stock still looks noticeably inexpensive right now.

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 $35.00.

I came out a bit high, surprisingly. Averaging out the three numbers gives us a final valuation of $37.66. That would indicate the stock is possibly 28% undervalued.

Bottom line: Iron Mountain Inc. (IRM) is the dominant firm in a niche industry, serving 95% of the Fortune 500. The legacy business is a stable cash machine. And management is adapting to changes in its business model. With an 8%+ yield, a reasonable payout ratio, almost a decade of dividend raises, and the potential that shares are 28% undervalued, this high-yielding stock offers a mountain of dividends and should be strongly considered by 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 47. 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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