The Reddit set had their fun with Geo Group (NYSE:GEO) stock. Like other heavily shorted stocks, shares in the private prison operator popped in early June. Investors who bought in following the company’s dividend suspension in April, and held on until the squeeze, saw tremendous gains.
But I wouldn’t count on another squeeze in the immediate future. Instead, the stock (at around $7 per share) could trade sideways in the near term.
So, if the squeeze is over, what’s the appeal of holding onto it? After all, didn’t President Joe Biden’s executive order earlier this year mark the beginning of the end for the controversial private prison industry? Not exactly.
Yes, once existing contracts expire, the private prison industry will no longer do business with the Federal Bureau of Prisons (BOP), or the U.S. Marshals Service. But this alone won’t sink this company, or its main publicly traded peer, CoreCivic (NYSE:CXW).
That’s not to say the coming years won’t be without challenges. Geo Group will likely experience some hiccups as it restructures. But with the potential for shares to soar well above today’s prices, once it adapts to this industry’s “new normal,” the stock’s still a buy, even after its recent boost.
GEO Stock and the Private Prison Executive Order
Biden’s executive order certainly wasn’t good news for Geo Group or CoreCivic. But it’s a headwind they’ll likely be able to work through. As I broke it down back in February, state and local governments, along with Immigration and Customs Enforcement (ICE) detention facilities make up a larger portion of annual revenue.
According to Geo’s most recent 10-K filing, federal prisons and the U.S. Marshal’s Service contracts made up 14%, and 12.7% of the company’s annual sales, respectively. ICE contracts made up 28.2% of revenues. The rest are primarily, state and local contracts, with the company’s international segment making up the final 9% of sales.
The eventual losses of more than a quarter of its revenue will obviously dent its future earnings. But with the big decline in the GEO stock price, this factor may be more than factored into its current valuation. As InvestorPlace’s David Moadel pointed out July 1, shares sport a single-digit price-earnings ratio.
It may be facing the loss of a large chunk of its business. The company also has substantial debt on its balance sheet. Yet it’s still a profitable, cash generating business. With the dividend suspension, Geo has the means to pare down this debt and restructure its business.
Fast money traders may have cashed out when GEO stock bounced from $5 to $11 during last month’s squeeze. If you find yourself still holding it at $7 per share, or if you bought in at or above today’s prices, you may still want to hold.
Why? There’s still a path for GEO stock to make up for some, if not, most, of its losses over the past few years.
Although 42.4% of its outstanding float has been sold short, that alone may not mean another squeeze is coming in the near term. However, it may enable shares to avoid falling back to their lows.
What’s really going to move GEO stock higher? A successful restructuring of its business. As mentioned above, the company slashed its dividend to preserve cash. In conjunction with this, the company is planning on converting from a real estate investment trust back to a C-corp. The end of it (for now) as a dividend play may have sent many of its investors heading for the exits.
But if it can use the bulk of its cash flow to reduce debt, and to restructure the business? Even if earnings go down in the coming years, the stock could be worth substantially more than it’s worth today, just on multiple expansion alone.
The Bottom Line
Once its federal contracts expire, earnings per share could go down substantially. But given the pessimism priced into shares today, GEO stock could still rise substantially, if its forward multiple bounces back to prior-year levels (10x-15x earnings).
In short, even if earnings fall 50% in the future (to around $1 per share), once the uncertainty hanging over it clears, it could resume trading for 15x that amount, or $15 per share (more than double its current price). If the earnings hit is just 25%? It may have a path back over $20 per share.
A full rebound may take time. But with the situation not so dire, it’s possible. With substantial gains outweighing downside risk, GEO stock remains a buy.
On the date of publication, Thomas Niel held long positions in CXW and GEO stock. He did not have (either directly or indirectly) any positions in any other securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.
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