Iron Mountain (IRM): A Storage REIT Yielding Over 6%

Real estate investment trusts (REITs) are some of the most popular high dividend stocks for income investors.

 

Iron Mountain (IRM) is one such business and offers a dividend yield in excess of 6% today. The company has steadily lifted its dividend for over five consecutive years and offers mid-single-digit dividend growth potential going forward, too.

 

Let’s take a closer look at Iron Mountain to see if this could be an appealing stock for retired investors living off dividends.

 

Business Description

Founded in 1951 in Boston, Massachusetts, Iron Mountain is one of the oldest REITs in America, though it didn’t officially register as one until 2014.

 

While the company initially started off as a paper document storage facility for New York City-based corporations, it has since expanded to one of the largest data storage centers in the world.

 

Iron Mountain serves commercial, legal, banking, healthcare, accounting, insurance, entertainment, and government organizations around the world to meet their information storage (and sensitive information destruction) needs.

 

 

The REIT operates 87 million square feet of storage space in over 1,455 facilities in 46 nations. In total it serves 230,000 global customers, including 95% of the Fortune 1000. This creates a massively diversified and recurring stream of cash flow, with no single customer representing more than 1% of revenue.

 

 

Better yet? Iron Mountain offers a relatively low risk way of profiting from the growth of fast-growing emerging markets, but while still enjoying a generous dividend yield.

 

 

Business Analysis

Iron Mountain is a hybrid between storage REITs and data center REITs. However, unlike storage REITs such as Public Storage (PSA), it focuses on the commercial side of high value document storage. This helps to create the highest retention rate in the industry (98%), with many clients storing documents with the REIT for decades.

 

 

This also helps to give the REIT a wide moat in its industry, which results in relatively strong pricing power. For example, in Q1 of 2017 it was able to raise its rental costs by 3%, and its long-term rental rate increase has historically been able to keep up with inflation while still allowing for very strong growth over time.

 

 

That impressive growth has been helped along by a highly experienced management team that has a good record of evolving the business model as the world shifts towards a larger focus on digital data.

 

This includes targeting faster-growing emerging markets and adjacent services such as document shredding that have helped to keep both the top and bottom line growth strong.

 

 

Combined with a proven track record of growth through acquisition in a highly fragmented market, Iron Mountain expects to be able to continue growing at a relatively strong pace (for a REIT) for the foreseeable future, which bodes well for income investors.

 

For example, in North America alone there is 720 million cubic feet of potential acquisition growth that Iron Mountain could go after. Given that the company’s total storage record capacity is just 680 million cubic feet right now, this shows you the large growth runway this REIT enjoys.

 

 

As a result of Iron Mountain’s competitive advantages, continued push into emerging markets and adjacent businesses, and the fragmented nature of the North American storage industry, the company’s management team expects solid cash flow growth over the coming years.

 

 

Even more impressive? Despite strong long-term growth Iron Mountain’s excellent management team has been highly disciplined about how they allocate capital, resulting in not just some of the strongest margins in the industry that are likely to improve over time.

 

 

Continued margin improvement is thanks to the company’s increasing economies of scale in its emerging market operations, which should mean stronger profitability going forward.

 

 

In addition, management has targeted the vast majority of future investments into those areas where it believes it can achieve even greater profitability.

 

 

Here’s why that matters. Over the past 12 months Iron Mountain’s returns on invested capital (ROIC) was 8.81%, but management thinks it can raise that to 13% by the end of 2020 thanks to both rising economies of scale and its targeted higher profitability investment plan.

 

For a REIT to be able to grow its dividend sustainably over time it’s vital that its weighted average cost of capital (WACC) be lower than its ROIC.

 

This ensures that any new equity issued (which dilutes existing investors) still ends up being accretive. Or to put it another way, the adjusted funds from operations (AFFO) per share, which is the REIT equivalent of free cash flow, (and what funds the dividend), grows over time despite a rising share count.

 

Fortunately as you can see Iron Mountains WACC is far below its 12 month ROIC indicating that management is growing profitably and increasing shareholder value.

 

 

Equally importantly, management’s plan to invest up to $1.34 billion into growth through 2020 is backed by ample low cost liquidity (cash + available borrowing power) of $1 billion.

 

In addition, management also has a long-term plan to deleverage the balance sheet going forward, which should help the REIT get upgraded to an investment-grade credit rating, a major advantage in a rising interest rate environment.

 

 

Key Risks

There are three risks to keep in mind before investing in Iron Mountain.

 

First, although the company is investing heavily into digital data management, which is the major secular trend in the industry, for now it’s core business remains storing paper records and data on physical media.

 

 

This legacy business is likely to face a secular decline in the coming decades, though regulated businesses, which by law need to keep paper record copies, should give the company plenty of time to adapt to these changing market conditions.

 

However, that will mean that going forward Iron Mountain is likely to have to compete in a new industry against data center REITs such as Digital Realty Trust (DLR).

 

Then there’s the question of whether or not management can actually achieve its long-term targeted ROIC.

 

Remember that a high ROIC is crucial to any REIT’s investment thesis, especially when interest rates are rising. That’s because higher costs of debt mean that the cost of capital will increase, making it harder to find profitable growth opportunities.

 

In addition, keep in mind that REITs as an industry are highly sensitive to interest rates. That’s because the REIT business model, specifically the legal requirement that a REIT can only avoid paying corporate taxes if it distributes 90% of taxable income as unqualified dividends, means that REITs can only retain a small fraction of their cash flow.

 

Thus, in order to grow they are reliant on external debt and equity capital markets, which explains why REIT share counts rise over time. However, the downside is that a REIT’s long-term growth prospects are partially dependent on fickle investor sentiment.

 

For example, in recent years record low interest rates have sent income investors searching for high-yielding stocks to serve as high-quality bond alternatives. This has resulted in a lot of capital flowing into the industry and bidding up REIT prices, and thus making growth capital cheap and plentiful.

 

However, with the Federal Reserve now projecting that interest rates will rise by 2.25% through 2020, this could result in risk-free U.S. Treasury yields rising significantly and reversing those capital flows. This is why storage REITs such as Iron Mountain could see much higher yields, (and lower share prices) in the coming years.

 

For example, given the storage REIT sector’s beta to yield of 0.7% below (meaning that for each 1% increase in 10 year US Treasury Yield a REIT’s yield will increase by 0.7%), Iron Mountain might see its yield driven up potentially to 7.8%. Given management’s guidance of $2.54 in annual dividends by 2020 that would translate to a price of $32.56, or 6.3% below today’s value.

 

 

While that small potential decrease isn’t necessarily a concern for long-term investors, it would mean Iron Mountain’s cost of equity could rise to around 9.2%.

 

Add in rising debt costs, especially if the REIT can’t get its credit upgraded to investment grade, and this could result in an overall cost of capital increase from about 5.1% to 6.8%, or potentially even higher if the REIT has to shift its capital structure away from debt and more towards higher cost equity.

 

Or to put another way, Iron Mountain’s long-term dividend growth potential is hinging on management being able to grow its profitability at least as fast as its cost of capital rises along with interest rates in the coming years.

 

Iron Mountain’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Iron Mountain’s Dividend Safety Score of 65, indicating that the REIT’s dividend is safe and dependable. In fact, this score is one of the better ones across the REIT sector.

 

When reviewing Iron Mountain’s dividend profile, keep in mind that the company didn’t become a REIT until 2014. The company began paying dividends in 2010 and made several special stock distributions during this period.

 

Now that it’s a full blown REIT, Iron Mountain is likely to be far more consistent with its payout growth, which management expects to steadily increase each year. More importantly than a growing dividend is a safe one, which generally means you want to see the AFFO payout ratio at 85% or less.

 

That’s because for a REIT with a highly diversified, stable, and predictable business model such as Iron Mountain, a payout ratio below this level usually indicates solid dividend security.

 

 

The other important factor to consider when it comes to dividend safety is the strength of the balance sheet.

 

 

As you can see, Iron Mountain has, on an absolute basis, a substantial level of debt. However, due to the capital intensive nature of the REIT industry that’s to be expected.

 

When we compare Iron Mountain’s debt levels to its industry peers we do see that its leverage ratio and debt / capital ratio are in fact substantially higher.

 

 

That, along with the low interest coverage ratio explains the low credit rating, which management hopes to raise with its future deleveraging plans. Which means Iron Mountain shareholders will want to keep a close eye on these important metrics going forward.

 

However in the meantime investors don’t have much to worry about with this REIT’s sustainable dividend, which is backed by consistent and reliable cash flow.

 

Iron Mountain’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Iron Mountain’s Dividend Growth Score is 45, indicating that it’s overall dividend growth potential is about average compared to the broader market. The company last raised its dividend by 13.4% in late 2016 and has increased its regular dividend each year since 2010, but more moderate growth is likely going forward.

 

Given management’s stated long-term goals and guidance, it’s likely that Iron Mountain will continue to grow its payout at slightly below the market’s long-term 5.8% annual median rate.

 

However, that doesn’t mean that this REIT doesn’t make for an attractive income investment, especially at today’s valuation.

 

Valuation

In the past year Iron Mountain has underperformed the market by 20% due largely to investor concerns about rising interest rates.

 

However, this has lowered the REIT’s forward price-to-AFFO ratio (the REIT equivalent of a forward P/E ratio) to just 12.5. That’s in line with its historical average of 12.2 and much lower than the S&P 500’s forward PE of 17.3.

 

Meanwhile IRM’s 6.3% yield is much higher than its historical yield of 3.6%. Now keep in mind that that historical figure is artificially low because Iron Mountain’s recent conversion to a REIT means that it’s now legally obligated to pay a much higher payout.

 

However, when we compare its yield to other storage REITs we can see that it offers the most generous payout by far, likely reflecting the company’s elevated debt load and relatively lower long-term growth outlook.

 

 

When combined with the REIT’s likely 4% to 5% long-term dividend growth, income investors might expect around 10% to 11% annual total returns in the coming years (6.3% dividend yield plus 4-5% annual dividend growth), assuming management delivers on their stated goals.

 

Overall, Iron Mountain’s valuation seems reasonable today. However, the most conservative income investors might prefer to see the company make progress on its deleveraging initiatives before getting too excited.

 

Concluding Thoughts on Iron Mountain

While Iron Mountain has its flaws (the highly leveraged balance sheet chief among them), it also offer one of the REIT industry’s most generous and consistently growing dividends.

 

Combined with a reasonable valuation, Iron Mountain appears to be a high-yield dividend growth stock worth keeping on your radar. I plan to continue watching the stock for consideration in our Conservative Retirees dividend portfolio.