Iron Mountain stock downgrade to hold after 33% gain (NYSE: IRM)
The investment thesis
I first published my bull thesis on Iron Mountain (NYSE: MRI) in July 2021. At that time, the stock was priced at $42.85. And a simple dividend discount analysis showed its price to be below fair value almost of 50%, offering a wide margin of safety. As you can see from the following chart, the stock price has appreciated over 28% and has made a total gain of over 33% since then.
At this point, the company’s fundamentals remain strong. It also acquired ITRenew which will provide several growth catalysts in the near future. However, the sharp rise in prices so far has also significantly reduced the margin of safety. And there are a few other uncertainties, both macroeconomic and specific to MRI. Accordingly, I am changing my thesis from buy to keep as detailed below.
IRM and general market conditions
The following chart compares the price action of IRM against the overall market since I wrote my bullish thesis about a year ago. As you can see, its stock price has been in a consolidation window for a few months, giving investors a good window to accumulate stocks. Then it has rebounded strongly since the start of 2022. In total, its prices have gained around 28% over the past 1 year. By comparison, the overall market went nowhere (in fact, it lost about 1% of its price).
The strong rally in IRM price is certainly supported by strong fundamentals. The first quarter 2022 fiscal year earnings call (April 28, 2022) reported strong numbers across the board. It posted record quarterly revenue and also adjusted EBITDA profit. Net income was $42 million and organic storage rental revenue increased 6.8%.
Looking ahead, management is confident and has confirmed guidance for FY2022, as CFO Barry Hytinen commented (abbreviated and underlined by me):
And now, on to our outlook. We are happy to reiterate our guidance for the full year 2022. I must stress that this despite the impact of the deconsolidation and strengthening of the US dollar. With the closing of the ITRenew transaction, I thought it would be helpful to share our preliminary view on purchase accounting. We currently expect the amortization of intangible assets to be approximately $60 million per year. For the second quarter, we expect total revenue of approximately $1.3 billion. We estimate high single-digit organic growth of nearly 10% in the second trimester. We expect adjusted EBITDA to be approximately $450 million and AFFO to be approximately $260 million.
In total, after ITRenew’s purchase accounting adjustment, he expects the AFFO for the year 2022 to increase by up to 10% YoY (and the lower bound is still solid from 6%). And then we’ll see that the ITRenew acquisition does indeed offer strong near-term growth catalysts.
Potential for renewal and growth
ITRenew focuses on disposing and recycling technology assets such as PCs and servers after IRM has deleted the sensitive data they contain. As such, the acquisition of ITRenew offers superb cross-selling opportunities. It naturally relies on IRM’s existing clientele. The acquisition has already facilitated the conquest of a key client with a major financial institution. As CEO William Meaney commented (abbreviated and underlined by me):
When it comes to our ALM business, we’ve had several solid wins across multiple industries, many of which were made possible by the strong combination of Iron Mountain and the recently acquired ITRenew, which performed even better than we expected. An example of the power of this combination can be seen in our expansion on a customer won with a large financial institution that were awarded to us in early 2021. With the additional expertise we gained with ITRenew, we expanded our offerings to include market-leading recycling expertise, as the world focuses on how to better embrace the concept around a more circular economy and reduce our impact on the environment.
Valuation and Projected Returns
However, its recent price gains have made the valuation less attractive. In terms of FFO multiple, it is currently valued at around 13.3x FFO, or around 4% above its historical average. In terms of dividend yield, it currently yields 4.5%, about 22% below its historical average. Despite the variance between different metrics (or because of the variance), I see the margin of safety for investment significantly thinner than 1 year ago, even with new growth catalysts taken into account.
Assuming a projected growth rate of 5% (consensus estimate calls for a CAGR of around 4% through 2025) over the next 3-5 years, the upside is somewhat limited (my bullish projection is about 4% annual return), but there is a negligible non-possibility of a negative total return now (although a small negative return of about 6%).
Summary and other risks
MRI has returned 33% since I first wrote a bullish thesis on this about a year ago. At this point, despite its strong fundamentals and growth potential enabled by the acquisition of ITRenew, I see the upside is limited and the possibility of a negative total return is beginning to emerge. As such, I am changing my pending purchase thesis.
Along with valuation risks, there are also a few other risks to consider at the same time:
- As a global business, IRM faces currency risks. As the Fed raises rates and the dollar strengthens, its earnings will be negatively affected when expressed in US dollars.
- The acquisition of ITRenew also stretched its balance sheet. Its debt burden has increased by more than $1 billion since the start of the year, including about $750 million due to the acquisition of ITRenew. Around ~81% of its debt is fixed rate and around 20% floating risk. Therefore, it could also suffer from higher interest charges as rates climb further.
- Finally, the war in Ukraine and deconsolidation caused additional headwinds of approximately $5 million compared to the second quarter of fiscal 2021. The war is still ongoing and may have other impacts.