Prison Stock 'That's Hot' (CXW, GEO)

By Matthew McCall | June 25, 2007 AAA

The nation's correctional facilities just lost one of their most famous guests recently, but fortunately for private-prison companies there are plenty more inmates set to take Paris Hilton's spot. Watching the nation get swept up in the release of the infamous socialite from her Los Angeles cell (note: Hilton was housed at a public facility), I was taken back to a group of stocks that initially caught my eye last year. Now it's time to have another look at privately run correctional facilities.

Growing Prison Population
With the number of inmates in prison on the rise, the need for more correctional facilities and qualified personnel to manage the incarceration process is in high demand. The current system has both public and private run prisons on both the state and federal level. However, as more state governments are looking to cut costs anywhere they can, moving the management of prisons to the private sector becomes attractive.

In 2006, the number of people incarcerated in state or federal correctional facilities grew by approximately 42,000 people to 1.6 million. The largest increase since 2000. The actual number of federal prisoners increased by 3.6% to 191,080. Amazingly, 42 of the 50 states reported an increase in prison population from 2005 to 2006. The bottom line is more inmates means more beds needed to house the convicts.

Prison Bully
Corrections Corp of America
(NYSE: CXW) is the nation's largest provider of correctional facilities to government agencies and the founder of the private corrections industry. The company has approximately 72,000 beds in 65 facilities located in 19 states throughout the United States and in the District of Columbia. Through the ownership of 40 of the facilities and its management services, CXW offers both educational and rehabilitation classes to its inmates.

The influx of inmates into the system was recognized directly by CXW. During the first quarter of 2007 the portfolio occupancy increased to 98% from 93.7% a year earlier. With its facilities nearing capacity, the company must consider expanding the number of facilities it owns or manages to take advantage of the increase in inmates. As far as the company holding onto current contracts, investors should not fret. According to its website (correctionscorp.com), CXW maintains a 95% contract renewal rate; that is an impressive number in any industry.

Global Convicts
The Geo Group
(NYSE: GEO) runs a very similar business to CXW with one major difference - location. The company operates correctional facilities around the globe. It has facilities in Europe, Africa, Canada and Australia. Along with the global operations, GEO also offers an array of services such as home detention, electronic monitoring and the development of mental health institutions. GEO is a bit smaller than CXW, in that it only manages a total of 61 facilities worldwide with approximately 49,000 beds.

Fundamentally the company is solid, reporting 28% revenue growth for the first quarter 2007 and raising future guidance. Lehman Brothers also raised its guidance on GEO recently, looking for earnings per share of $1.03 in 2007 and $1.35 in 2008. Both represent solid growth numbers, and based on the 2008 guidance, the stock is currently trading at a P/E ratio of about 20. Considering the growth rate is higher than the forward P/E, GEO would not be considered overvalued even with the recent rally in the stock price.

Technical View
Both stocks have had amazing runs during the first half of 2007, and over the long term they have been exceptional winners. Since bottoming in early 2001, GEO is up over 960%, and CXW has gained an amazing 1250%! The first thought is to move on because the big move has already taken place. True, the enormous gains are probably already baked into the stocks, but with the growth potential and fair valuations make the stocks attractive investments at current prices.

The charts of GEO and CXW have been kind to investors because every few weeks the stocks pull back a few percentage points, offering a new buying opportunity. The best strategy is to look for a few days of light volume weakness and take advantage of the lower price.

Future Potential
A 2005 study on the number of inmates in public facilities versus private facilities found that there is potential for growth in the private sector. According to the numbers, only 7% of all federal and state inmates were housed in privately run facilities. As the number of inmates grows, coupled with the U.S. Secure Border Initiative, it appears to be a "no-brainer" that the stocks mentioned above will see increased demand for their services.

On the flip side, don't forget the monster run the sector has had over the last few years and that stocks can fall as quickly as they rise. The key is to buy on a pullback and use calculated stop-loss orders.

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