Canaccord gets bullish on prison REITs

Canaccord initiated coverage of two prison REIT stocks on Tuesday with a "favourable view on the industry."

Looking for criminally low valuations in the real estate investment trust space? Try prison REITs.

Canaccord Genuity initiated coverage of the space , with a “favourable take on the industry.” Additionally, it noted that prison REITs are relatively cheap when compared with their peers.

“We believe the sector provides a unique blend of very defensive fundamentals with significant and accretive external growth potential,” Canaccord analysts Ryan Meliker and?Michael Kodesch write inside a note to clients.

REITs have been punished this year as anxiety about higher interest rates has investors looking elsewhere for income. Most investors buy REITs for their yield, meaning any prospect better rates tends to create a stampede from the space.

Prison REITs, however, offer some upside potential that protects them from rising rates. For starters, Canaccord notes that the two prison REITs it covers – GEO Group and Corrections Corp. – trade at a low valuation of 4.8 and 4.6 times funds from operations (FFO), respectively.

“The stocks offer extremely attractive valuations on the free cash flow yield, dividend yield as well as on FFO multiples relative to the broader REIT sector,” the Canaccord analysts write.

Prison REITs also needs to benefit from some recent trends in American politics. The largest driver will probably be privatization of the prison industry as local municipalities turn to trim their budgets. Canaccord highlights that while this has been accelerating recently, private prisons still maintain an only 8.3 percent marketshare.

Between GEO Group and Corrections Corp., Canaccord prefers the former, noting it has a higher yield (seven per cent versus 6.4 percent) and a global business design, with presence in Nigeria, Australia and Canada, in addition to the U.S.