Iron Mountain: Expensive Relative To Other REITs (NYSE:IRM)

Dear readers,

Iron Mountain Incorporated (NYSE:IRM) is a data storage REIT focused on innovative solutions in data center infrastructure, asset lifecycle management, and information management services. The REIT primarily owns two distinct types of properties – paper storage facilities and data centers. While the former is likely to experience a secular decline over time, the latter has boomed lately as a result of the rise of AI. Both segment complements each other quite well as IRM often takes in paper documents that it digitizes and stores in a digital form on their servers, therefore providing end-to-end data storage solutions to their customers.

I started coverage on the stock with a HOLD rating at $63 per share back in July 2023 and was quite skeptical about the stock’s future prospects for a number of reasons, in particular:

• a heavy presence in a declining paper storage market
• high (initial and maintenance) CAPEX of data centers
• decelerating revenue growth, particularly in the services segment
• and most importantly premium valuation at a time when most other REITs were trading at a discount

Since my article, IRM has outperformed the broader REIT index (VNQ) and has returned RoR of 11%. But the stock remains expensive relative to the rest of the REIT sector, despite clear deceleration trends seen in the latest earnings.

The company has also recently made an acquisition of Regency Technologies for $200 Million. The acquisition is meant to expand IRM’s lifecycle business into a new segment of recycling IT assets. The company made the following statement regarding the benefits of the acquisition:

This strategic transaction represents a significant milestone in our efforts to strengthen Iron Mountain’s presence in the Asset Lifecycle Management sector and our sustainability offerings and will propel our enterprise growth forward.

I like the acquisition because it continues to shift the portfolio further away from traditional paper storage facilities, which have a questionable future.

Good performance, but decelerating growth

When I wrote the original article, IRM had reported a great first quarter with year-over-year AFFO growth of 9%, which at least somewhat supported the premium valuation. I warned that service revenue growth started decelerating and that going forward organic revenue growth, as well as AFFO growth, would likely slow.

Indeed, year-to-date AFFO per share grew by just 3% YoY, and during the third quarter growth was minimal at just 1% YoY as AFFO per share reached $0.99.

The deceleration in AFFO growth was, in large part, driven by flat service revenues over the past nine months.

Year-to-date, organic storage revenues grew nicely at 10.5% YoY, but have also started to come down from record levels seen in late 2022 and early 2023. Growth in organic storage revenues was driven by 20% YoY growth in the data center business, driven primarily by new data center commencements.

For the full year, management expects AFFO to come in at $3.91-$4.00 per share, up 4% YoY. Beyond that, analyst consensus calls for 7% growth in 2024 and 9% in 2025. Notably, those analysts have a 100% 2-year hit rate (with a 20% error margin), but I see their estimates as ambitious in light of current growth deceleration trends. To err on the side of caution, I assume revenue growth of only 4% per year in my calculations which is consistent with the long-term growth CAGR.

I also want to point out that IRM’s balance sheet has a relatively poor rating of BB-. Their leverage is relatively reasonable at 6.1x adjusted EBITDA, but they have 19% of floating rate debt and an already high-weighted average interest rate of 5.6%. Among their most expensive debt is the $1.28 Billion outstanding on their revolving line of credit which currently accrues interest at a whopping 7.2%. I mentioned in my previous article that IRM tried to refinance the credit line with 7% notes due in 2029 but has made little progress on this front.

The REIT has no material debt maturities until 2025, but given their high exposure to floating rate debt, the interest expense will likely rise in 2024, posing headwinds to an ambitious AFFO growth forecast.

An expensive price tag relative to other REITs

IRM pays a 3.9% dividend yield and the dividend hasn’t increased much over the years despite a healthy 64% payout ratio. I see no imminent risk of a dividend cut here and fully expect the dividend to remain and grow slightly in the following years.

But here’s the thing. IRM trades at a high multiple of 16.8x AFFO, which is meaningfully above its historical average of 12x AFFO.

IRM doesn’t report NOI, but it can be approximated by deducting the cost of sales and SG&A from total revenues. With net debt of $11.5 Billion and a market cap of just under $20 Billion, I estimate that the stock trades at an implied cap rate of 6.2%.

To put things into perspective, Realty Income (O) which is one of the safest REITs, trades at 5.5%. Long-term treasury bonds trade at 4%, which implies a 220 bps risk premium for IRM. I consider such a premium relative to treasuries more or less fair given IRM’s BB- rating.

It’s also worth noticing that IRM is in fact quite inefficient in the way it runs the business and consequently has very low operating and income margins of 17% and 6.5%, respectively. That’s extremely low for a REIT.

All things considered, I can see why the REIT would appeal to investors who believe in AI. But at the same time, I cannot ignore the fact that revenue growth has slowed materially this year. I don’t feel entirely comfortable with the consensus forecast which calls for an acceleration in growth, largely out of nowhere, despite headwinds from a higher interest expense. More importantly, I am not comfortable buying a REIT at what I consider fair value when I can buy others at steep discounts. For these reasons, I downgrade IRM to a SELL here at $66.50 per share.

The only risk to my thesis is that IRM, for some reason, continues to trade at a premium to the rest of the REIT sector. This could happen if the AI-fueled rally continues and/or strengthens. Moreover, a re-acceleration in revenue growth and/or a lower valuation which would put the risk-reward in line with the rest of the sector would also make me reconsider my stance.