With the S&P 500 index yielding a scant 1.3%, Iron Mountain (NYSE: IRM) and its relatively generous 5.4% yield look quite appealing. However, investors need to look beyond yield here because this real estate investment trust (REIT) is unique. It's also in the middle of a major portfolio transition. Here's what you need to think about before buying Iron Mountain.
The core of the story
Iron Mountain's largest business is the secure storage and management of paper records. The company also handles other items, such as art, but corporate record-keeping is the big driver. It's more than just putting Bankers Boxes in a warehouse, however. The REIT also offers a host of services, including things like document retrieval and shredding. It's not exciting, but it is reliable.
Roughly 70% of Iron Mountain's revenues come from this type of business. And generally, when a company puts a box into storage, it stays there for a long time -- with the company posting a retention rate of 94.4% in the second quarter. In some ways, this is the kind of business a dividend investor could love.
There's just one problem: Paper records are being replaced by digital records. The transition to all-digital will likely be slow, but Iron Mountain's core business will almost certainly decline over time.
Which is why management has begun expanding into the digital storage realm via the construction of data centers. This is clearly the right move. The company currently operates 15 facilities across 13 markets. Basically, the REIT is using its legacy business and business relationships to expand into a new one.
Riskier than it seems
On the surface, this sounds fairly low-risk. However, Iron Mountain is a REIT, which means it has to pass a significant amount of cash on to its investors in the form of dividends. And that reduces the amount of internal cash available to fund the company's growth plans.
This isn't unique to Iron Mountain; all REITs work this way. REITs looking to raise cash generally tap the capital markets via stock and bond sales or get loans from banks. This is where the first sign of trouble arises.
Iron Mountain's balance sheet is heavily leveraged, with a debt-to-equity ratio of 7.7 times. For comparison, other large REITs, including Realty Income, Prologis, and Digital Realty Trust, all have debt-to-equity ratios that are below one time.
It would be easy to argue that the high retention rate in Iron Mountain's legacy physical storage business gives it the ability to use more leverage. However, that has to be juxtaposed against building out a new digital business, which is a very expensive proposition. The REIT appears to be comfortable with its leverage profile, but it's a risk that can't be ignored.
As you might expect, investing in its digital business is a core priority for Iron Mountain, as it doesn't want to go the way of the buggy whip. Other core goals include maintaining leverage at around current levels and reducing the adjusted funds from operations payout ratio from around 70% today to something in the low- to mid-60% range, suggesting the current dividend is going to be stagnant for a little while.
And since new data centers have to be built before they can generate revenue, Iron Mountain's transition will really be a delicate balancing act, financially speaking. In other words, the REIT is going in the right direction, but it won't be an easy path.
The final call
If you are a dividend growth investor, Iron Mountain is not for you. If you like to focus on REITs with rock-solid balance sheets, you'll probably be happier elsewhere. These are two prime areas where Iron Mountain's risks are going to be most prominently displayed.
That said, if you are comfortable with a 5.4% yield and static dividend while the company works to transition with the world around it, you might find it of interest. The problem is that the stock has witnessed a big run over the past year: It's trading near all-time highs, and its yield is in the middle of its historical range.
So it would be hard to suggest that Iron Mountain is a bargain today. Paying full fare for a REIT with a highly leveraged balance sheet and a stagnant dividend doesn't seem like a great risk/reward balance -- even though it is making solid progress in its business transformation. In other words, most investors will likely find this REIT too risky to bother with.