Why Did Michael Burry Buy Prison Stocks?

Why Did Michael Burry Buy Prison Stocks?: During the 2008 financial crisis, fund manager Michael Burry became a nearly household name for being one of the few people to correctly predict the collapse of the housing market.

 

Burry has been back in the news this year, this time predicting another large economic downturn in 2023.

 

One of the stocks the famously eccentric investor has chosen to ride out this coming downturn is private prison operator CoreCivic (NYSE:CXW). Another is GEO Group (NYSE:GEO). Why is Burry buying prison stocks?

 

The CoreCivic buy seems to be a continuation of Burry’s recent bullishness on private prison stocks.

 

Earlier this year, Burry sold all but one of the stocks held by his Scion Capital Management fund. That stock was the GEO Group (NYSE:GEO), another company involved in operating private prisons.

 

Together, GEO and CoreCivic now make up over 50 percent of Burry’s portfolio.

The bet on private prison stocks may reflect Burry’s belief that the stock market at large still has much more room to fall.

 

The investor has spent much of 2022 warning of a potentially worse economic contraction than the one that followed the 2008 financial crisis. If such a downturn occurs, stocks would almost certainly extend their losses well into 2023 and face a long climb to return to their previous highs.

 

Prisons, by contrast, are largely recession-proof. Because they are funded with government money, private prisons are unlikely to see their revenues drop alongside those of consumer-facing companies. If the kind of economic upheaval Burry believes could occur, prison stocks could be one of the few safe havens in the stock market.

 

Some have also speculated that Burry’s bullishness on private prison companies may have been connected to the November midterm elections. If the so-called “red wave” phenomenon had occurred, Republicans in statehouses across America might have doubled down on law enforcement. This could have led to higher incarceration rates and, as a result, more business for private prisons.

 

A final possible reason for Burry’s private prison bullishness could be the potential for a spike in criminal activity during his projected economic crash. Recessions are known to bring about increases in property crimes and robberies due to economic desperation. If a downturn as deep as the one Burry sees on the horizon comes to fruition, demand for prison space could increase as criminal activity rises.

 

Another strong possibility for Burry’s position on CoreCivic is the stock’s valuation.

 

At just 9.36 times forward earnings and 0.76 times sales, CoreCivic is attractively priced. CoreCivic’s debt is also fairly reasonable at a ratio of 0.79 to total equity.

 

While CoreCivic is priced at a higher multiple to earnings and sales than GEO, its debt-to-equity ratio is considerably lower. As such, Burry may have decided to diversify his private prison bet to hedge against debt risks associated with GEO.

Other analysts seem to agree with Burry’s evaluation that CoreCivic is undervalued. The price target for CXW is $15, a 23.1 percent jump over the current price of $12.19.

 

It should be noted, though, that only three analysts have offered price projections for CoreCivic. As such, more bearish views may not be fully represented in this small sampling of price targets.

 

One point against the value argument, however, is CoreCivic’s inconsistent cash flow. Since Q2 2021, the company’s cash flows have oscillated between positive and negative. Prior to that, CoreCivic had not reported a quarter of negative FCF since Q4 2018. This raises the question of whether the company can return to sustained and predictable profitability.

 

While Burry is obviously bullish on CoreCivic and private prisons in general, the stock does have its drawbacks. To begin with, CoreCivic stopped paying dividends in 2020 and has not resumed its distributions. The stock has not performed particularly well in the intervening time, meaning that it has not proven its ability to generate solid returns without a quarterly payout.

 

It’s also important to recognize that many economists and financial analysts reject Burry’s view on the stock market outlook for 2023.

 

Banking giant JP Morgan, for instance, predicts that the US economy will contract just 0.5 percent in Q1 2023, kicking off a mild recession. The prevailing view at the moment is also that the Federal Reserve will be able to bring inflation under control sometime in 2023, resolving the inflationary pressures that have plagued many companies.

 

If this more moderate view is the case, there could be many solid companies for investors to look at outside of the private prison industry. Burry’s investment decisions at the moment seem to be based on a worst-case economic scenario that, while possible, is far from inevitable.

 

While private prisons are more insulated from macroeconomic conditions than many companies, they may also be subject to increased political risks.

 

In 2021, President Joe Biden issued an executive order aimed at cutting ties between the federal government and private prisons. Given that Biden is openly seeking re-election in 2024, there’s a good chance that expiring contracts will not be renewed.

 

With all of this said, the case for CoreCivic as a potentially undervalued company is quite compelling. Although it is still struggling in the cash flow category, the selloff CoreCivic experienced has likely left the stock priced somewhat below fair value.

 

The small pool of analysts covering the stock seem to concur with this view, and it’s fairly likely that a correction could earn investors a decent return against today’s prices.

 

Ultimately, CoreCivic is a stock that has real potential as a non-cyclical value buy. Investors who believe that a deep and prolonged recession is on the horizon may want to consider CoreCivic as a choice for potential gains in a challenging macroecnomic environment.

 

Overall, though, CoreCivic looks like a stock that may be better to hold or keep an eye on. Because there could be other stocks that are likely to perform better without CoreCivic’s difficult political risks, investors may want to take a “wait-and-see” approach before buying shares in this company.

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