Prison Stocks Still Facing Headline Risk Despite GEO Group's Federal Contract Renewal

GEO announced that the BOP had extended its contract for the company-owned D. Ray James Correctional Facility by an additional two years. The contract provides for the housing of up to 1,900 federal inmates, with a fixed payment or 1,800 beds compared to GEO's previous contract, which contained a fixed payment for 1,962 beds.

The renewal came despite the DoJ's announcement that the BOP would review and likely cancel private prison contracts as they came due for renewal. But, GEO maintained that the company still had a written letter of intent from the BOP to renew, as the contract details were incorrect upon first submission.

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"While contract terms may appear slightly softer (8 percent fewer beds than previous fixed payments), per diems appear higher in the contract, and if all 1900 beds available in the contract are used, revenues would be up," Meliker wrote in a note.

That said, Meliker said the latest development wouldn't change his perception on prison stocks as the sector is grappling with several headwinds including DoJ/DHS announcements to review the use of private prisons, BOP reductions, family detention dynamics and general sentencing reform dialogue.

"We note that this doesn't change our thesis given that the BOP's agenda is still at large, but this decision could drive incremental uncertainty surrounding the DOJ's movement, which would be a positive for stocks that we believe already price in the termination of all BoP contracts," Meliker highlighted.

The analyst maintains concerns surrounding federal contract cancellation headlines, a likely dividend cut from Corrections Corp Of America CXW, and risk of a Corrections Corp covenant breach. All these events could hurt near-term performance of GEO and Corrections Corp shares.

However, Meliker maintains his Buy rating on GEO, as he prefers the stock versus Corrections Corp on GEO's lower risk to family detention, safer dividend yield and diversified business model.

At the time of writing, shares of GEO rose 3.22 percent to $24.03, while Meliker has a price target of $28. Corrections Corp shares were up 1.37 percent at $14.02.

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