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Morningstar | Expense Pressures Eat Into Margins, Setting Up a More Difficult 2019 for Iron Mountain. See Updated Analyst Note from 25 Apr 2019

Narrow-moat-rated Iron Mountain had a more difficult quarter to start out 2019. Total revenue was okay, up 1.1% on a reported basis despite more exchange rate headwinds and with underlying organic growth of 1.9%. The bad news came from expenses, as they were up 2%, largely coming from pressure within the cost of sales line item. This led to deteriorating EBITDA margins, down to 30.8% from 32.9%, and an overall decline in operating income, down nearly 4%. Adjusted earnings per share came in at $0.17, down from $0.24 one year ago. Management is sticking to its original guidance as it believes certain cost-cutting measures recently put in place will come through for the remainder of the year. As a reminder, the firm’s targeted midpoint EBITDA growth for 2019 is roughly 2.7%, which implies overall margin expansion. Management believes that margins should expand roughly 150 to 200 basis points in the second quarter alone and then another 200 to 300 basis points in each quarter thereafter for the rest of 2019. This could put overall EBITDA margins in roughly the mid-33% range if management consistently hits the low end of guidance, which would represent a roughly 50-basis-point deterioration for the year. Iron Mountain will also need $0.91 in adjusted EPS for the remainder of the year to meet the low end of guidance, or roughly a $0.30 quarterly run rate, which it achieved in only a single quarter last year. While it is still possible for the firm to meet its reaffirmed guidance, we recognize that it'll be an uphill climb, putting more risk to the downside, in our view. After making adjustments to our model, we are decreasing our fair value estimate to $32.50 from $34.50. The share price had already begun shooting past our previous fair value estimate, and while we may not have predicted quite the miss that occurred this quarter, we did believe any margin of safety had completely evaporated.

A couple items went against Iron Mountain on the expense side. The main item called out was overstaffing within the shred business. Management stated that there were some extra costs due to shifts in demand and the related attempt to manage overtime hours, but this has already been addressed. A lease accounting adjustment also increased expenses, along with front end weighted investments in efficiency initiatives. Even so, the firm is relying on current efficiency initiatives to payoff in the back half of the year. The next quarter may still be a bit unimpressive, but after that Iron Mountain will really have to prove that these shifts in margins were indeed more transient in nature and that these efficiency initiatives do have the potential to more than pay for themselves over the longer term.

Organic revenue growth was 1.4% in developed markets, with both organic service and storage revenue growth contributing. Organic growth was 2.7% in international markets for a total organic revenue growth rate of 1.9%. Organic volume growth continued to be slightly negative in developed markets, while the other international segments saw upper-single-digit growth. The North America RIM segment was essentially flat from a revenue standpoint, while the Data Management segment continued to see small declines. Growth from Western Europe was steady at 3.2% on a constant currency basis, while the other international segment, data center segment, and the corporate and other segment all continue to see strong growth. Iron Mountain also laid out a potential JV opportunity in Frankfurt within the data center space, which could accelerate more MW development. Overall, growth is coming in relatively as expected, but Iron Mountain will have to prove its margin targets are feasible throughout the rest of the year.