Can You Find Profits at the Local Cemetery?
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While most people probably don’t want to spend too much time at a cemetery, at least until their number is called, there are profit opportunities at the nation’s resting places. Municipalities own most local cemeteries, but national death services companies have also made this segment a core part of their business. The death services sector also enjoys steady, low growth economic characteristics, with the U.S. Census Bureau estimating that aggregate annual deaths will climb from 2.5 million in 2010 to 3.2 million in 2025. So, how does an investor participate in this morbid sector?
Service Corporation International (NYSE: SCI) was founded in 1962 to bring about consolidation in the funeral home market, ultimately amassing a network of 4,500 funeral homes in 20 countries by 1999. However, its debt-fueled acquisition binge almost sank the company, leading it to restructure and limit its geographic reach. Currently, Service Corporation is the largest domestic death services company, with 1,457 funeral homes and 374 cemeteries in the U.S. and Canada as of December 2012.
In its latest fiscal year, Service Corporation reported decent financial results, with increases in revenues and adjusted operating income of 4.1% and 6.9%, respectively, versus the prior year. The company’s sales growth benefited from rising sales volumes in both its funeral and cemetery segments, as well as slightly more favorable average pricing. In addition, Service Corporation’s operating margin reached a three-year high due to gains in its investment-related income, which rebounded alongside broad-based gains for the equity markets.
Consolidation, part 2
The death services companies are really quasi-financial services organizations, since they sell price-guaranteed services today to be used at an indeterminable future date, while investing the sales proceeds in the meantime. This structure leads the companies to hold significant assets in third-party trust accounts and to generate a meaningful portion of their revenues from investment income. Obviously, creating efficiencies and reducing risk in both operating and investment areas is the name of the game for the industry's players, a goal which is achieved most easily through acquisitions.
Despite its brush with bankruptcy from its first consolidation binge, Service Corporation continues to play the role of industry consolidator, buying mega-operators Alderwoods in 2002 and Keystone North America in 2010. The company’s latest gambit is its May 2013 offer to acquire the #2 death services player Stewart Enterprises (NASDAQ: STEI) for $13.25 per share in cash or roughly $1.1 billion in equity. While the merger would unite the top two operators in the industry, their combined market share of less than 20% would likely mass muster with antitrust authorities.
In FY2013, Stewart Enterprises has posted solid financial results, with increases in revenues and adjusted operating income of 4.7% and 22.1%, respectively, compared to the prior-year period. Like Service Corporation, Stewart Enterprises has enjoyed a better pricing environment for its services, as well as a stronger contribution from investment-related income. In addition, the company’s restructuring process that was initiated in April 2012 has started to benefit its bottom-line, with greater levels of efficiency and accountability at individual properties. With roughly 8% of the industry’s total funeral homes and 5% of its cemeteries, the combined company should be able to drive further profit gains for investors.
Picking up the scraps
Of course, removing a major competitor from the industry should improve the economics for everyone else, including #4 death services company Carriage Services (NYSE: CSV). Unlike its larger competitors, Carriage Services’ properties are mainly concentrated in suburban and rural areas where it can command the #1 or #2 market positions, usually in competition with smaller family-owned funeral homes. Its strategy has also allowed it to grow slowly with selective acquisitions, leading to a network of 167 funeral homes and 33 cemeteries as of December 2012.
In its latest fiscal year, Carriage Services reported solid financial results, with increases in revenues and operating income of 8.5% and 31%, respectively, versus the prior year. The company’s sales growth benefited from the addition of eight funeral homes to its network, as well as a low single-digit rise in average pricing, in line with the industry. More importantly, Carriage Services' operating margin hit a five-year high due to its ability to leverage its existing overhead across a larger base of properties.
The bottom line
Death is not usually a good thing, unless it is your core business. While advancement in medicine is leading to longer lives, the aging of the baby boomer population in the U.S. should provide growth for the death services companies, with the U.S. Census Bureau expecting the over-65 population to reach 63.5 million by 2025. Service Corporation and Carriage Services are leading the consolidation wave and are the stocks to watch in the sector.
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