Death Cancels Everything … Except Profits

by Lawrence Meyers | March 20, 2013 9:00 am

I read Peter Lynch’s book One Up On Wall Street many years ago, and still specifically remember a point he made: Companies that do something distasteful are often both profitable (because nobody else wants to do whatever they do) and overlooked (because they’re distasteful).

One such company he mentioned was Service Corp. (NYSE:SCI[1]) — a company in the deathcare business and an investment that had done very well.

Anyone who has ever watched Six Feet Under already knows that funeral service, crematoria, preparation, embalming and selling various merchandise like caskets, memorialization products, burial vaults, crypts, urns, flowers and more can be rather lucrative.

Pre-need arrangements can even be sold via an insurance policy, with the funeral company earning a commission. As humans, ritual is very important to us. The trappings of these rituals are a necessity and somebody has to provide them. I think it’s a good thing, not distasteful at all, but I imagine many people may not feel that way.

Since first coming across Service Corp., I have discovered three other public companies that operate in the same area: Carriage Services (NYSE:CSV[2]), Stewart Enterprises (NASDAQ:STEI[3]) and StoneMor Partners (NYSE:STON[4]). However, these companies only make up 20% of the country’s business … combined.

Still, according to data from the companies, the number of deaths in the U.S. increased at a rate of 1% from 1980 to 2000 … but things are about to change as Baby Boomers come of age. The percentage of people age 65 and over is expected to increase from 13% in 2011 to over 20% in 2030.

Bottom line — even if it sounds morbid — is that such a trend means more business for these companies. With that in mind, let’s take a look at each pick individually.

To start, Service Corp. is gigantic, with almost 13,000 employees, 1,400 funeral locations and 374 cemeteries across 43 states, Canada, and Germany. Its financial can be a bit of a sticky read, though. Just under 80% of company revenue comes from insurance-paid pre-need policies (it accounts for pre-need and at-need differently) and trust accounts are involved.

There are also numerous off-balance sheet arrangements. I don’t think there’s anything untoward here that will wake the dead, but it should be noted that this company does require its due diligence. The good news, though, is that Service Corp. throws off a solid $250 million in annual free cash flow …  and has been pretty reliable in that regard.

Some not-so good-news, though, is that the business is growing at a steady 10% clip, but the stock trades at 18.5x earnings. I think that’s a hefty premium, even for a business that will (how do I say this?) always be in business.

Carriage Services is much smaller, with some 170 funeral home and 32 cemeteries. Growth seems more robust with this smaller, leaner operation. Only three analysts cover the stock and long-term growth looks to be around 15% with the stock trading at 18x. Free cash flow was only $5 million for the first nine months of 2012, though, so 15% growth may be optimistic.

Next up: StoneMor Partners, which only focuses only on cemetery ownership. The company’s operating structure is a bit fuzzy and it seems to generate revenue from its trust account, which is managed by an investment advisor. Quite frankly, I don’t want to own a cemetery business that is in fact some kind of mutual fund.

Last but not least, Stewart Enterprises is also relatively small, clocking in with 3,700 (living) employees, 217 funeral homes and 141 cemeteries across 24 states. The company just reported earnings, and surprised investors with a 9% revenue increase and 80% increase in earning per share — beating the consensus by a nickel. It generated about $57 million in free cash flow over the trailing 12 months, trades at 15x earnings and is growing at about that same clip.

All in all, it seems to be the most fairly valued of the plot … er, I mean, lot.

Lawrence Meyers does not own shares of any security mentioned, or a cemetery plot at this time.

  1. SCI:
  2. CSV:
  3. STEI:
  4. STON:

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