As always, below represents my opinions and should not be construed as financial advise. Always do you own due dilligence. I welcome your feedback of my opinions.
· Company Description
o ELI5 the company’s business model
§ SCI is the leading provider of deathcare services. They operate 1,471 funeral service locations and 488 cemeteries across 44 states, 8 Canadian provinces, DC and Puerto Rico. They operate under Dignity Memorial, Dignity Planning, National Cremation Society, Advantage Funeral and Cremation Services, Funeraria Del Angel, Making Everlasting Memories, Neptune Society and Trident Society brands.
· Company Soundness
o How does the company collect revenue? Does the company have a good or services that is purchased frequently or a regular interval?
§ Stable one-off transactions. Terrible business, no repeat customers /s
§ Revenue is collected two ways, pre-need and at-need services. Pre-need would be your prepaid funeral. This allows SCI to collect the premiums up front and invest them in the trust. Upon death the expenses are withdrawn from the trust. At need services are managed like more traditional transactions.
§ The deathcare industry is a little unique, given that they make up ~15% of the deathcare market in the US, they have steady revenues as sadly about 0.83% of the population passes each year.
o Do they operate with significant leverage?
§ Yes, SCI has slightly more leverage than I would prefer. They have $2.5 of debt for every $1 of equity and have a fairly low interest coverage of 6.4x. Having said that, they are extremely well entrenched in their market will likely never be obsolete.
o Is their balance sheet will suited for a downturn and why?
§ A downturn is highly unlikely. Having said that they have $551.3 million of borrowing capacity and have used $325 million for a remainder of 226 million. That is approximately a months’ worth of expenses. That’s kinda tight, but funerals don’t have too many recessions.
· Can it be Replicated?
o Is their evidence that the company has defended its market position in the past?
§ Yes, they were originally formed in 1962 and have only grown from there. Many of their assets like cemeteries and crematoriums are subject to strict regulations and require extensive permitting to establish. Not all regulators will be anxious to add another funeral home to their town/city. Time alone is a test in and of itself and 60 years of operations suggest entrenchment.
o Is their evidence that market power is growing and that this will lead to strong financials?
§ Yes, SCI consistently earns ~12% free cash flow margins, has grown fairly consistently and had average ROEs annually of 33% per year.
o What is the competitive advantage?
§ Low-Cost Provider. As I mentioned earlier, roughly 0.8% of Americans pass annually. This for specific locations can be fairly lumpy but in aggregate is fairly smooth. SCI leverages their massive footprint and enables their back office operations to be shared across numerous funeral service locations. Through scale alone, you can enable less total staff per funeral as the staff can be used more efficiently across a wider footprint of funerals.
§ Additionally, SCI has permits in place. In smaller areas this leads to efficient scale. The idea that small regional markets are typically best served by one player and therefore not likely to get additional regulatory approval and granting a small regional advantage.
o Would $10 billion of capital be enough to re-create the company?
§ I don’t think so. Since they are so large and more profitable than the plethora of mom and pop operators the natural attempt would be for a smaller player to acquire many other players (like they did). Now that SCI has the lowest cost operations, they could rationally pay more than anyone else should a bidding war occur.
§ To grow organically would likely take to long and be too difficult given how mature this market is.
o Are parts of the company not able to be recreated with capital? Which parts and why?
§ I think their entire business is able to be replicated with capital, but it would simply take too long and be too difficult to do given the permits and scale disadvantage of being a smaller player. Long story short, it likely wouldn’t be high returning for a long time for a new entrant.
o Are their competitive threats on the horizon?
§ Threats often come in the form from changes in taste of consumers. Do they want cremations or burials. The largest threat is likely a new-fashioned development of burial practices. For example, I know being buried in the root ball of a tree has come into fashion of late. While these changes can be real and impactful, I don’t think it is the kind of change that nullifies their advantages.
· Growth
o Is there a 90% chance that earnings will be up 5 years from now?
§ Yes. Currently 56 million Americans are over 65. By 2030, that amount is expected to rise to 71 million.
o Is there a 50% chance earnings will continue to grow in excess of 7% per year after the 5 year period?
§ Yes, the fastest growing demographic is the over 65 categories.
· Watch List Decision
o Do you honestly know enough about the industry and company to make an investment decision?
§ I feel I do.
o Bottom Line: Based on your answers is the company well insulated from economic and competitive shocks while able to grow for many years to come?
§ Yes
· Valuation
o Value the company
§ Revenue 3 years from now is estimated to be $4.239 billion.
§ With an average FCF margin of 12% over the past 5 years, I believe margin will hold around that level meaning FCF is expected to be $500 million. Given investments in automation and additional scale, there is an argument to be made that they may increase.
§ Over the last 3, 5, 7 and 10 years share count has reduced by an average of ~3.0% per year. Let’s assume this continues.
§ Shares Outstanding as of 11/02/2022 are 153,805,512. 12/31/25 would be 3.08 years away. This implies shares outstanding 3.08 years from now would be about 140 million.
§ This means forecasted FCF per share is estimated to be between $3.57 per share.
§ Free cash flow Yields have averaged ranged between 4% and 6% over the past 5 years.
§ If we assume a FCF Yield between 4% to 6% this implies a Dec 2025 price of $59.50 to $89 per share.
§ Current dividend yield is 1.7% or 1.00 per share. Let’s assume $1.00 is received each year
§ With a current price of $68 this implies a 3-year CAGR between -2.86% to 10.88%
o Would it be a prudent investment to buy the company at current levels?
§ No. SCI in my view is too highly rated from the sad surge in passing from Covid and the economic uncertainty causing a flight to safety. I would be a buyer around $55. At that price the expected returns would be between 4.5% to 19%. Having said that, my guess is free cash flow yield will be at the lower end of the range (i.e higher ending price) as the population ages and therefore growth accelerates in the coming years. This may open a price at ~$60.
Sources:
https://www.americashealthrankings.org/explore/senior/measure/pct_65plus/state/ALL Demographic data
https://finbox.com/NYSE:SCI aggregated data
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