When Death Becomes Life

There are only two certain things in life: death and taxes.

We cannot invest in the IRS. Yet, it is in fact possible to capitalize on the certainty of death, funeral traditions, and people’s grief.

Nowadays, nearly all of the deceased receive some sort of burial or cremation. Families also tend to disregard their financial conditions at times of distress, spending large amounts in funerals and memorials. Consequently, companies that operate in the so called “death care industry” possess a business model that takes advantage of people’s misfortunes.

Though, it may sound unethical and despicable, this is in fact a hidden jewel for equity investors.

The feelings of “sorrow,” “apprehension,” “discomfort,” and plain “rejection” that people experience towards the topic of death make the industry often overlooked by investors and the general public; in other words, an extremely lucrative opportunity.

Moreover, death care is recognized as one of the most defensive industries in the world, given that people die regardless of the state of the economy. In fact, death care is one of the few industries that could be considered borderline counter-cyclical. It is precisely during worst economic times that death rates tend to rise the most: low income levels prevent individuals from obtaining proper and sufficient health care, and the number of suicides skyrocket—as exemplified by the figures from the financial crisis in 2008.

The death care industry, thus, represents a good investment as the U.S. economy continues its path towards a late business cycle.

Even more, according to the National Funeral Directors Association, the number of deaths per 1,000 of population is expected to increase by 25% in 2045. This denotes a compound annual growth rate of 2.9%, a huge growth driver for the industry.

So, the death care industry offers great opportunities for investors. However, taking advantage of such opportunities may be a challenge given that the industry is highly fragmented. Today, there are about 15,000 private funeral homes with little market share and only less than 10 large public companies.

On the bright side, there is a solution to this fragmentation issue: Service Corporation International.

Service Corporation (NYSE: SCI) is the largest provider of death care products and services in the United States. With operations in 45 states, 8 Canadian provinces, the District of Columbia, and Puerto Rico, the company offers a wide spectrum of funeral and cemetery services, crematoria, and memorial merchandise under its different brand names. What makes SCI so attractive, however, is its distinctive business model.

SCI is the first publicly traded company in the industry that acquires and combines the numerous private businesses scattered all across the country into one large public entity. Once Service acquires other firms, it allows them to retain their original names and staff. Such a unique branding strategy enables the company to capitalize on the reputation that each funeral home has gained within its particular neighborhood.

Service Corporation faces little direct competition from other major players since the industry is mostly comprised by small private firms. Other public death care companies include StoneMor Partners LP (NYSE: STON), Carriage Services Inc. (NYSE: CSV), Hillenbrand Inc. (NYSE: HI), and Matthews International (NYSE: MATW). Out of these, the most relevant and comparative competitor as of size and type of business operations is StoneMor Partners, the second largest company in the industry by market share.

As of the second quarter of 2016, SCI held an approximate market share of 26%. In contrast, STON, occupied only about 11% of the market, followed by HI and CSV with an approximate 9% and 8%, respectively. Private businesses still control a significant portion of the industry, about 42%, representing an enormous opportunity for the company’s acquisition strategy.

The company has had an outstanding stock performance over the last five years, in which it outperformed both the S&P500 and StoneMor Partners with total returns of over 150%. Furthermore, SCI has realized an average annual growth of about 6.5% since 2011. More than half of this number originated from comparable or same store sales, which typically account for an average of 98% of total revenues. Such a substantial composition demonstrates the company’s ability to grow based on its internal operations rather than on gains produced from acquisitions or divestitures.

Related to its top-line, SCI subdivides its operations into two divisions: funeral and cemetery. The revenue breakdown from each of these divisions has been considerably stable over the past 10 years. In 2015, more than 60% of the company’s revenues came from its funerals.

Service Corporation earnings history exhibits a trend of frequently beating consensus estimates. Since 2011, earnings per share have increased by an average of 21% year over year, a significantly higher growth than that experienced by StoneMor Partners during the same period. Similarly, the company has exhibited a higher average ROE than both of its two main competitors, STON and HI, with a current TTM of about 15%. These superior figures are a result of better financial leverage, higher return on invested capital, and higher asset turnover.

Finally, the company has not only increased its free cash flows over the years—with an 86% growth in 2015 alone—but also its dividend payments. Service normally targets a payout ratio of about 30% to 40% of recurring net income and has grown its quarterly dividend rate by almost 400% in the last 10 years.

With all this, the opportunities that lay within Service Corporation International and the death care industry become clear. Even though investing on a company that “takes advantage of people’s misfortunes” may seem offensive and unethical at first, it is important to understand that the industry will continue to exist regardless of one’s decision to invest.

It is your call whether to live taking the opportunity or die knowing what you missed.

 

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