Important disclosures appear on the last page of this report. The Henry Fund Henry B. Tippie College of Business Matt Detweiler ([email protected]) Carriage Services, Inc. (CSV) April 1, 2019 Consumer Staples – Death Care Services Stock Rating Sell Investment Thesis Target Price $17-20 We recommend a sell rating on Carriage Services, Inc. It is expected the cremation rate will continue to outgrow the burial rate in the United States over the next several years. This leads to smaller margins due to the price difference of traditional burials compared to cremations. Carriage’s main source of growth has been through acquisitions which we believe is ultimately unsustainable due to the high amount of debt it requires. There are also concerns about the environmental impact of current body disposition methods. Overall, there is little room for Carriage to grow in their current area. Drivers of Thesis • The cremation rate is expected to rise approximately 30% over the next two decades. Cremations deliver roughly one-third the revenue of traditional burials and customers may opt for cheaper direct cremation services. • Carriage has had to take on large amounts of debt to finance their growth strategy. In 2018 they issued approximately $320 million in senior notes due in 2026. We are concerned Carriage may be unable to service this debt. • Growth of alternative disposition methods, such as green burials, may cut margins further. This is not a certainty as these methods are not common. Risks to Thesis • Unique, personalized funeral packages can deliver higher margins. If Carriage shows these are a viable revenue stream they may have better than expected growth. • Carriage’s services have an inelastic demand and steadily rising death rates could provide sustainable growth in the funeral and cemetery segments. Henry Fund DCF $17.95 Henry Fund DDM $13.24 Relative P/S $19.63 Price Data Current Price $19.25 52wk Range $14.50 – 28.96 Consensus 1yr Target $26.00 Key Statistics Market Cap (M) $350.03 Shares Outstanding (M) 19.20 Institutional Ownership 73.60% Five Year Beta (Weekly) 0.85 Dividend Yield 1.40% Est. 5yr Growth 13.57% Price/Earnings (TTM) 29.55 Price/Earnings (FY1) 25.00 Price/Sales (TTM) 1.50 Price/Book (mrq) 2.80 Profitability Operating Margin 16.16% Profit Margin 4.35% Return on Assets (TTM) 1.27% Return on Equity (TTM) 11.67% Earnings Estimates Year 2016 2017 2018 2019E 2020E 2021E Analyst $1.37 $1.55 EPS $1.18 $2.25 $0.71 $0.86 $0.92 $0.99 growth 1.72% 90.68% (68.51)% 21.13% 6.98% 7.61% 12 Month Performance (Source: Yahoo Finance) Company Description Carriage Services specializes in high value personal services relating to after-death care. These include removal and preparation of remains, the sale of caskets and related merchandise, funeral home facilities, and transportation services. They also provide cemetery services including internment rights, markers, and burial containers. These services are provided on both an “at-need” and a pre-need basis. As of the end of 2018, Carriage operated 182 funeral homes in 29 states and 29 cemeteries in 11 states. 13.2 5.6 14.9 17.7 29.3 12.8 15.7 17.6 11.1 0 10 20 30 40 P/E ROE EV/EBITDA Source: Factset CSV SCI Industry -70% -50% -30% -10% 10% F M A M J J A S O N D J CSV S&P 500
Transcript
Important disclosures appear on the last page of this report.
Consumer Staples – Death Care Services Stock Rating Sell
Investment Thesis Target Price $17-20 We recommend a sell rating on Carriage Services, Inc. It is expected the cremation rate will continue to outgrow the burial rate in the United States over the next several years. This leads to smaller margins due to the price difference of traditional burials compared to cremations. Carriage’s main source of growth has been through acquisitions which we believe is ultimately unsustainable due to the high amount of debt it requires. There are also concerns about the environmental impact of current body disposition methods. Overall, there is little room for Carriage to grow in their current area. Drivers of Thesis
• The cremation rate is expected to rise approximately 30% over the next two decades. Cremations deliver roughly one-third the revenue of traditional burials and customers may opt for cheaper direct cremation services.
• Carriage has had to take on large amounts of debt to finance their growth strategy. In 2018 they issued approximately $320 million in senior notes due in 2026. We are concerned Carriage may be unable to service this debt.
• Growth of alternative disposition methods, such as green burials, may cut margins further. This is not a certainty as these methods are not common.
Risks to Thesis
• Unique, personalized funeral packages can deliver higher margins. If Carriage shows these are a viable revenue stream they may have better than expected growth.
• Carriage’s services have an inelastic demand and steadily rising death rates could provide sustainable growth in the funeral and cemetery segments.
Henry Fund DCF $17.95 Henry Fund DDM $13.24 Relative P/S $19.63 Price Data Current Price $19.25 52wk Range $14.50 – 28.96 Consensus 1yr Target $26.00 Key Statistics Market Cap (M) $350.03 Shares Outstanding (M) 19.20 Institutional Ownership 73.60% Five Year Beta (Weekly) 0.85 Dividend Yield 1.40% Est. 5yr Growth 13.57% Price/Earnings (TTM) 29.55 Price/Earnings (FY1) 25.00 Price/Sales (TTM) 1.50 Price/Book (mrq) 2.80 Profitability Operating Margin 16.16% Profit Margin 4.35% Return on Assets (TTM) 1.27% Return on Equity (TTM) 11.67%
Earnings Estimates Year 2016 2017 2018 2019E 2020E 2021E
Analyst $1.37 $1.55
EPS $1.18 $2.25 $0.71 $0.86 $0.92 $0.99
growth 1.72% 90.68% (68.51)% 21.13% 6.98% 7.61%
12 Month Performance (Source: Yahoo Finance) Company Description
Carriage Services specializes in high value personal services relating to after-death care. These include removal and preparation of remains, the sale of caskets and related merchandise, funeral home facilities, and transportation services. They also provide cemetery services including internment rights, markers, and burial containers. These services are provided on both an “at-need” and a pre-need basis. As of the end of 2018, Carriage operated 182 funeral homes in 29 states and 29 cemeteries in 11 states.
13.2
5.6
14.917.7
29.3
12.815.7
17.6
11.1
0
10
20
30
40
P/E ROE EV/EBITDA
Source: Factset
CSV SCI Industry
-70%
-50%
-30%
-10%
10%
F M A M J J A S O N D J
CSV S&P 500
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EXECUTIVE SUMMARY
Carriage Services operates in the death care services industry. This is a mature industry that is highly fragmented with limited organic growth potential. The majority of Carriage’s historical growth has come through acquisitions of smaller funeral homes and cemeteries. Carriage has a “Strategic Acquisition Model” that aims to acquire high quality private funeral homes and provide a succession plan for the current ownership.
Carriage has two main business segments: funeral home operations and cemetery operations. Funeral home operations is the segment that will be driving growth for Carriage as it is responsible for approximately 75% of their revenues. Carriage has shifted away from cemetery acquisition and divested three cemeteries in 20181.
The model shows that Carriage will have positive sales growth in each year of approximately 2.5%, a slower rate than previous years. This is due to the increased number of cremation services they are providing. Cremations have a much smaller margin than traditional burial services and cremations are projected to continue rising in popularity17. In 2017, Carriage had an average revenue of $8,886 per burial contract compared to $3,376 for cremation contracts. This leads to compressed margins and lower earnings in the model.
Carriage management believes they can compensate for declining margins by offering additional services and merchandise such as counseling services, tribute items, and memorial items that hold portions of the cremation remains. We have yet to see these sales increase, but the model shows that a reduction in cost of goods sold as a percentage of sales would give the company more upside than we are currently seeing. Carriage has an upside of approximately 4% and a downside of 12% based on the model at Carriage’s current stock price of $19.25.
COMPANY DESCRIPTION
Carriage Services, Inc. (CSV) is one of three publicly traded companies that specialize in death care services. They were incorporated in Delaware in 1993 and are headquartered in Houston, Texas. Their main business segments are funeral home services and cemetery services. These include the collection and disposition of remains, use of the funeral home and staff, funeral
services, and cemetery internment rights and related merchandise. These products are sold on a pre-need and at-need basis. A large portion of their properties are in California, Florida, and Texas.
Source: carriageservices.com/businesses
Carriage’s main competitors are Service Corporation International (SCI) and StoneMor Partners L.P. (STON). StoneMor is different from SCI and CSV in that the majority of their properties are cemeteries (77% as of 2017 end)4. Due to this difference STON is essentially run as a real estate investment trust (REIT), making comparison difficult. Matthews International Corporation (MATW) is tangentially competitive with CSV, as they produce cemetery memorial products. Hillenbrand Inc. (HI) is similar in that they also produce memorialization products. MATW and HI are both listed in the industrials sector as they are conglomerates, thus should not be considered true comparisons to CSV.
CSV SCI STON
Properties 211 1,962 409
Sales (000s) 267,922 3,190,200 348,900
Net Income (000s)
11,645 447,200 (75,158)
Rev/property (000s)
1,270 1,626 853
Source: CSV, SCI 10-K 2019, STON 10-K 2018
This table compares CSV, SCI, and STON’s properties and income for 2018. SCI has the definitive size advantage over CSV and STON. STON has negative net income due to large impairment charges primarily stemming from their funeral home operations unit.
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Acquisitions have been a large part of Carriage’s growth and will remain so going forward according to their strategic acquisition model. This plan aims to acquire profitable private funeral homes as a succession plan for the current ownership. The model projects Carriage acquiring an average of five funeral homes per year. Carriage has not acquired a new cemetery since 2010 and their actions would indicate they do not plan on doing so soon. We believe their reluctance to acquire cemeteries is because they are not as profitable as funeral homes. This is because once all available burial plots are purchased, the cemetery trust is responsible for generating excess return to finance the upkeep of the cemetery. If the trust cannot provide funds for cemetery maintenance, Carriage must divert funds from another segment. Carriage divested four cemeteries in 2018.
Source: CSV 10-K, 2015-2019
2014 2015 2016 2017 2018 2019E 2020E
TR change 5.69 7.24 2.35 4.00 3.79 2.53 2.55
Funeral change
6.53 6.95 1.93 6.06 4.90 3.18 3.20
Cemetery change
4.79 8.20 3.73 (2.63) 0.02 0.13 0.09
This table shows the percent change in total revenue as well as by revenue segment for the years in the preceding chart. The funeral home segment has experienced positive growth in recent years while the cemetery segment has had negative and near-zero revenue growth in the last two years. These trends continue in the model.
Funeral Home Operations
The funeral home segment accounts for 75-80% of Carriage’s total revenue. Within this segment, revenues
are split between same-store and acquired store categories. Acquired properties remain in the acquired category for five fiscal years after their acquisition.
Source: CSV 10-K 2019
In 2018 funeral home operating revenue was 78.65% of total revenue. The model projects a 50 basis point increase in annual funeral segment revenue as a percentage of total revenue in the forecast period. This is due to Carriage’s focus shifting to funeral home acquisitions rather than cemeteries.
The below chart shows Carriage’s revenue per funeral home on an annual basis:
Source: CSV 10-K 2019
Carriage has had increasing revenue per funeral home over the last several years. We believe they will see continued growth in the forecast period of approximately 0.6% per year. This is due to revenues per contract from the increase in the cremation rate. Cremations provide less revenue per contract than burials, causing overall revenue to grow at a slower rate.
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100,000
200,000
300,000
2014 2015 2016 2017 2018 2019E 2020E
Total Revenue by Segment ($000s)
Funeral Cemetery
-
100,000
200,000
300,000
2014 2015 2016 2017 2018 2019E 2020E
Funeral Operating Revenue by Home Type
Same-store Acquired
1000
1050
1100
1150
1200
2014 2015 2016 2017 2018 2019E 2020E
Revenue per Funeral Home (000s)
Revenue per funeral home
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Cemetery Operations
The cemetery segment accounts for 20-25% of Carriage’s total revenue. Revenues within this segment are also split into same-store and acquired categories. The same five-year rule applies to cemeteries in the acquired category.
Source: CSV 10-K 2019
Most cemetery revenue comes from same-store operations as Carriage has stopped acquiring cemetery properties over the past five years. Overall, the cemetery segment has had stagnant growth for Carriage. This is reflected in the model with an annual 50 basis point decrease for cemetery revenue as a percentage of total revenue. This is due to Carriage not acquiring new cemeteries as well as divesting current cemetery holdings. We will begin to see the acquired category approach zero as acquired properties begin to fall out of the acquired category and enter same-store.
Source: CSV 10-K 2019
Revenue per cemetery has fluctuated in recent years. The model forecasts relatively stagnant revenue from the
cemetery segment as Carriage has not shown they plan on acquiring cemeteries in future years. The increase in 2018 was due to revenue received from the divestiture of three cemeteries. The model assumes they will neither acquire nor divest any cemetery properties in the forecast period. Prior to the 2018 divestitures, Carriage had made no cemetery-related transactions since 2013.
Other Revenue
The “other” revenue segment consists of earnings from preneed trusts for both the funeral and cemetery segments. Carriage is required to place funds from preneed contracts in these trusts and they are invested in relatively safe securities. These earnings are shown in their annual report and are approximately 7.5% of contracts sold.
Trust earnings are subject to federal and state regulations. Carriage may be required to replenish trust balances if market performance causes them to dip below specified thresholds. Conversely, Carriage can withdraw allowable distributable earnings including gains before the maturity of the contract. The trust earnings or losses are included in their respective segment revenues.
Company Analysis
The majority of Carriage’s revenue, approximately 80%, comes from their funeral segment. This includes ceremonies and funeral services and disposition services (burial or cremation). The remaining 20% comes from their cemetery segment. This includes memorialization monuments and markers and inscriptions for burial plots.
Carriage has no specified target market. They are positioned in states with higher proportions of elderly residents, primarily Texas and Florida. They are not the only firm operating in these areas: SCI as well as many private firms operate in these retirement hotbeds.
The map on the following page show Carriage’s property locations by state. The 40 marker in the northeast region indicates there are 40 locations in that region, not in one state.
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40,000
60,000
2014 2015 2016 2017 2018
Cemetery Operating Revenue by Property Type
Same store Acquired
0
500
1000
1500
2000
2500
2014 2015 2016 2017 2018 2019E 2020E
Revenue per cemetery (000s)
Revenue per cemetery
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Source: carriageservices.com/businesses
This map shows the percentage of residents age 65 and older by county in the US.
Source: CensusScope.org
Carriage tries to differentiate themselves through providing high quality products and services. They have the advantage of being one of three publicly traded companies and own roughly one percent of the market share in the U.S. They exercise some economies of scale by being able to purchase large quantities of products such as caskets and urns. They are not able to exercise these economies of scale to the degree that SCI is due to their overall size. Below is a map of SCI’s locations in the US, Puerto Rico, and Canada.
Source: SCI 10-K, 2019
SCI has nearly 2000 properties compared to 211 for CSV. Most of SCI’s properties are in the same high-density areas of elderly as Carriage, making competition intense.
Carriage’s business model is heavily debt financed, but this is the trend in the industry.
CSV SCI STON
Total Debt/Total Equity 180.7% 253.2% 214.0%
Total Debt/Market Cap 64.2% 71.5% 66.4% Source: Factset
CSV, SCI, and STON use this debt to finance their acquisitions and pay off debt that will soon come due.
RECENT DEVELOPMENTS
Recent Financial Results
CSV announced 2018 Q4 earnings on February 20, 2019. Their non-GAAP EPS of $0.23 beat by $0.04. GAAP EPS of -$0.14 missed by $0.32. Revenue of $66.25 million (+ 2.2% year-over-year) beat by $0.11 million18.
They released their 2019 annual report on February 28, 2019. Their results are as follows:
Carriage has been a consensus strong buy or buy during the month of February20 between the two analysts that cover it. This runs counter to our sell recommendation. There are several reasons we are contrary to the consensus.
• We project decreasing margins for Carriage due to rising costs of goods sold and slower than expected growth in the funeral segment. This is the result of a higher cremation rate. This ultimately leads to lower earnings estimates.
• Carriage is a highly levered company. They have outstanding convertible notes due in 2021. We believe they will have to buy these back to avoid severe equity dilution.
• Carriage also issued approximately $320 million in senior notes due in 2026. This will affect their growth drivers moving forward.
• Much of Carriage’s growth is driven by acquisitions. We do not believe there are enough suitable acquisition targets to be a long-term growth strategy. Additionally, the synergies created from these acquisitions do not justify the increased leverage for Carriage.
The below table shows our model’s estimates versus the consensus and company guidance:
P/E (1YR) EPS 2019E EPS 2020E Sales ($mil)
Henry Fund 22.5 0.86 0.92 274.7
Consensus 15.6 1.37 1.55 273.5
Guidance (low) - 1.34 - -
Guidance (high) - 1.44 - -
Consensus Source: Factset
We believe the large difference between our model, the consensus, and company guidance comes from compressed margins. The analysts’ consensus indicates they believe Carriage will have lower costs of goods sold and maintain or improve margins in the forecast period. We are not as confident in Carriage’s ability to do so because they have not shown their ability to find alternate revenue streams as the cremation rate increases. If Carriage can increase their average revenue per cremation contract or lower their cost of goods sold relative to sales, our model’s estimates would move closer to the consensus.
Acquisitions and Divestitures
Carriage has outlined a “Strategic Acquisition Model” in their annual reports. This uses “strategic ranking criteria to assess acquisition candidates”1. These criteria include:
• Cultural alignment
• Volume and price trends
• Size of business and market
• Competitive standing
• Demographics
• Strength of brand
• Barriers to entry
Although not explicitly stated as a criterion for acquisition, the aging of current funeral home directors may also contribute to more acquisition targets. If these directors and/or owners cannot find replacements for retiring employees, they may be more likely to sell to Carriage.
They believe following this model will lead to acquisitions of larger, higher-margin businesses. In theory, this would lead to economies of scale for Carriage and help them compete against SCI and STON. We have yet to see this on the income statement, as Carriage has not had consistently increasing gross margins nor decreasing cost of goods sold compared to sales.
2014 2015 2016 2017 2018
Gross Margin
30.96 %
31.96 % 32.09 % 29.75 % 28.32 %
COGS as a % of Sales
69.04 %
68.04 % 67.91 % 70.25 % 71.68 %
Source: CSV 10-K, 2015-2019
Carriage mainly finances their acquisitions through debt. They acquired four funeral home businesses and divested three cemetery businesses in 2019. The four acquisitions had an aggregate purchase price of $38.0 million1. Carriage had $4.71 million in revenue from their divested operations.
We foresee Carriage having trouble paying their debt if their margins continue to compress. They have taken new debt to pay down old debt and finance acquisitions in recent years. If they are unable to refinance or acquire new debt to pay off their 2026 senior notes we do not expect Carriage to have the cash flow to service this debt.
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Lawsuits
Carriage Services may be exposed to possible claims from burial and funeral practices from time to time. This may subject them to litigation and liability in some cases. Since most of their cemeteries have been acquired through acquisition of other businesses, they may be subject to legal proceedings stemming from actions or events that occurred before their acquisition of the company or cemetery.
Carriage is currently party to a class action lawsuit based on employment practices stemming from one funeral home location in California. This was filed in March of 2018 in the state of California. In October of 2018 the parties mediated an agreement and executed a Memorandum of Understanding for class settlement. In February 2019 a settlement agreement was fully executed and submitted for preliminary approval by the court. Carriage has accrued $ 650,000 for the estimated settlement amount related to this case. This has a relatively small impact on a per share basis.
Carriage self-insures against these risks based on assessment of risk to maintain an acceptable level of financial exposure.
INDUSTRY TRENDS
The most important factor facing the death care services industry is the cremation rate. It is projected to rise steadily over the next several years and this will result in lower margins not only for Carriage, but for all firms in the industry. There are several reasons for the increasing cremation rate: a lower cost than traditional burials, changing consumer preferences, and lower accessibility to burial plots.
Employment is also a factor for the industry as it is not a common field for people to pursue. There are jobs in the field, but it may be challenging for homes to find new hires. Finally, firms are expanding their online presence to engage with new potential customers and offer more personalization.
Cremation Rate
The cremation rate has been rapidly rising since 2010. This trend is expected to continue over the next two decades due to costs and personal preferences for consumers.
2010 2015 2019E 2025E 2030E 2035E
Burial % 53.3 45.2 39.0 30.1 22.5 15.0
Cremation % 40.4 47.9 55.1 64.0 71.6 79.1
Other % 6.3 6.9 5.9 5.9 5.9 5.9
Source: NFDA
The “other” category refers to alternative disposition methods including cryogenics, “green” burials, and resomation27.
The cremation rate passed the burial rate in 2015 and will be nearly 80% by 2035 according the National Funeral Directors’ Association17. This is concerning for Carriage and the industry, as the average cremation contract delivers approximately one-third the revenue of a burial contract1. The table below shows the average revenue per contract and the burial and cremation rates for CSV from 2015-2017.
In 2015 CSV’s cremation rate was ahead of the national average compiled by the NFDA. Below is revenue ($millions) by service type and number of contracts for CSV over this same time span.
Carriage is providing more cremation contracts every year, and cremation contracts are growing at a faster rate than burial contracts. In 2017, the average cremation contract for CSV provided 38% of the revenue of the average burial contract. For comparison, if Carriage’s burial and cremation rates are what the NFDA predicts in 2025,
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Carriage would have $ 132.7 million in revenue from burial and cremation contracts. This is a 16.18 % decrease compared to their 2017 revenue of $ 158.32 million.
The difference in revenue for burial and cremation contracts is due to several factors. There is a different casket used for either process. Burial caskets are typically metal-lined to weather the underground conditions whereas cremation caskets are made of wood to burn easily. The price difference, on average, is around $1,000. The rest of the discrepancy in average revenue comes from the services involved in burials or cremations. Burials typically involve a traditional funeral service, transportation to the burial site, the cost of a burial site, and markers for the gravesite. Cremations can have these as well, but cremations have other, less-expensive options for memorials. An urn with the remains can be placed in a columbarium, for example, which has a lower cost that a burial plot. The family is also able to keep the urn and remains, eliminating the need to pay for a burial plot. Both burials and cremations have certain fixed costs that are difficult to circumvent, such as the cost of transporting the body after death and the preparation of remains.
Carriage has stated in annual reports that their goal is to increase the average revenue of cremation contracts by selling accessory items with the cremation service. This includes cremation containers, keepsakes, and jewelry. So far this has only resulted in modest increase to the average cremation contract revenue. We do not foresee Carriage being able to drastically increase the average cremation revenue in the forecast period as the cremation rate continues to rise.
As of 2019, CSV, SCI, and STON no longer report average revenue per contract type or the number of each contract type. They have not given a reason for this reporting change. We interpret this as a negative signal.
Employment Prospects
Funeral service work is a niche field but has relatively low barriers to entry. To enter the field usually only an associate’s degree is required, although more education may be necessary to advance. It also provides an above average median wage.
Source: Bureau of Labor Statistics
The employment of all funeral service workers is expected to grow approximately 5% from 2016 to 20268. This is partially attributable to workers aging and retiring from the field, opening positions for new workers. Morticians, undertakers, and funeral directors have the lowest expected growth rate at 4%.
Source: Bureau of Labor Statistics
Many firms have the challenge of finding employees looking to enter the field, especially those with funeral director and embalming licenses28. This is especially prevalent at locations in less population-dense areas. Carriage theoretically has an advantage in their economy of scale to be able to incentivize employees to move to less desirable locations. Some homes may not require new employees, as a succession plan could be in place in accordance with their Strategic Acquisition Model. Our model anticipates higher gross wages paid as Carriage acquires new funeral homes in the forecast period, but relatively stable wages for employees at each position.
$0 $40,000 $80,000
Total, all occupations
Funeral directors
Funeral service workers
Funeral service managers
Funeral Service Workers
Median annual wages (May 2017)
0% 2% 4% 6% 8%
Funeral directors
Funeral service workers
Funeral service managers
Total, all occupations
Funeral Service Workers
Percent change in employment, projected 2016-2026
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Digital Presence
Firms in the industry are beginning to market more of their services online. They are hesitant to embrace social media, but that could be due to the morbid nature of the industry.
Carriage is hoping that offering more personalization of services online will allow customers to spend more in a lower-pressure environment. By allowing customers to shop at their own pace, there is potential for them to choose items that may not have been considered at first glance. However online sales can also work to the detriment of the company. Customers may be more reluctant to spend more on higher quality items if they do not have the pressure of buying face-to-face.
Carriage has not broken out online statistics in annual reports at this time.
Religious Importance
The impact of religion in death care services has been declining in recent years. This can be partially explained by younger generations having a lower importance of religion in their life.
Source: Pew Research Center
The portion of Americans who believed a religious component was “very important” in the funeral of a loved one fell from just under half in 2012 to around one-third in 2016.
Source: Statista
This decrease in perceived importance may be correlated with the decrease in traditional burials. For example, Catholicism used to suggest traditional burials and shy away from cremation. However, the Vatican has recently said cremation is acceptable in certain circumstances22. If the importance of religion continues to decline it could lead to a rise in non-traditional, cheaper disposition methods.
MARKETS AND COMPETITION
Industry History
Death care services have been necessary as long as humans have been alive. Until the 1970s, almost all funeral homes and cemeteries in the U.S. were independently owned25. As of 2018 approximately 14% of funeral homes were owned by CSV, SCI, or STON. SCI has such a large market share they had to seek antitrust approval from the FTC when acquiring Stewart Enterprises in 2013. This trend of acquisition and consolidation has led to a decline in the number of funeral homes in the U.S. There were 21,528 funeral homes in the U.S. in 2004. This number has fallen to 19,177 in 2018. We believe the decline is caused by consolidation as well as fewer funeral homes being required to service specific geographic areas.
Industry Dynamics
The death care services industry is a highly fragmented and mature industry. There is not a viable threat of new entrants that could compete on the level of CSV, STON, and SCI. This is because there are large capital costs required to operate a funeral home that continue to grow as homes and cemeteries are acquired.
30.00%
40.00%
50.00%
2012 2013 2014 2015 2016 2017 2018
Religious Importance in Funeral Services
Percentage of Americans who feel religion in a funeral isvery important
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The three main competitors are CSV, SCI, and STON. The rest of the industry is comprised of small, private firms. The three public companies are in competition with each other as well as the private firms. Part of their competition with each other is the acquisition of successful private homes. This can lead to them overpaying for a home in order to keep it out of the control of their competition. CSV and STON do not have the resources or size to compete on the same level as SCI.
This is an industry where firms are required to operate almost solely with “red ocean” strategies24. “Red ocean” strategies refers to market environments where there is heavy competition, whereas “blue ocean” industries are novel industries where there is no competition in the current state.
• Carriage must compete in the existing market. The nature of the industry prevents firms from creating a truly “new” market.
• Firms strive to beat their competition. This can be through offering lower prices or product and service differentiation. However, CSV, SCI, and STON can make their competition irrelevant to a degree through acquisitions of funeral homes and product brands.
• Firms struggle to capture more of existing demand from each other. It is not possible to create more demand for funerals as a service. Therefore, acquisitions are a large part of growth for CSV, SCI, and STON. Firms may be able to create demand of specialty products, but not their services in general.
• Firms are forced to make the value/cost trade-off. They have the choice to provide customers more value at a higher cost, or relatively average value for the price.
In this market, SCI is the established market leader and will be difficult to beat competing head-to-head. CSV and STON need to differentiate themselves either through geography, quality of products and services, or price.
Peer Comparisons
There are 19,177 funeral homes in the United States16. Approximately 86% of these are privately owned by families or individuals16. The three publicly traded companies that own funeral homes and cemeteries are Carriage Services (CSV), Service Corporation International (SCI), and StoneMor Partners L.P. (STON).
Source: NFDA
The industry is highly fragmented with many small, private firms operating in specific geographic areas. It is based on traditional, family-owned businesses. These are the types of firms CSV, SCI, and STON acquire.
This table shows how many properties each company has, and SCI has the most by far. This is partially due to SCI owning properties in Canada whereas CSV and STON only operate in the U.S. Below is the revenue per funeral home and cemetery for each company, in thousands, for 2018.
CSV and SCI have similar revenue per funeral home although SCI has a much higher revenue per cemetery. We believe this is because SCI is able to truly recognize economies of scale in their cemetery operation due to their size and market share in the industry.
U.S. market share by revenue is shown on the next page (total industry revenue comes from Statista):
1% 12%1%
86%
Ownership of Funeral Homes, United States (2018)
CSV SCI STON Private
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Source: CSV, SCI 10-K 2019, STON 10-K, 2018
Market share by revenue is similar to market share by number of properties. CSV and STON still have roughly 1-2% of the market apiece, however SCI has 20% of the market revenue. This is considerably higher than their funeral home market share of 12%.
CSV SCI STON
Op. Margin 16.16% 19.27% (3.16)%
ROA 1.26% 3.50% (4.16)%
ROE 5.56% 29.31% (51.84)%
ROIC 2.07% 9.20% (16.44)% Source: Factset
Carriage and SCI are well ahead of STON based on common ratio analysis. The concern for Carriage is how to compete with SCI. SCI is much larger and can take advantage of economies of scale as shown by their ratios. Carriage doesn’t need to compete directly with SCI, however due to their large geographic overlap Carriage will naturally compete with SCI in high-density areas.
Disruption
Increased popularity of “green” funerals could take away revenue from the main competitors if they do not provide these alternative services. These services include being buried in an environmentally-friendly fashion using fewer materials that damage the environment, such as a shroud9. A natural burial including a burial plot, internment fees, and an environmentally-friendly container costs between $2,000-$3,00030 – a price in-line with cremation costs.
A more controversial disposition method is resomation27. This includes alkaline hydrosis, a type of cremation using
water to dissolve the body. The energy use and outputs from this method are much lower than standard cremations. This method is a topic of debate both legally and ethically11. If this method or another like it were to be approved, it could take revenue from traditional firms.
ECONOMIC OUTLOOK
Natural Gas Prices
Natural gas is the most common fuel source for cremations. As the cremation rate rises, Carriage and other firms with crematorium services will have increased exposure to fuel prices.
Source: US Energy Information Administration
Natural gas prices have remained steady over the past five years. Carriage will still have exposure risk to fuel prices, but we do not foresee it being crucial to their margins. Carriage does not disclose fuel costs and does not state any hedge position if they were to have one.
It should be noted that standard cremation ovens require a large amount of fuel to reach temperatures capable of cremation. Once hot enough, the body fat of the cremated bodies supplies fuel to keep the oven at cremation temperatures.
Interest Rates
Carriage Services has approximately $320 million in outstanding 6.625% senior notes due in 2026. These carry a ‘B’ rating from Standard and Poor’s. A decrease in interest rates could raise the price of these bonds if Carriage wishes to repurchase them in the future.
0.2673.19
0.338
12.205
Revenue ($B) 2018
CSV SCI STON Other
0
5
10
15
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
US Commercial Price of Natural Gas
$ per 1000 cubic ft.
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They have also opened a new line of credit with their “New Credit Facility”. This facility allows up to $150 million of borrowing, under which they already have $27.1 million of outstanding borrowings. They are vulnerable to interest rate increases under this agreement as borrowings are at variable rates. Below is a breakdown of Carriage’s debt:
Source: CSV 10-K, 2019
Carriage used the proceeds of the senior note issuance to pay down their credit facility debt as well as purchase the majority of the 2021 convertible bonds. We believe purchasing the convertible bonds was a good decision by Carriage. Many of the bonds were “in the money” and if converted to equity would have severely diluted the company’s equity. We believe they will repurchase the remaining bonds in the next two years. However, we also believe that Carriage is pushing their debt burden into the future by issuing such a high amount of debt at one time. If Carriage has continued cash flow problems or is unable to open new lines of credit, we do not think they will be able to service this debt.
CATALYSTS FOR GROWTH
Disposable Income
Disposable income has risen steadily in the U.S. in the last decade. Aside from a large dip in 2013, real disposable personal income has risen approximately 0.5% per month over the past 10 years. Consumers have more money to spend how they wish, especially in upper-class households.
Source: FRED St. Louis
This income could be a boon for Carriage and the death care industry as the boomer generation hits old age. It is not a certainty that consumers will be willing to spend more on funeral and cemetery services just because they have the money, especially when the services are prepaid.
U.S. Death Trends
Although the average life expectancy has been increasing in the United States, the amount of total deaths has been steadily increasing. It will get a slight bump in the next decade as “baby boomers” begin passing away. This is shown on the graph below.
Source: US Census Bureau
Even though the percentage of the population that is 65 and over will increase over the next 10 years, those who live to 65 are expected to live longer than previous generations.
1980 1990 2000 2015
Male 14.1 15.1 16.0 18.0
Female 18.3 18.9 19.0 20.5 Source: U.S. Center for Disease Control
0
100000
200000
300000
400000
Debt Obligations by Year ($000s)
2017 2018
0.00%
10.00%
20.00%
30.00%
0
2000
4000
2016 2020 2025 2030 2035 2040
U.S. Deaths and Population Age 2016-2040
Total Deaths in the US % of population 65 and over
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This shows that although the number of deaths is increasing, it is not due to people dying sooner. Rather there is a larger portion of the population entering old age than in previous years.
An increase in the raw number of deaths is a positive for Carriage as it creates more potential customers. It should be noted they have their strongest presence in popular retirement states such as Florida, Texas, and California. Being in heavily populated areas at least gives them the potential for a larger customer base. However, SCI and STON also have strong presences in these states. This is shown below:
Source: CSV, SCI 10-K 2019, STON 10-K 2018
Although CSV has their largest presence in these states, SCI dwarfs them by comparison.
Cremation Rate
The cremation rate is the biggest factor affecting Carriage. It is the biggest driver for their margins moving forward and if they cannot improve margins with the changing product mix, their earnings will continue to decline, and they will struggle to pay off their debt. The chart on the next page shows historical and predicted burial and cremation rates for the industry as a whole.
Source: NFDA
One possible fix would be the introduction of alternative disposition methods. These include green burials, water cremation, and personalized send-offs tailored to the customer’s wishes. These industries are not yet mainstream. Alternative dispositions such as alkaline hydrosis are in a legal and ethical gray area11. It has yet to be seen if these methods will provide higher or lower margins.
INVESTMENT POSITIVES
• Carriage is making a concerted effort to sell more auxiliary products with their services to combat compressed margins. We have not observed this being successful yet, but it is possible in the next several years.
• Death care services is a unique industry that has constant demand. Carriage should face no shortage of customers with the US death rate increasing steadily in the next decade.
• Disposable income increases could potentially provide more opportunities for higher margin products. It has not been shown customers are willing to spend more solely because they have more disposable income. It also does not mean they have budgeted funds for funeral expenses.
INVESTMENT NEGATIVES
• The rising cremation rate has compressed margins for Carriage and will continue to do so over the next several years. They have not demonstrated their ability to mitigate declining margins.
0
50
100
150
200
Florida California Texas
Funeral Homes by State (2018)
CSV SCI STON
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
2010 2015 2019E 2025E 2030E 2035E
Burial and Cremation Rates
Burial Cremation
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• Other alternative disposition methods could cut margins further. Methods such as “green” burials aim to use the lowest number of environmentally-damaging products as possible. This would mean lower sales of high margin items such as caskets and burial accessories.
• Carriage is heavily debt financed. This is mostly due to their acquisition strategy. Their growth is partially due to these acquisitions, however there is a limited number of profitable funeral homes to acquire. This is ultimately not a sustainable long-term growth strategy. It is unclear how they intend to grow aside from acquisitions.
VALUATION
The model valuations for Carriage Services are as follows:
• DCF/EP: $17.95
• Dividend Discount Model (DDM): $13.24
• Relative P/E: $13.70
• Relative P/S: $19.63
The current price for CSV is $19.25. The relative P/S indicates the stock is slightly undervalued while the DCF, DDM, and relative P/E models indicate it is overvalued. The consensus one-year target price is $26.007. There are two analysts currently covering Carriage. The relative models are limited by only having two or three companies for comparison.
We believe the DCF and relative P/S provide the most reasonable estimates of Carriage’s value. Relative P/E has the lowest value for Carriage, and we believe this is due to the companies available for comparison. SCI is much larger than Carriage and STON has had negative earnings for the past two years and are projected to be negative in the future. HI and MATW are poor comparisons to use as they are conglomerates and are not representative of the industry. Carriage has not given guidance on dividends making it difficult to estimate future dividends in the DDM.
Revenue growth was projected by the two main segments: funeral and cemetery.
2019E 2020E 2021E 2022E 2023E
Funeral 3.18% 3.20% 3.22% 3.24% 3.26%
Cemetery 0.13% 0.09% 0.06% 0.02% (0.02)%
Total 2.53% 2.55% 2.58% 2.60% 2.63%
We believe Carriage will see steady growth in their funeral segment due to their acquisition strategy, however this is lower than historical growth due to the increasing cremation rate. The cemetery growth rate is near zero due to divestitures and stagnant growth in their cemetery segment in recent years. We foresee this trend continuing as Carriage is not planning on acquiring new cemeteries.
It should be noted that cemeteries are subject to much less regulation compared to funeral homes. Cemeteries are not required to disclose pricing lists and there is no federal regulation giving consumers the right to purchase only the products and services they want. Although some states have cemetery pricing regulation, some cemeteries can mislead customers which could lead to higher revenues.
This leads total revenue growth to be 50-60 basis points above our expected inflation rate of 2%. This is lower than historical growth for Carriage. We believe this is possible because there are fewer viable acquisition targets for Carriage and they have had slowing same store growth.
COGS as a percentage of sales has been increasing for Carriage in recent years.
2016 2017 2018 2019E
COGS/sales 67.91% 70.25% 71.68% 69.00%
We believe this is because Carriage has not been able to recognize economies of scale from their acquisitions as well as the shift to lower-margin cremations. The growth of their costs has outpaced sales growth leading to compressed margins. The forecast predicts COGS as a percentage of sales growing at two basis points annually. This is a conservative estimate compared to the historical growth. The model has COGS as a percentage of sales starting at 69.00% in 2019 due to divestitures lowering their costs of cemetery products. If they can get the percentage around 67%, their valuation improves dramatically. Historically, SG&A as a percentage of sales has not always moved with COGS. We have SG&A decreasing by eight basis points annually. The increase in COGS as a percentage of sales is the main driver behind our projected stagnation or slight decline in margins. Carriage’s projected gross, operating, and net profit margins are shown on the next page.
Page 15
2018 2019E 2020E 2021E 2022E 2023E
GM 28.32% 31.00% 30.98% 30.96% 30.94% 30.92%
OM 16.16% 18.93% 18.99% 19.05% 19.11% 19.17%
PM 4.35% 6.36% 6.59% 6.79% 6.98% 6.65%
Many of these margins initially increase in 2019 then fall or remain stagnant in the forecast period. This is due to COGS as a percentage of sales being lower in 2019 than in 2018, which is more in-line with historical averages, but then rises in the forecast period.
Carriage management has provided guidance for 2019 capital expenditures of approximately $18 million. This is slightly higher than recent years. Carriage’s capital expenditure expenses are broken into two categories: growth and maintenance. The growth category is dedicated to cemetery and funeral home construction as well as renovations. The maintenance category covers general facility and equipment repairs and improvements.
We project capital expenditures continuing to rise due to continued renovations and improvements as Carriage acquires new funeral homes. If capital expenditures remain around their 2016-2018 levels, Carriage will have significant gains in their future cash flows.
Carriage’s WACC was calculated using the yield on the 10-year U.S. Treasury Bill for the risk-free rate of 2.698%. The assumed market risk premium is 4.95%. This is based on historical and forward-looking data. This gives a 6.91% cost of equity. The cost of debt is assumed to be 6.08%, via Factset. Carriage has no preferred stock. This results in a WACC of 5.51% that is used in all years. Carriage has a debt
to equity ratio of 1.35 that is kept relatively constant in the model.
Dividend yield is kept constant at 1.4% in the forecast period. This was the value in 2018 and is higher than the previous several years. Carriage has given little guidance on dividends, but we believe they will at least maintain their current annual dividend of $0.30.
We foresee Carriage having problems improving margins during the forecast period. This is the primary force of the difference between our price target and the consensus. If Carriage can lower their costs respective to revenues, then we will see our target get closer to the consensus.
KEYS TO MONITOR
The most important factor affecting Carriage’s future is the cremation rate. They must find alternative revenue streams to compensate for the lower average contract price of cremations. If they can grow revenue through new offerings they will see margin improvement.
Carriage’s debt structure should be monitored carefully in the future. They have reduced their outstanding convertible bonds, a good decision by the company. If they were to offer more convertible bonds in the future, their possible dilution of equity should be considered in valuation methods. Carriage’s large amount of debt also makes them susceptible to interest rate risk, if rates were to rise in the future. This affects their ability to grow through acquisition.
Alternative disposition methods should also be followed closely. Government regulation could allow new methods that consumers may find more appealing. It has yet to be seen if these methods would be financially beneficial to Carriage and consumers, but they are worth monitoring in the next decade.
0
10
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40
2014 2015 2016 2017 2018 2019E
CSV Capex ($mil)
CSV Capex
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REFERENCES
1. Carriage Services, Inc. 10-K 2009-2019 2. Carriage Services, Inc. 8-K, February 21, 2019 3. Service Corporation International 10-K, 2018 4. StonMor Partners L.P. 10-K, 2018 5. United States Death Care Market Outlook and Forecast
2018-2023 – Researchandmarkets.com 6. Statista – Death care services – Statistics and Facts 7. Factset 8. Funeral Service Workers: Job Outlook – Bureau of Labor
Statistics 9. Thinking About Having a ‘Green’ Funeral? Here’s What
to Know – New York Times 10. What is the Cost of Human Cremation? –
cremationresource.org 11. Dissolve the Dead? Controversy Swirls Around Liquid
Cremation 12. United States Census Bureau – Births and Deaths 13. U.S. Bureau of Economic Analysis, Real Disposable
Personal Income – FRED St. Louis 14. US Energy Information Administration – Natural Gas
Prices 15. CDC – Life expectancy at birth and at age 65, by sex 16. National Funeral Directors’ Association (NFDA) –
General Funeral Service Facts 17. National Funeral Directors’ Association (NFDA) –
Historic Rates of Cremation and Burial and Future Projections
18. Seeking Alpha – Carriage beats by $0.04, beats on revenue
Right Now? 21. US Census Bureau – 2017 National Population
Projection Tables 22. CNN – Vatican issues guidelines on cremation, says no
to scattering ashes 23. CensusScope.org – Percent of a county’s residents
aged 65 and over 24. Blue Ocean Strategy – W. Chan Kim, Renee Mauborgne 25. Forbes – The Death of the Death Care Industry and
Eternal Life Online 26. Carriage Services, Inc. Locations –
carraigeservices.com/businesses 27. LiveScience – After Death: 8 Burial Alternatives That
Are Going Mainstream
28. Des Moines Register – Death isn’t a dying industry, but Iowa funeral directors are becoming harder to find
29. Pew Research Center – Importance of religion in one’s life by age group (2014)
30. Market Watch – Why Americans are considering ‘green’ funerals
31. Bloomberg
IMPORTANT DISCLAIMER
Henry Fund reports are created by students enrolled in the Applied Securities Management program at the University of Iowa’s Tippie College of Business. These reports provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of our students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold an investment position in the companies mentioned in this report.
Gain (loss) on early extinguishment of debt 3,303 4,329 2,694 4,988 5,137 5,291 5,450 5,614
Other interest income & other income (expense), net (1,788) 1,118 1,238 893 920 947 976 1,005 Income (loss) before income taxes 32,241 32,782 18,266 18,956 20,068 21,193 22,378 21,856
Total current provision (benefit) for income taxes 7,804 7,240 6,621 4,739 5,017 5,298 5,595 5,464 Net income (loss) 19,581 37,193 11,645 14,217 15,051 15,895 16,784 16,392
Gain (loss) on early extinguishment of debt -0.23% 0.00% 1.01% 1.82% 1.82% 1.83% 1.84% 1.85%
Other interest income & other income (expense), net -0.72% 0.43% 0.46% 0.33% 0.33% 0.33% 0.33% 0.33%Income (loss) before income taxes 12.99% 12.70% 6.82% 6.90% 7.12% 7.33% 7.55% 7.18%
Total current provision (benefit) for income taxes 3.14% 2.80% 2.47% 1.73% 1.78% 1.83% 1.89% 1.80%Net income (loss) 7.89% 14.41% 4.35% 5.18% 5.34% 5.50% 5.66% 5.39%
Plus: Change in deferred tax (DT) liabilitiesCurrent year DT liabilities 40,555 31,159 31,263 31,576 31,891 32,210 32,532 32,858 - Current year DT current assets- Current year DT long-term assets
Net DT liabilities for current year 40,555 31,159 31,263 31,576 31,891 32,210 32,532 32,858 Previous year DT liabilities 39,956 40,555 31,159 31,263 31,576 31,891 32,210 32,532
- Previous year DT current assets - - - Previous year DT long-term assets - -
Net DT liabilities for previous year 39,956 40,555 31,159 31,263 31,576 31,891 32,210 32,532 Net change in DT liabilities 599 (9,396) 104 313 316 319 322 325
Weighted Average Cost of Capital (WACC) Estimation
Inputs Source
Risk-free rate 2.698% 10-yr Treasury (via WSJ)Equity market risk premium 4.950% Henry Fund consensus
Beta 0.851 5 year dailyCost of debt 6.08% Factset
Cost of equity 6.91% Risk-free + Beta(MRP)Marginal tax rate 25% Based on historical, accounting for new federal corporate tax rateCost of preferred stock 0% Factset - no preferred stock
Present value of Operating Lease Obligations (2018) Present Value of Operating Lease Obligations (2017) Present Value of Operating Lease Obligations (2016)
Operating Operating OperatingFiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases
