This week we look at a lesser known "bond like" investment vehicle called "Term Income Deferrable Equity Securities" (TIDES), a subordinated convertible preferred security, from Carriage Services Inc. (CSV). This debt instrument matures in June of 2029 and is currently indicating yield of about 7%. If this relatively midsized funeral operator continues its rapid growth and significantly increases in value, this bond's convertibility feature allows for the possibility of adding long-term capital gains into its total return potential. After further review, we see this as a rare and unusual opportunity to achieve higher US dollar yields in the very profitable funeral industry, which is starting to benefit directly from the baby boomer cycle. Therefore, we have selected these Carriage Services convertible notes for addition to our Fixed Income portfolios.
A Look at the Issuer
Headquartered in Houston Texas, Carriage Services was incorporated in 1991 and is currently the fourth largest publicly traded deathcare company. Not only is it a leading provider of professional funeral and cemetery services and products in the US, it is the leading consolidator of family owned deathcare businesses. Its vision for the next ten years is to affiliate with many of the best remaining independent funeral firms around the country. Carriage operates 167 funeral homes in 26 states, and it operates 33 cemeteries in 12 states.
We like companies that are profitable
Carriage Services recently announced record results for the quarter and full year ending December 31, 2012, achieved strong Q4 revenue growth of 13.1% to a record $53.3 million, and Adjusted Earnings Per Share growth of 140% to $0.24 per share. Full year results were also outstanding, achieving year over year revenue growth of 8.8% to a record $204.1 million and Adjusted Earnings Per Share growth of 30.8% to a record $0.85 per share. It also substantially raised its Rolling Four Quarter Outlook of Adjusted EPS to $1.11 to $1.14 from its previous guidance of $1.03 to $1.05.
Strong Historical Growth in profits
Total Field EBITDA
Adjusted Earnings Per Share
EPS of $0.85
EPS of $0.40
Interest Coverage Ratios
Interest expenses for the year ending Q4 2012 appear to be $17.0 million, while operating income (EBITDA) was about $80.6 million, indicating a healthy interest coverage ratio that's over 4.7 times. In the fourth quarter they completed a refinance of $130 million of 7.875% senior notes due in 2015 with a $235 million syndicated bank financing comprised of a $130 million five-year term loan and a $105 million five-year revolving credit facility, with interest savings of over 400 basis points on the refinanced term loan.
We like companies with lower debt to cash ratio
The long-term debt of Carriage Services at the end of 4Q 2012 was $268 million. Cash and cash equivalent at the end of Q4 was about $1.7 million, giving them the appearance of a rather poor cash ratio. However, as revealed previously in our StoneMor Partners (STON) high yield bond review, our research into the funeral industry business shows that it is not uncommon for these operators to have and maintain control over large trust funds of pre-sold business. StoneMor is the income beneficiary of a $250 million perpetual care trust. Service Corporation International (SCI) is the income beneficiary of an $1.1 billion perpetual care trust fund. Stewart Enterprises (STEI)'s perpetual trust fund is over $270 million. Carriage Services is no exception, as it controls a $177 million trust fund, equivalent to about 68% of its total debt. Consequently, we do not have the same concerns that might otherwise arise from such a very low cash level indication.
Carriage Services has demonstrated aggressive profit and production growth over the last 20 years and is forecasting more of the same kind of growth in the future. Yet, with future earnings projected at about $1.11/share and its stock trading currently around $19.33, the approximately 17:1 price to earnings (P/E) ratio is less than what might be expected for a company evidencing such consistently robust growth. Hence, we think this company's stock has plenty of potential for appreciation, even if it only achieves about half its historical trend. The United States on average has about 2.5 million funeral cases each year, and we have seen forecasts that by 2040 this number will nearly double, making this industry the final beneficiaries of the great and long lasting Baby Boomers cycle.
We like companies that have good balance sheets
Carriage Services' debt of $268 million appears to represent about 45% of the near $592 million enterprise valuation currently given to it by the equity markets. This is a better managed and less leveraged balance sheet than most of the companies we have investigated in the funeral care industry. Considering that its 7.875% bonds were just refinanced at about 4%, there are strong possibilities that this 7% convertible note might also soon be called and replaced with a less costly option. The underlying stock is trading at about a mere 5% discount to its convertible position, after which the bond price should reflect a one to one valuation to any stock price increase. Should the stock trade lower, bondholders continue to reap the 7% coupon yield, which in our opinion makes this 7% income play an extraordinary value if bonds are obtained at or below its call value.
We like higher yields
It appears that there are no credit ratings currently assigned to this debt, making it very different than the ever popular and highly rated sovereign debt of our spend happy government. Yet, when set in comparison to the paltry 2% yields of ten-year U.S. Treasuries, we think the 5% difference in yield AND the added capital gains that its convertible feature allows for (the conversion price being $20.4375 per common share) represents a remarkable opportunity for higher rewards given the level of risks that we can identify.
The default risk is Carriage Services' ability to perform. Credit rating agencies do not rate this convertible debt, but considering its historical trends, recent performance and its forecasted levels of earnings, its excellent position within a very solid industry, and the excellent cash flow that easily services their interest bearing debt, it is our opinion that the financial default risk for this convertible debt is minimal relative to its more favorable return potential.
The hardest risk for us to identify is the future valuation of the stock. With that said, the management team of Carriage Services has a well developed business growth plan that has proven itself to be very successful and profitable, and we have no reason to think that the company will deviate from this same kind of growth in the future. Furthermore, it appears that Carriage Service will continue to find numerous opportunities for growth, as aging practitioners of many small family funeral businesses find it easier to exit by selling the business to Carriage rather than broker it to an heir less caring of its worth.
With the increase of low cost cremations during the last ten years, the funeral industry has experienced significant pressures on its margins. We are aware that on the West Coast, funeral operators have seen the cremation rate exceeding 75%. While this remains a risk, it does make the EBITDA growth for Carriage Services over the last few years even more impressive. Lately, these high West Coast cremation levels seem to currently be receding, a trend that is expected to slowly spread across the rest of the nation.
Carriage Services may face increasing competition from any number of substantially larger and better financed companies, such as Service Corporation of America International, Stewart Enterprises Inc., or StoneMor Partners. All of these companies have significant resources, but the largest industry competition continues to be the thousands of small operators.
This convertible preferred security has similar risks to other convertible bonds that we have reviewed, such as the Tricon Capital convertible bonds, which have appreciated about 15% in the 3 months since our first review, and TransGlobal Energy convertibles (which after its recently reported quarter may be on a similar path).
Summary and Conclusion
Over the last twenty years, Carriage Services' growth is impressive. All things considered, it is our opinion that this company has established itself as a strong player within the funeral supply and services industry, and has done so possibly right in front of an even greater growth impetuous, the Baby Boomer cycle. We think this fixed income investment vehicle offers sound diversification, as well as a very high yield relative to the risks that we can identify. In addition to its already high coupon yield, these notes hold the possibility for significant capital gains due to its convertibility feature. For these reasons, we have selected Carriage Services Capital Trust 7% Convertible Preferred Securities, maturing in 2029, as an addition to our portfolio of Fixed Income bonds.
NYSE: $17.07 4/17/13
Convertible Preferred (Hybrid Bond) Symbol: CSVSP
Callable: anytime after 6/5/2001 (with not less than 30 days notice)
Call Redemption Price: 50
Conversion Price : $20.4375 (bondholder's option)
Recent Price - $50.00 4/18/2013
Yield to Maturity: 7%
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
Additional Disclosure: Some Durig Capital clients may currently own Carriage Services Convertible Preferreds.