Service Corporation International (NYSE:SCI)
Bank of America Merrill Lynch Health Care Conference Call
May 14, 2013 6:00 PM ET
Tom Ryan -- President and CEO
Eric Tanzberger – SVP and CFO
Unidentified Company Representative
I'd say the debt care starts [ph] should quietly outperform just about everything else that I do in the pharma services. Very pleased to have Service Corp International here to present today as the industry leader. Tom Ryan who's president and CEO will speak to the company's opportunity. He's joined on the podium by Eric Tanzberger who is the Chief Financial Officer.
Thank you, Bob [ph] and thanks to Bank of America Merrill Lynch for inviting us again this year, and thanks everybody for participating. I will run through this presentation and have time for you guys to ask questions here shortly.
See if this works. There's the forward looking statement that's going to point you to safe harbor protections, the 10-K and the reconciliations, I'm not going to say much more than that. And off we go, business and industry overview.
So, SCI at a glance, most of you probably know a lot of these statistics, but I think it's important for particularly new people to the story. The company has been around quite some time. You can see it's been just over 50 years now. And we have over 1,800 locations which sounds like quite a bit. Our market cap now is approaching $3.5 billion. Our revenues for 2012 ended about $2.4 billion. And so, surprisingly, I think this shocks a lot of people as big as everybody thinks SCI is. We're still only 13% of the industry revenues.
One of the interesting features of our business model and our competitors as well is the backlog related to what we sell. We sell prearranged funerals and pre-need cemetery property, and merchandise, and services, and this creates a backlog of future revenues. Today, our backlog totals about $7.5 billion, which if you do the math you can see it's a little over three times our annual revenues. These funds are supported one of two ways; either by cash in regulated trust funds that we have oversight for or in third party life insurance policies where they're underwritten and we are the general agent for.
If you think about the earnings power of the business and again, this is a pretty consistent business run appropriately. Since 2004 we've grown at a compound annual growth rate earnings per share at around 12% and cash flow approaches that as well.
And so, the importance of the robust nation under consistent level of the cash flow generated by the company you can see that for 2013, we've guided people to $260 million to $320 million of free cash flow, which is pretty significant when you think about our share account.
And so, we utilize that free cash flow to enhance shareholder value, primarily looking for strategic acquisitions which fit our story. And we've also been pretty active in share purchases in increasing our dividend, all the while again, managing that dept profile. And all of this being done with the knowledge that the baby boomers are already impacting our business and we'll have an impact probably over the next 40 to 50 years.
Okay. So our competitive strength again, we mentioned the 1,800 locations. You can see the breakdown of funeral homes and cemeteries, were in 43 states, eight Canadian provinces. An important feature of our business is we have a multi-brand portfolio. Our primary co-brand is Dignity Memorial.
So you'll see a location name and a town and a Dignity logo as the co-branded part of that network. We have a couple other smaller brands. We've got Neptune on the direct cremation side. We've got Funeraria del Angel as it relate to again, the ethnic opportunities in the Hispanic markets.
So now, our ability to leverage scale is probably one of the most important aspects of this business. On a local basis, we have a sharing of personnel, vehicles and other resources. We centralize some of the back office things that we do and can put those offshore as it relates to IT, and finance and accounting opportunities.
Clearly, we've got tremendous purchasing power when it comes to vehicles and in caskets and other large items. We're trying to leverage that scale all the time at various aspects of our business.
And lastly, through the preneed sales opportunity, again, utilizing lead procurement opportunities. And again, professional improvements that we make in one place that we can move into other markets. And we do this as you can imagine, one of the most important things that we do is our education platform digging to university. It's been around since 2004 and it's really how we distribute strategy, process and control to 21,000 employees which is quite if you can imagine for a company revenue base like ours.
Now, to the favorable demographic trends. And I mentioned before, everybody talks about the baby boomers and I want to talk about the impact on that need to funeral. Well, that's a long ways away. But the important thing to know is that the average preneed cemetery customer is 63 years old while the oldest baby boomers are 67.
So we believe a lot of the opportunity already exists and you've seen it in some of our preneed cemetery numbers that the baby boomers are just beginning to impact preneed cemetery and will do so for another 20 years. That shifts into preneed funeral where the average customer is 72 years old, that'll be shifting in the next five or six years and dramatically impact that channel.
And then finally, baby boomers will buy unfortunately for the lot of us. But that's probably a ways off. And so baby boomers are beginning to impact this now and will so for the next 40 or 50 years.
Now, if you look at the recent results of our business and again, these are not ones to project into the future, we've had a lot of success. 2012, we were able to go grow earnings per shares some 23%. And the first quarter was extraordinarily strong in a 40% growth on the earnings per share basis. And you can see the numbers there down below, 65 to 80, 20 to 28.
A lot of this have been driven by some things that I'd say are much within our control, and that is expense management, capital deployment, and our preneed selling channel. As we sell preneed cemetery properties, the one component that isn't tied to the event of death.
So we've been very success at growing our preneed sale, managing our expenses, deploying capital wisely to acquisitions or buying back our shares, and that’s had particularly a strong impact on 2012 when you look at our full-year results. What happened in the first quarter of 2013 is that the volumes finally came through. We’ve been talking about the fixed cost nature of this business and the ability to drop revenue to the bottom line, and it began to happen in the fourth quarter and it happened pretty profoundly in the first quarter of 2013 and, therefore, our ability generate $0.28 versus $0.20.
So a lot of good things lined up, wouldn’t expect it to continue at these trends, but again a lot of momentum in the business today. I mentioned before, this is probably the number 1 item for us; preneed cemetery sales production. It’s what allowed us to generate returns above normal, I’d say, over the last three years. And what I’d focus you on is the yellow boxes, not the red lines because they can vary from quarter to quarter. But these are the annual year-over-year comparable cemetery production growth, the same store.
2010, we grew 6%, 2011 we grew 12.3%, 2012 we grew another 10.2%. We can see in the first quarter we’re able to grow 6.7%. Again, if you go back to the prior year quarter, you can kind of see it on there, we grew 14.1 in last year’s first quarter.
So we really are continuing to grow at in my opinion extraordinary rates. And I attribute it, if you look at the keys to continued success over on the right, these are supposed to be forward-looking, all but the first one are things that we’ve been doing really well and continued to want to do. Training and development aimed at – our counselor productivity has just been tremendous over the last three of four years.
We’ve been generating quality leads outside of our jurisdictions of business, targeting through direct mail, select media and advertising, seminars that are targeted at certain audiences, and again even the Internet in generating those sales. So that’s allowed us to succeed over the last three. And then, again, I believe that the baby boomers are just a larger population that are out there to sell to.
So as we step back and look at 2013 and ’14 and ’15 we said, “How can we keep this up? How can we take it to a higher level?” And it really came back to people power. We need to have more sales counselors and we haven’t done a good job of putting more out there over the last three or four years. It’s really been a productivity play.
So we’re focused now on hiring and retaining and on-boarding and insuring that we got the appropriate sales management to drive larger pools of sales counselors, again, against this demographic pool that’s getting larger and larger every year. I believe that will be the key to generating growth at the 9%, 10%, 12% levels. And if we don’t, I think they’ll still be respectable levels, but that’s the exciting opportunity as I think about, particularly 2014 and ’15.
There it is. So now, here’s the funeral side and I think it gives you an idea. The top is at-need funeral. And so if you look at the red bar, I believe that is the comparable growth and average revenue spend. And you can see that some pretty tough growth opportunities in 2010 coming out of the recession. You saw some lift in 2011 in the 2% to 3% range, and a lot of that was refreshing our Dignity packages and the like and rolling out some new products and services.
And now, we’re back to that kind of 1% to 2% growth rate. When you look at the funeral volumes, you can see the challenges we’ve had over the last few years. In the excitement, you can share with us the 1.5% of the fourth quarter and 4.3% in the first quarter of this year.
So that’s been the challenges to keep that revenue aligned. And now that we’re getting some volume, it’s a lot easier to do. At the bottom you’ll look at preneed funeral production and again here, I’d point you to the blue boxes. We’ve grown preneed funeral production sales 8.4% 2010, 7% in 2011, 3.6% in ’12, and the first quarter is up 5.2%.
So again, very positive trends here. We don’t have the benefit of the baby boomers really impacting this yet, because again I’d tell you that the typical consumer here is going to be early 70s. So we think this pool of people is again going to be poised to grow as the demographic impact occurs. Very, very important, not generating EPS today, but we believe value in the future.
So in wrapping it all up, what are the keys for 2013? Number 1, remaining relevant to the consumer, and what that means is providing products and services that they see value in. We’re asking people to spend quite a bit of money. And so they’ve got to walk away and say, I got value for money. They took care of everything, they thought, they anticipated my needs and met those needs or exceeded those needs. And those are new products and services in keeping, again, our loyalty scores high.
Continuing on for some preneed sales, I think I’ve beat that one up enough. The next one, targeting expansions through acquisitions. And so again, we’re continuing to see opportunities to grow through acquisition. I wish we had more of them. But again over the last three or four years, they’ve been very accretive and great returns, internal rates of returns as it relates to, in particular, our weighted average cost of capital.
We’ve seen real success in expanding the Neptune Society brand, sSaw tremendous growth in T1. We think we’ll take that from 36 markets today to 43 markets by the end of the year, and again, probably exceeding our expectations on that acquisition. And lastly, two things that we do very well and will continue to do; improving leveraging our scale through purchasing power, again through finding more efficient ways to do things. We think there’s ample opportunity to continue to do so. And then taking that free cash flow that we generate, enhancing shareholder value through acquisitions, share of purchases and an increase in dividend.
With that, I’m going to turn it over to Eric before we got to questions.
Thank you. Good afternoon, everybody. I’m going to start with talking about our free cash flow. We’re proud of this this year in terms of our guidance, as you see on the left on slide 12, because of the increase in cash taxes that we’re forecasting. You could see that it’s top of the page. An increase of $18 million to $28 million is expected. We actually paid about $17 million of cash taxes in 2012 and we’re expecting $35 million to $45 million of cash taxes in 2013.
Despite this headwind that’s included in this free cash flow calculation, you could see we expect to grow our cash flow in a range of $260 million to $320 million in the midpoint of $290 million in 2013. And it’s a healthy growth over the $272 million in the prior year in 2012.
We calculate free cash flow by taking our cash flow from operations less our two components of recurring capital expenditures which is maintenance CapEx and cemetery development CapEx. That’s generally about $110 million. And you can see that in the appendix how we calculate the free cash flow during the year.
On the right-hand side of the page was the great quarter that we just announced. First quarter of this year, we had $133 million of free cash flow versus $75 million of free cash flow in the prior year quarter. Predominantly, that had to do with the funeral volumes that Tom mentioned earlier in the presentation where the strong December, January and February funeral volumes, the cash collections being 20 to 30 days later occurred during the January, February, March timeframe in terms of cash.
Secondly, the increase in preneed sales that we talked about earlier continues to go well in terms of how we’re approaching the customer in larger down payments and again collecting better cash related to those preneed sales. We also had a one-time pick up of about $20 million to $25 million related to accounts payable system that we finished implementing in the first quarter.
We had some choppiness in the third and fourth quarter related to our payables of 2012, and now that we have this system complete and implemented we return to more normalized levels of accounts payable, and that caused a working capital pick-up of about $20 to $25 million. That’s included in this increase that you see quarter-over-quarter on the right side of the page.
What are our deployment principles as you think about the sizable free cash flow that we have? You see them in order here on slide 13. First thing we like to do, you’ve seen the demographic slide, we want to continue to expand our network through acquisitions, getting ready for the baby boomer generation that as Tom mentioned is starting to affect positively the preneed cemetery sales segment of the business, but ultimately that’s going to affect our at-need funeral volumes as well, and we’d like to continue to form an opinion of where we think that is within, geographically, in North America and continue acquisitions to be there and expand our network.
Secondly, absent a high return acquisition, we’ll shift to share purchases, we’re big believers in share repurchases, we’ll throttle our share repurchases up or down based on the free cash flow yield, accordingly. But ultimately, we’ll continue to do share repurchases. We think that adds value to our shareholders.
Dividends as well, another way to return cash to our shareholders. You can see we target a payout ratio about 30% of our current net income. Last week or a couple of weeks ago, we just raised our quarterly cash dividend from $0.06 per quarter to $0.07 per quarter. You’ll see us continue to do that as we grow our business and grow our free cash flow and can turn around and return that to the former dividend to our shareholders.
Lastly, is debt repurchases. We really do this in terms of opportunistically managing our short-term debt maturity profile, so for the most part you’ll see our free cash flow go more to the upper side of the slide in terms of those items.
Deployment strategy, as I just mentioned, this is really talking about the principles but specifically showing how we deployed our free cash flow from the first quarter of 2011 all the way through the first quarter of 2013 and what you’ll notice is it’s somewhat of a balanced approach but ultimately we’re deploying it in terms of what has the highest value.
So when we have acquisitions and are at the proper return well above our way to average cost and capital, you’ll see us first deploy that which is the yellow acquisitions that you see in these slides and these quarterly periods and you’ll also see the share purchases in the red. And you’ll see the share-prices, the average price paid for share purchases. So you can see as I mentioned before it’s a flexible strategy, we’ll receive value in terms of share price, you’ll see us go more towards share purchases and as the free cash flow yield comes down you’ll see us continue to share purchase but perhaps at a lesser extent to what you’ve seen at different free cash flow yields.
I talked about our financial position, our favorable debt maturity profile. You could see this on slide 15. We really don’t have any meaningful debt maturities at all in the next two years. The first debt maturing is $137 million in April of 2015 and you’ll see that absentee credit facility that we have in March of 2016 which is a $500 million credit facility with $87 million outstanding on it currently, you’ll see for the most part of debt maturity profile is very favorable because not only is the debt pushed out but if you ever had to work with the maturities just from your free cash flow stream, you could see that it’s very manageable, where for the most part the maturities are below our annual free cash flow stream which we believe is very consistent. We’ve proven that over the years.
From a leverage perspective, you see that we generally targeted three to three and a half times net debt to EBITDA ratio in terms of leveraging, you see we’re well in that at the lower end. We generally target the lower end of that particular arrange, you can also see on slide 16 the liquidity profile that we have. We have tremendous liquidity, we believe in that because that gives us the financial flexibility in terms of the continued acquisition program within the North American market as well as other opportunities as the free cash flow yield steers us towards further share purchases.
So lastly, what do we think of SCI? We think it’s a solid, long-term investment. Tom told you very clearly that we’re the predominant player. It’s a very stable industry as well, unparalleled network and scale but most importantly not only there are significant cash flows within the industry and within our company, they’re very consistent as well.
We like to keep a strong liquidity profile to give us the financial flexibility as we mentioned on the previous slide and the capital allocation strategy is very disciplined, we showed you our choices in terms of acquisitions and share purchases and dividends as well as a very favorable debt maturity profile and maintaining that as well.
Most importantly, there’s organic growth in the future of the business, you saw that early in the presentation in terms of the demographic slides related to the baby boomers and we think that goes well favorable for our company as well as the industry as well.
So with that, I think Bob will go ahead and turn it over to questions at this time.
Can you tell more, Eric, can you speak to the opportunities; I mean cremation was viewed as a negative for years and now obviously through Neptune and through some other initiatives you and the industry have done a very good job, kind of repositioning cremation just as more of a revenue and profit driver. Can you speak to the kinds of things you’re up to and ultimately top being help meaningful in the cremation opportunity be you?
Sure I’d break that up. I mean you can put slice it up a bunch different ways but we view the cremation consumers through two channels particularly as we think about the funeral business and I’ll say cemetery to the back.
There are cremation consumers that are predominantly driven by price and have a maybe a negative opinion of funeral homes. And then there’s cremation consumers that don’t really have that negative overhang or choose in for a variety of reasons, price may be one of them but that is a different consumer choice and we believe we present a different set of opportunities.
So the way we’re approaching it is those that aren’t bothered by funeral homes, those that we believe we could put through a presentation of offering unique opportunities that don’t include the casket but might include services, might include ancillary products, those are coming through our funeral homes. And as we’ve got a very strategically set merchandise opportunity where we walk them through the variety of options that exist on the cremation side.
And through that packaging concept and discounting associated with the packaging concept, we’re finding that if they choose a package they’re going to spend about $1,500 to $2,000 more for a more robust approach if products and services, or bundling of products and services. And that’s an effective way to make sure at the very least we’re making all the options available to that consumer and they’ll choose it easy to a package or something that they choose through an a la carte selection.
So we’re seeing some success there. We’re seeing growth rates on average revenue per spend that exceed barrel consumers, so we believe it will continue to work as long as we can be adapted to their wants and needs and providing products and services they like.
The second set is a cremation consumers predominantly driven by simplicity and price and this is one we’ve always struggled with as a consolidator and what I would say as a people that are better at dealing with full service wants and needs, I mean I think as an industry that’s what funeral directors want. So it’s really troubling for somebody come in and say I don’t want much, give me something minimal and cheap. It’s tough for people to react to that.
So I think what we’ve done we believe with Neptune is found a way to profitably go after that segment. And what we do is, it’s basically a sales and marketing approach. Neptune is really more of a sales and marketing company than it is a cremation company.
The actual service of cremations provide by us, Neptune is very good at finding consumers that meet this wants and needs and then bundling products that are well suit to them and that would be away from home protection, it would be some form of urn and a direct cremation service. And they bundle those services into an $1,800 product which we can make money at. $700 direct cremations are pretty tough to make money.
So it’s an avenue for us to serve that customer in a way that we can make a profit, not as big as we’d make otherwise and we believe it’s a different segment because it’s people that don’t want to go to funeral home.
Bob Willoughby: And can you speak, you’ve mentioned products and services, so what are the year-over-year or what’s new and maybe two years or three from now what could Service Corp. offer that it currently is not offering?
Well I think that the most recent products and services that we’ve launched that have been successful, one is the catering opportunity and again this isn’t like a brand new idea. We’ve seen it in pockets. And what we did is that we institutionalized the idea. We found a way to do it in 1,800 locations and do in a standardized way and a simplified way, and we try to get into pricing and how to bid out vendors and do the things right, and then in the presentation of the offering. And we’re finding tremendous success as you would expect in 70%-80% of our locations and then you got the 20 or 30 that’s hard to win over as it relates to that product.
We’ve also done a joint venture on internet flower we called our friends and family. And the concept is not the family to buy flowers but the avenue of the friends and family that are going to the internet to find out directions, that are going to the internet to see the biography and information about the individual and when they’re doing so they may be presented with options to buy flowers. And we’re finding a lift there.
And lastly in the cemetery flower section, we’re finding success in offering annual flower maintenance contracts. So basically it says we’ll lay flowers five times a year on mom’s grave on Mother’s Day, on her birthday, you pick the other three and we’ll send you an email or photos that you can see – here’s what’s happening at mom’s grave. And it’s a way to stay in touch with the consumer. It’s a way to create a revenue stream and we’ve seen success again doing some of that.
When you think out three and four years, I think about things and these are all exploratory. But with our leverage and our size and our scale and make things easier on people and be a place where you go and everything is taken care of, I can see a form of almost a concierge where when something happens, you arrange a pre-need with us, you have access to our national network that’s going to get people logistically on flight, get people on hotel rooms, rental cars if you need them. These are things we could do in a very cost effective way for consumers and something that a local operator just couldn’t do. It’s virtually impossible. And so again finding ways to leverage our size to our advantage not just on the cost spectrum but on the revenue spectrum and on the customer satisfaction spectrum. So that’s to-be-created later but those are things that we think about.
And can you speak to in terms of catering and the flower offerings, I mean year-over-year, the growth in those offerings, any metrics you can show us.
In 2012 I’ll be speaking from – I apologize I don’t have those in front of me but if you think about catering, I believe that the growth in that business went from – Eric, help me here but I think last year we did $16 million. Did that sound right to you?
Yes about $13 million, $14 million.
So I think Bob, the year before that, you’re talking probably in the $5 million to $6 million range. And so now, with $13 to $14 million, my belief is we’re going to do $17 million to $18 million next year and get close to $20 million the year after that. So it’s just not the same exponential growth and impact but it’s continuing to grow, continuing to be a core part of what we do.
And you cited the first quarter results, I mean truly were exceptional, is that the future when that death rate finally does pick up here opportunities upon us. I mean is that glimpse of the future that should be a profit profile or could there be other areas to – within holding it back there in the first quarter?
Nothing is holding us back, I just think it was over 4% volume growth and so you wouldn’t expect that even with demographics. But your point exactly if we believe if you put a dollar revenue driven by volume on the top, you ought to drop 65% down as it relates today.
Cemetery, similar on a pre-need sale perspective, so when you get revenue growth in these businesses, it generates a lot of cash and I would expect that dynamic to continue and demographics to help us. They’ve really been interfaced the last10-15 years at least.
Questions from the audience, up front.
Can you touch on what’s driving I guess the acquisition market, why are people selling, is that generationally driven or is it financially driven, is that something you expect to become more difficult as demographics improve? And do you have kind of a market share that you’re targeting?
I think what drives it is really generational. You’re finding that less and less descendants of these owners, theses businesses go through three and four and five generations and the kids just really don’t want to take the business over. And that’s a natural way this thing grows.
And so the other thing that’s happened in my opinion is, for years we had no acquisitions because the industry went through its trouble and financial cycles and the things, so we’ve got a little bit of a pin-up sale mentality. Tax law changes definitely drove some behavior last year but I would expect it to be again naturally pretty robust. You are seeing consolidators being a little more aggressive I think. And so that may accelerated if price begins to come up again.
I think there’s a lot of room for market share in this industry. I point back to worth 13% of the market and everybody thinks we’re shocking people like you’ll have to be 40%-50% of the market [inaudible]. It’s very mom and pop industry still. We, and Stewart, and a few others, if you add all of the consolidators together, we’re 20% of the market. So our natural competitor is the local business. And so I see lots of room for consolidation as it relates to that.
Thank you everyone for being here, I appreciate it.
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