StoneMor Partners, L.P. (STON) offers income investors a high distribution yield. The current 9.3% distribution yield is enticing when compared with the Treasury Bond market's sub 3.25% interest rate yields. The master limited partnership does have areas of caution. In this article, I will focus upon a few aspects that warrant further investor caution.
StoneMor Partners operates cemeteries and funeral homes in the U.S. and offers the full suite of death care products and services. These items include burials, cremations, entombment, and funeral and memorial services. It derives its revenue from merchandise and services. StoneMor (pdf) is one of the largest such providers with facilities in 28 U.S. states and in Puerto Rico, with a combined total of 69 funeral homes and 274 cemeteries.
4 Investor Risks
As the below graph highlights, there are a four issues to warrant investor caution.
This article will highlight SEC 10Q filings that indicate the company is paying current quarterly distributions based upon secondary offerings instead of operating profits.
On November 29, Standard and Poor's downgraded StoneMor's credit rating. Standard and Poor's stated, "...StoneMor Partners L.P. has not met our free operating cash flow expectations, which has heightened the risk of the company's need to raise outside funds to make unit holder distributions....". This credit downgrade will impact the partnership's borrowing costs.
StoneMor received negative first page attention on January 10. The partnership has a corporate tax bill of zero. The peer group, organized as corporations, pay tax rates of over 40% per 2010 tax filings. As a pass-through entity, StoneMor is exempt from the competition's 40% tax burden. As Congress attempts to identify new tax revenue sources, master limited partnerships may warrant scrutiny for paying an equitable tax share.
StoneMor has issued a significant amount of units to pay for its growth and distributions. The operating activities, even in the context of a pass-through entity, must adequately earn income to support the distribution level.
StoneMor, on its balance sheet, manages two funds. Both the Merchandise Trust and Perpetual Care Trusts are funded by customer payments for future merchandise and services. The low interest rate environment prevents the partnership from growing the current value to a risk adjusted future value for customer obligations.
StoneMor grows its business through acquisitions, by offering high quality services that would result in referrals and repeat business, and by taking care of its staff who are key to providing high-quality end-of-life services in a sensitive and respectful manner.
The SEC 10Q balance sheet displays the two essential trusts that the company manages: 1) Merchandise Trusts, and 2) Perpetual Care Trusts. StoneMor invests the proceeds for future expenditures as the clientele requires the merchandise and services. In a low-interest rate environment, the partnership has to extend its investment risk to earn higher interest rate returns. The trusts, if earning inadequate returns, may not earn adequate returns if interest rates are low.
Per the below balance sheet comparison, StoneMor's long-term debt has expanded and the trusts have lost over 7.7% in fair value. This 7.7% loss was based upon the third-quarter SEC 10Q versus the second-quarter SEC 10Q.
For the 12 months ended September 2011, StoneMor reported revenue of $230 million, operating income of $12.9 million and a net loss of $6.8 million primarily due to debt-related early extinguishment and interest expenses. StoneMor reported cash holdings of $20.1 million, total assets of $1.1 billion, long-term debt of $175.5 million and shareholders' equity of $194.8 million. The partnership has a rather high debt-to-equity ratio tied to debt related to acquisitions, expansion and facility upgrades. The recent SEC 10Q's highlight the extent to which the company is issuing secondaries to generate funds to pay out its quarterly distributions.
StoneMor appears to have made progress when comparing third-quarter results from 2011 to 2010. For example, third-quarter revenue was $60.2 million in 2011, compared with $52.1 in 2010, third-quarter operating profit jumped to $3.9 million in 2011 versus $0.7 million in 2010, and third-quarter interest expense dropped to $4.8 million in 2011 compared with $5.9 million in 2010. StoneMor generated $14.1 million in cash from operations in third-quarter 2011 compared with roughly half that amount in third-quarter 2010. Given its high debt load compared with cash flow, working down this debt will take a sustained long-term effort.
Even though StoneMor recorded a loss of $6.8 million for the 12 months ended September 2011, it generated $25.3 million in cash and paid out $2.34 in distributions. With shares trading at $25.51 as of February 3, that results in a rich 9.3% yield.
As of February 3rd, 2012, StoneMor units were trading in the middle of the 52-week range of $20.55 to $29.86. The partnership has a market capitalization of $493 million (2.5 times book value). Over the past 12 months, StoneMor has delivered a -13.6% return on equity.
StoneMor's peers include similar roll up businesses in niche sectors. In death care, specifically, it compares with Service Corporation International (SCI), which operates in 24 U.S. states and Puerto Rico with 141 cemeteries and 218 funeral homes. Stewart has a $2.5 billion market cap and a 1.8% dividend yield.
Carriage Services, (CSV) offers death care services and merchandise within the U.S. The company has two business segments, including Funeral Home Operations and Cemetery Operations. Carriage has a $110 million market cap and a 1.7% dividend yield.
StoneMor is in a stable business with stable demand for its services. While the company's units have not performed well, investors can get some comfort from its commitment to paying high distributions. Although master limited partnerships have a history of issuing secondary units to fund expansion, StoneMor's cash flow statements do not indicate a strong cash flow growth rate. In my opinion, StoneMor is a speculation story and not worthy of investment at this time.