Despite my pessimistic view about StoneMor Partners (NASDAQ:STON), the stock has remained buoyant. The quarterly dividend has also been maintained at $0.66. Does this change the underlying thesis? No. I believe that StoneMor remains an unprofitable company that destroys shareholder value every year. The details can be found in my previous article: Short StoneMor Partners. The gist of it is that the company produces no cash flow, is not building up equity value for shareholders, and dilutes whatever value there is left consistently through equity offerings.
In the previous write-up, some commenters noted the timing issue of the thesis, as the company has been funding the distribution with equity for quite some time now. When does the music stop?
For all intent and purposes, the dividend has become a fixed cost to the company. Dividend is the key in supporting the stock price, and in turn, the dividend itself. A healthy company's regular dividend is financed by the cash that it generates from operations. It does not matter whether the stock price is at $1 or $100, the dividend itself will not be impacted by the stock price.
Because StoneMor Partners relies on the equity market to fund the dividends, the dividend liability grows every year. Theoretically speaking, the dividend can be sustained ad infinitum as long as the stock price is high enough. Since each round of equity issuance increases StoneMor's dividend liability, it is really no different from how issuing debt increases the interest expense. Sure, if one has unlimited access to credit, bankruptcy would never be a concern, but that is not reality.
A key question is how quickly the dividend liability is growing. If we assume that the company is breaking even cash-wise (which it is not, 2015's free cash flow was -$11 million, excluding the $19 million spent on acquisitions), the current quarterly dividend of $23 million would require the issuance of 935.4 k units every quarter at the current price of $24.75. The rate of the dividend increase would be 2.67% per quarter, which compounds to 11% annually. Will this pose a problem? Yes, eventually, as the company would need to raise increasingly higher amounts of cash. However, as long as there is a willing party to take on the offering, the dividend can be "sustained" for quite a while.
The chart below illustrates the projected cash needs (i.e. dividend liability), the required number of new units, and the company's projected market cap.
Source: author's calculations
As you can see, even after 20 years (quarter 80), the company could still keep kicking as long as it can raise $712 million. This may seem like a lot, but in comparison to the projected market cap, it is still only 10.7% of the equity market value, not impossible. Note that this occurred because I assumed that the price will stay constant, not an unrealistic assumption given that the present investor base seems to judge the company based on yield alone. Will it ever get out of hand? Eventually, yes. Based on the model, the company would need to issue $2 billion of equity per year in 30 years to cover dividends, surely that will raise some eyebrows. As soon as funding gets pulled, I believe that the dividend will no longer be paid, which will be the key catalyst for the short-sale.
The Best Time To Short
In a typical short-sale, one would want the price to be as high as possible. In StoneMor's case, it is the opposite. A lower price will be the trigger as the company would have to issue increasingly more units to cover the dividend, which will in turn increase the dividend liability through a vicious cycle. I believe that a critical level would be $17.60/unit, which would cause the dividend liability to compound at 15%, bringing the dividend liability to a "critical mass" much quicker.
Below I've included a model from finbox.io. The details of the model show that all of the existing value comes from the assets on the balance sheet. On top of potential losses, each equity issuance will further dilute existing equity holders' share of the assets. In other words, I believe that investors' share of the pie gets smaller and smaller every year.
I believe that StoneMor Partners' fundamentals are still unsustainable. However, given that the equity market can continue to fund the dividend in the foreseeable future, the catalyst may not come soon enough for one to realize a good return on a short position due to the cost to borrow and the persistent dividend payments. Depending on the appetite of the equity market, the dividend could be maintained for decades. The opportunity will present itself if the stock price drops significantly, but in the meantime, I believe that short sellers should leave StoneMor Partners alone.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.