StoneMor Partners, L.P. (NASDAQ:STON) describes itself as a full service cemetery and funeral home company. It owns/leases and operates over 300 cemeteries in 24 states and Puerto Rico and operates over 100 funeral homes. The company is organized as a limited partnership, so limited partner common unit holders can expect, from time to time, a mix of passive income, depreciation and other non-cash pass-through K-1 items, and distributions from cash flows composed of income (loss) or return of capital, in various proportions, from year to year. The data for this report come from Morningstar, accessed through a proprietary system (a college library), the STON website, Yahoo Finance, and the SEC's EDGAR database. This analysis responds to the request of a reader.
The common units currently trade in a range between $25 and $30, with a .44 beta.The current annual level of distribution to common unit holders of $2.64 yields about 10.0%. As STON's GAAP net income amounts reported for each of the last seven years are losses, traditional financial measures such as return on sales, return on invested capital, return on equity, and price/earnings ratios are meaningless. Per STON's explanations in its SEC filings, the company's financial objectives include producing operating cash flow sufficient for debt service, continued expansion through capital improvements and acquisitions, and funding distributions to unit holders. Operating surplus (i.e., earned capital) is defined by the partnership as cash from operating activities (as opposed to financing activities) plus a cushion of $5.0 million, plus beginning cash at September 20, 2004 (inception). The company is required by its bylaws to distribute all of its available operating cash surplus within 45 days after the end of each calendar quarter.
Operating cash flows
For many companies, operating cash flow can be derived from a sales forecast, estimates for net income, and analysis of historic cash flows and their relationship to sales and net income. A sales forecast based on a straight line projection of ten years' of STON sales revenue, least squares method, indicates sales could grow to $415 million for 2021. If the mean relationship of operating cash flow to revenue of 8.5% holds (which it may not, as the standard deviation of the statistic is 5.5 percentage points), 2021 operating cash flow could be roughly $36 million.
Sales are affected by many variables, including US population, age of the population, US death rates, STON's share of the market, the mix of cemetery business with funeral services and other related lines and services, US inflation, pricing decisions, activities of competitors and providers of alternative services (e.g., Neptune Society), effectiveness of STON's selling/marketing efforts, terms of sale, and so on. Nonetheless, there exists a logical expectation of some correlation between cemetery industry sales and US population (or US deaths, which is dependent on population). For the nine-year period ending in 2015, STON's sales revenue and the US population are highly correlated (coefficient of correlation 0.967; coefficient of determination 0.935). The other vectors and constraints, inter alia, appearing to cancel, it appears reasonable to make a 2021 sales estimate based on this relationship, using a straight line forecast (least squares method) projection of the US population. This second sales forecast, based on the proportions of revenue to US population, and a projected population of 337 million folks for 2021, produces estimated STON sales revenue for 2021 of $426 million. Applying the 10-year average operating cash flow (OCF) to sales percentage (8.5%) produces estimated operating cash flow for 2021 of $42 million. This second sales and operating cash flow forecast confirms the first forecast.
If the limited partners' units traded like a stock, it would follow that the multiple of unit market price to operating cash flow per unit could stand as a proxy for a price/earnings ratio, and a forecast of future unit prices could be constructed. Unfortunately, the limited partners' units trade more like junk bonds or other interest-bearing securities, and less like equity securities. Converting operating cash flow to a per diluted unit basis, and calculating high and low average price per OCF ratios produces no usable data; the average high price/OCF ratio is 60, and the low is 47. Throwing outliers for the high and low price/OCF ratios, such as the 140 high price/OCF ratio for 2010, or the 237 times ratio for 2015, out of the calculation does not seem to help because the units are not priced based on operating cash flow data. Operating cash flow has dropped to $.13 per common unit in 2015, from a high of $2.08 per common unit for both 2006 and 2007. The common units traded in a tight range between the 10-year average high of about $26 per unit and the average low per unit of about $20.
The average yields for STON over the last 10 years were about 12.0% for the high yield and about 9.0% for the low average yield for the period. Currently, the risk-free rate in the US is about 1.5% (Bloomberg, US one-year Treasury bond). The S&P US issued corporate bond index currently yields around 7.0% for the investment grade bonds. Junk quality corporate bonds (S&P rated BB or less) yield various rates of interest, but the comparison is complicated because investors generally expect capital gains as a significant portion of the return on junk bonds (i.e., the bonds often trade at significant discounts to their nominal maturity values). The point is that the 10.0% yield accorded STON common units indicates the market is pricing in significant risk.
Distributable cash flow
As noted above, the STON partnership pays out its distributable cash each quarter, and focuses on distributable cash flow, based on its partnership mandate and its partnership agreement controlled definitions for distributable cash surplus and capital surplus. The distinction between distributable cash surplus and capital surplus is analogous to the GAAP distinction between earned capital and contributed capital, and the distinction affects the tax characterization of distributions as either taxable income or return of capital, much in the same way. Comparison of STON's reconciliations of distributable cash flow and GAAP net income (loss), to its GAAP statements of cash flows is useful and informative. Note that this discussion does not challenge the veracity or accuracy of STON's calculations under either the tax law or their governing documents, and is done without comment of STON's tax documents. Rather, this discussion points out the economic reality shown by the STON's GAAP cash flow statements. According to the aggregate of the cash flow statements of the ten years ending December, 2015:
- STON posted net losses in seven of the ten years, with an aggregate loss of about $58.9 million.
- Investing activity, mainly acquisitions and investments in property, used cash in each of the last ten years, and absorbed an aggregate of $432.6 million for the period.
- Aggregate net cash flow from operating activities was a positive $171 million, leaving STON $261.6 million short of covering the $432.6 cash spent on investing.
- Borrowing (net of repayments and other financing activity) produced about $171.8 million cash, but still left coverage of the investing activity short about $89.9 million.
- New units, mainly limited partner common units, were issued in significant quantities in seven of the 10 years, raising an aggregate for the 10-year period of $503.9 million cash in the form of new contributed capital. Take off the $89.9 million to cover the last of the investing activity, and this leaves $414 million in cash raised for the 10-year period.
- Distributions to unit holders for the ten years aggregated $405.9 million. By the analysis above, these distributions appear to be almost completely funded by issuing new units.
- An alternative analysis, using the same numbers, could be that the $171 million from operations, and the $171.8 from net new borrowing and other financing activity funded an aggregate $342.8 million in unit holder distributions, with the $503.9 million from new units being used to fund the $432.6 of investing, with only $63.1 million of the remaining $71.3 million cash from new units going to unit holder distributions. Money is fungible.
A clearer statement of the economic reality revealed by STON's GAAP cash flow statements is that a) the company does not earn a profit, b) STON's investing activity uses cash (it does not produce cash), and c) the substantial amounts of cash from operating cash flow and from net new borrowing are not enough to fund both the investing program and the distributions to unit holders. This may be easier to see in the table showing aggregate cash flow totals for the ten-year period.
STON 10-year summary of cash flows
Cash from operating activity
Borrowing, net of repayments
Issued new common units
Distributions to unit holders
The investing programs for expansion and improvements and the distributions to unit holders shown in the cash flow statements cannot have been funded without the cash raised by new units being issued on a regular basis over the years. Another consequence of a steady diet of secondary offerings of the common units is that book value per common unit (diluted weighted average units) has dropped more or less steadily over the decade, to about $6 per unit in 2015, from the high in 2007 of about $15 per unit.
In the long run, it seems prudent to own investments that make money and that earn the cash it needs to operate, invest for the future, and reward its shareholders. STON produces the cash needed to operate, but does not cover investing and distributions without borrowing and issuing dilutive new common units. Although it has managed to do so for more than a decade, a business model that does not earn profits and does not generate sufficient internal cash to fund its acquisitions and distributions does not seem sustainable.
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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.