We last summarized the short case for Stonemor Partners in December of 2011, and the case remains as strong today, although profiting may take some patience. Our original thesis was based on some key points:
- Stonemor issues misleading financial presentations, including misrepresenting the cash flows on a typical contract. They have also watered down their non-GAAP numbers over time.
- Cash flow is far below what the company pays out to LPs and has been deteriorating since 2008.
- The company has bridged the difference by issuing stock, with shares outstanding up 128% in 4 years.
- The company's fundamental valuation is far above peers, and their profitability is far worse.
The primary developments since our last writeup include the following:
- In April the company's CFO, one of the original founders, retired as CFO. He was replaced by Tim Yost, who previously was primarily their pointman for investor relations.
- In June the company announced the acquisition of Lohman funeral homes of Florida, which has 5 cemeteries and 9 funeral homes, for an undisclosed purchase price.
- Net debt has risen from $172 million to $194 million, due entirely to the payment of $23 million in "distributions" to "unitholders".
- In 1Q12, STON stashed far less in merchandise trusts than in prior years, allowing them to record more revenue and report better 1Q results, including higher cash flow. All of this appears to be due to management discretion rather than operating improvement. We'll discuss the reasons for this below.
- Stonemor's 2011 operating cash flow was actually worse than we had estimated, at $5.5 million versus our $12 million estimate.
The CFO retirement may be no big deal (Shane is around 65), but obviously the CFO has more knowledge of and control over the financials than any other executive, and a CFO departure is often a major red flag. STON followed their usual playbook,highlighting the good (promotion), downplaying the questionable (long-time CFO leaving), and throwing in an unprovable claim ("As part of our planned management succession").
With regard to the balance sheet, this is the modus operandi for Stonemor. Their business model is based on bringing future revenue into merchandise trusts (and perpetual care trusts which fail to cover their growing maintenance costs), which the co can then highlight as increasing complexity, and allows the co to highlight non-GAAP results. Between periodic stock issuances, the company borrows to fund the dividend.
This brings us to 1st quarter results. On the surface, financial results appeared much better than the prior year:
|$ amounts in millions||1Q12||1Q11|
Reading down to the footnotes, one finds that flows into merchandise trusts were down significantly, meaning the co diverted more money to report as revenue, operating income, and even cash flow:
|$ in Millions||1Q12||1Q11||1Q10||1Q09|
|Merch trust inflow||$2.6||$8.6||$4.0||$1.5|
Fewer flows into merchandise trusts were responsible for nearly all the improvement. It's interesting to compare these results to Service Corp, which had essentially identical trust flows in the 1Q to the prior year. Corporate America is notorious for managing some degree of earnings. But Stonemor manages earnings, revenue, and even cash flow in the short-term, because of the degree of control they have over merchandise trusts. Why in the first quarter, why now? It could be because they have continuously failed to meet financial covenants for their debt and are in danger of being considered in default or of having to cut the dividend.
Stonemor's stock has rallied lately due to enthusiasm for anything with a yield. The Dogs of the Dow were up 16% last year versus a 2% gain for the S&P 500. Pharmaceutical stocks, telcos and other high-yielders have been on a tear due to ultra-low interest rates.
In the case of Stonemor, payouts are a return of principal, and there's little principal left. Net debt is near $200 million, tangible equity is about $8 a share, and financial results are consistently underwhelming. Shareholders are likely to be disappointed in the end.