Resurrect your income portfolio with these high yielding bonds from StoneMor Partners L.P. (STON), an owner and operator of cemeteries and funeral homes in the United States and Puerto Rico. Each week, we search for what we believe to currently be the best corporate bond for investors needing or seeking higher yields with the least amount of risk as possible relative to its projected return. The following is our review showing why we believe this about 5-year, 10.25% yielding, US dollar bond passes the criteria for our clients, and why we have selected it for addition to other high yielding corporate bonds in their investment portfolios.
A look at the issuer
StoneMor Partners L.P., together with its subsidiaries, engages in the ownership and operation of cemeteries in the southeast, northeast, and west regions of the United States. It offers funeral and cemetery products and services in the death care industry, and currently owns and operates over 270 cemeteries and 75 funeral homes. Founded in 1999, it is headquartered in Levittown, Pennsylvania, and together with its affiliates employs about 3,000 employees.
StoneMor cemeteries and funeral homes generally serve customers that live within a 10- to 15-mile radius of a property's location. Within this localized area, competition is primarily from other cemeteries and funeral homes located in the area, most of which are independently owned and operated. The limited competition from the three publicly held deathcare companies that have U.S. operations - Service Corporation International (SCI), Stewart Enterprises, Inc. (STEI) and Carriage Services, Inc. (CSV) - do not directly operate cemeteries in the same local geographic areas as StoneMor. These three publicly held death care companies have historically been the industry's primary consolidators, but have largely curtailed cemetery acquisition activity since 1999. With cemetery operations accounting for approximately 87% of their revenues, StoneMor is the only public deathcare company that focuses a significant portion of its efforts on cemetery operations, and it is currently the second largest owner and operator of cemeteries in the United States.
As 78 million Baby Boomers continue to enter retirement, the U.S. faces one of the most dramatic demographic shifts in its history. One of the implications of this is the projected increase of the death rate from about 2.4 million per year to over 3.5 million by 2035. Funeral home operations primarily generate revenues from at-need sales, which have a smaller potential customer base than pre-need sales. By focusing primarily on cemeteries and deriving significant revenues from pre-need sales, StoneMor markets itself to a larger potential customer base. Although the combination of its focus on pre-need contracts (which produces deferred income) and the structure their business (as a potentially tax advantaged Limited Partnership) greatly complicates the accounting and makes its analysis more difficult, overall it appears to be a good business decision.
We like companies that are profitable
As a result of StoneMor's business model and its focus on marketing to pre-need, in fiscal year 2011 a significant portion of StoneMor's sales production were reported as deferred revenues. Although noted on its balance sheet, they are not reported as earnings and their meaning is easily missed at first glance. A closer look also reveals that most of the expenses for those deferred revenues have already been included in previous year's Profit & Loss statements. Therefore, we need to peel back the picture skewed by generally accepted accounting principles (GAAP) in order to see the real earnings power and the actual profitability of the company.
Notwithstanding the difficulty in sorting out the true nature of StoneMor's business, we know that bondholders have a much superior position relative to stockholders (or in this case, unitholders) and therefore think it relevant to focus more on its balance sheet and the changes in deferred revenues, which totaled $441.9 million in 2011, an increase of $55.4 million over 2010. Adding this $55.4 million to the stated net income loss of $9.7 million quickly reverses the perception of a loss, and further helps to explain why, given the tax advantaged structure of its limited partnership, StoneMor would pay out about $44.6 million in dividends in 2011. Also worth noting are the merchandise and perpetual care trusts, whose assets totaled a fair value of $1.249 billion at the end of 2011 (an increase of $103.5 million from the year prior), and the subsequent revenue the management of those trusts generates for StoneMor.
On the most recent (August 7, 2012) quarter's earning call, the CEO of StoneMor, Larry Miller, noted that if the company serviced and/or payed off every liability (including accounts payable and 100% of its debt) that it had today and collected 100% of its trust fund and accounts receivable, it would have over $128 million in cash on its balance sheet. He then stated:
"We have $250 million in the perpetual care trust that we are the income beneficiary of... and have almost 13,000 acres of land, 272 cemeteries and 76 funeral homes all of which are free of debt. So, we would have 350 profit centers, no debt and still have all that cash on our balance sheet and earnings from the trust fund."
He went on to say that the assets since inception have grown from $627 million to $1.3 billion, while the debt has only increased from $103 million to $214 million.
Finance expenses for 2011 were about $19.2 million, while operating income was reported $9.8 million. Although at first this may not look like it would provide adequate cash flow for interest payment coverage, it must be kept in mind that StoneMor takes in a significant amount of additional cash (from pre-need sales) that is recorded on its books as "deferred revenues." Generally speaking, businesses will not pay a sales commission until the money from the sale is secured. Considering this simple fact confirmed our realization that there is nothing "iffy" about its deferred revenues. StoneMor already has the cash for this future performance set aside and held in trust accounts. In short, this is not just contracted future business; it is future business that has extremely low costs associated with it, and it is future business which they have already collected the payment for. On top of that, all of the accrued revenues continue to build into a significant income producing asset on its balance sheet.
Of further consideration is the fact that bondholders will always maintain seniority over any dividend payouts, which StoneMor is not obligated to make. These distributions are no doubt related to what may be required to retain the current favorable tax status with the IRS. In fact, under certain circumstances unitholders may have to repay amounts wrongfully returned or distributed to them if the distribution would cause StoneMor's liabilities to exceed the fair value of its assets. Considering the strong underlying cash flow and its continued growth of deferred revenues, we view StoneMor's overall ability to make its interest payments over the next five years as being very strong.
Balance sheet flexibility
StoneMor's debt of $214 million is about one third of its currently indicated enterprise value. While its growth plans are heavily dependent on continued additional funding through loans and/or additional equity (unit) sales, management appears to have had little difficulty in accessing additional new capital when it is needed. Just last week it was announced that the purchase of 8 funeral homes, four cemeteries and two cremation facilities for a total package price of $25 million, comprising cash, equity and non-compete things, was completed. Considering further that the $458.8 million in deferred long-term liability charges residing on its liabilities ledger sets against extremely high margin deferred revenues assets, we consider StoneMor to have very good balance sheet flexibility.
A primary component of StoneMore's business strategy is to grow through acquisitions of cemeteries and, to a lesser extent, funeral homes. Historically, a significant portion of these acquisitions have been funded through borrowings. Inherent with any business acquisition are various associated risks, such as difficulties integrating an acquired business into existing operations, diversion of management's attention and unanticipated problems or liabilities, some or all of which could have a material adverse effect on operations and financial performance.
If the trend toward cremation in the United States continues, StoneMor's revenues from cemetery sales may decline, which could have an adverse effect on their business. Industry studies indicate that the percentage of cremations has steadily increased and that cremations represented approximately 38% of the United States deathcare market in 2009. Declines in the number of deaths could also cause a decrease in revenues; however, it is worth noting that the larger baby boomer generation is now approaching retirement age.
StoneMor's operations are subject to regulation, supervision and licensing under numerous federal, state and local laws, ordinances and regulations, including extensive regulations concerning trusts/escrows, pre-need sales, cemetery ownership, funeral home ownership, marketing practices, crematories, health and safety laws, environmental matters and various other aspects. If regulatory laws or their interpretations change, or new laws are enacted relating to the ownership of cemeteries and funeral homes, StoneMor's business, financial condition and results of operations could be adversely affected.
We believe that these StoneMor bonds have similar risks, similar maturities, or similar yields to KEMET Corporation (KEM), Tutor Perini (TPC), Georgian Railway, Seagate Technologies (STX), or Netflix bonds (NFLX) reviewed previously on our Bond-Yields.com blog.
Summary and Conclusion
In summary, we can see that the business model for StoneMor is highly profitable, but the complexity of accounting and the deferral of very high margin items masks its true profitability and underlying cash balance from the undiscerning eye.
This is an exceptional bond yield, especially considering the company's recent strong non-GAAP revenues performance and its relatively short 5-year maturity. Although StoneMor's bonds are rated as B3/B-, our research tells us that much of the underlying financial strength of this company is easily missed and obfuscated by the complexity of the accounting, and by the growth of the business while structured as a tax advantaged limited partnership. After factoring in the high growth and deferred revenues, we believe these bonds actually carry significantly less risk than what the extraordinarily high yields typically tend to indicate, and used this opportunity to add them to client's fixed income portfolios.
Ratings: B3/ B-
Rank: Senior unsecured
Yield to Maturity: 10.255 %
Please note that all yield and price indications are shown from the time of our research.
Additional disclosure: Some clients of Durig Capital may have positions in StoneMor bonds.
Disclaimer: Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports.