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Founded in 1910, Stewart Enterprises, Inc. (NASDAQ:STEI) is the second largest provider of services in the death-care industry in the U.S.

I first told Today’s Financial News readers about this stock back in February (Smart Stock Investing: The ultimate contrarian play). At the time, it was trading at around $6.40 a share.

Since then, the share price hit $10 after the company’s larger competitor, Service Corporation International (NYSE:SCI), made a truly tempting acquisition offer.

An earlier bid from SCI for $9.50 a share was summarily declined. But after the second more attractive offer, the company retained Goldman Sachs as financial advisors and Skadden, Arps, Slate, Meagher & Flom LLP as legal counsel to evaluate their strategic alternatives.

From Stewart’s Form 10-Q Quarterly Report filed with the SEC September 9, 2008:

As previously disclosed, during the third quarter of fiscal 2008, Service Corporation International (“SCI”) made proposals to acquire all of our stock for cash. In a letter dated July 21, 2008, SCI offered $11.00 per share in cash for all of our outstanding shares, subject to the negotiation of mutually satisfactory definitive written agreements and the completion of certain limited, confirmatory due diligence. Our Board of Directors unanimously approved the formation of a committee of independent directors (the “Independent Committee”) to evaluate alternatives available to us to maximize shareholder value. The Independent Committee has commenced the process of working with its advisors and management to collect information and analyze all strategic alternatives available to the Company. Neither the Independent Committee nor the Board intends to provide any update with respect to the Independent Committee’s review of potential strategic alternatives until the Board has approved a definitive course of action.

As this situation has remained pending, and the markets have deteriorated, the stock price has slipped back down to under $8.

What comes next?

Let’s assume for a moment that the deal with SCI doesn’t go through. What will happen with the company? Will Stewart Enterprises, Inc. continue the profitable, dividend-producing advances they’ve achieved so far this year?

Last week, I drove through neighborhoods still scarred by Hurricane Katrina. My destination was the large office building housing Stewart Enterprises, Inc. in Jefferson, La. My mission: To meet with the top brass of the company… Thomas J. Crawford, President and Chief Executive Officer, and Martin R. de Lauréal, Senior Vice President of Corporate Development and Investor Relations.

Right off the bat, I noticed that the interaction between the two men is dynamic. They appear to compliment each others’ strengths: With 30 years at Stewart, de Lauréal has a historical and reflective viewpoint about the company and its values. Crawford has been with Stewart less than two years and has a more clear and direct business focus.

As de Lauréal phrased it, Crawford has brought “fresh DNA” to the company.

Sound financials

“The industry is recession-resistant. I don’t know if anything is recession-proof.”
– Thomas J. Crawford
President and CEO, Stewart Enterprises Inc.

The third quarter for Stewart brought a 12% increase in net earnings. I asked Crawford to elaborate:

“Our indicators were really pretty good on all fronts compared to the same period of the previous year. In a tough environment, we were pleased with what we achieved. As a matter of fact, the margin progression all the way from sales to net income was very strong.”

When asked if a key reason for the company’s success during a volatile economy is the recession-proof nature of the market, the CEO was careful in his response. He said: “The industry is recession-resistant. I don’t know if anything is recession-proof.”

(And certainly, since my meeting with the folks at Stewart, the stock price has dropped over 8% — right along with the markets.)

The main drive to their business is what they term “at need” services that start when a death occurs. And it’s that kind of demand that continues… and will continue… to expand.

Crawford freely admitted that that didn’t mean their business wasn’t affected by the grim economic outlook: Another quick look at Stewart’s 3rd Quarter Financials shows a drop in preneed cemetery sales. To industry outsiders “preneed” services are those arrangements made before necessity dictates.

A recessionary economic environment understandably results in a deferment of funeral services from preneed to “at need”.

Experience matters

But with almost 100 years of doing business under their corporate belt, what survival skills has Stewart picked up along the way?

According to Crawford, the company has continued to build through the years from a very humble origin. He gave credit to Frank B. Stewart Jr., the current Chairman of the Board and grandson of the company’s founder, and his powerful and positive vision of the business.

“Before I came to the company, Stewart Enterprises was the only business in this [death services] sector that I invested my own personal funds in. I liked the people and what they stood for… and I thought they had good basic business principles that would last.”

That doesn’t mean the company hasn’t had its bad spells. They learned a lot from an aggressive acquisition period they went through in the 1990s. The main lesson, that rapid growth has to be managed.

A clear long-term vision

“Because it’s such a long-term business, we take a long-term view.”
– Martin R. de Lauréal
Senior Vice President of Corporate Development and Investor Relations,
Stewart Enterprises Inc.

As de Lauréal explained, “The fundamentals are irrefutable… you, me and everybody we know will die. So those needs don’t change if the market’s up or down.

“Because it’s such a long-term business, we take a long-term view. And so it’s not just the next 90-day report card that we’re focused on to drive our decisions.

“We’ve been in the ‘at need’ cemetery business since 1910. We’ve been selling preneed [services] for 65-70 years. Where some of our competitors move in and out of [the different aspects of] the business, we’ve tended to have a more consistent long-term focus.

“And finally, 30 or so years ago we got in the funeral business. We realized that all the consumers know is their loved one died… and they need someone to help them deal with that. They don’t know there is a different business on the funeral side and on the cemetery side. Combining the two just made a whole lot of sense – not to sound crass, but one-stop shopping… it’s convenient.”

Benefits of scale and size

Crawford agreed that the convenience of this arrangement is key to the success of the company… “We have the highest percentage of cemetery/mortuary combinations and our cemeteries tend to be much larger than average. That separates us from our competitors.

“We tend to grow faster with those combinations, and we have better margins because we can utilize the benefit of scale and size. We can use our resources much more wisely and economically.

“Every little bit helps… the death rate grows at a little less than 1% a year. Now it’ll start to speed up a little bit in the next few years as the population ages, but it’s a slow-growth industry.”

A cash-flow focus

With the focus one appreciates in a CEO, Crawford stated, “As we manage the company, we look at cash and what we generate. We really manage for cash flow. I’ve seen many companies that grow their earnings at a rapid rate but have absolutely no cash. They’re burning it up in investing heavily in accounts receivable, or they can’t collect it.

“As we run our business, we look at not just what our investments do to our bottom line, but we make sure they have a good cash return as well.”

Going forward

I asked the gentlemen if they felt the banking crisis could impact possibilities like mergers or acquisitions in their sector. Admittedly, that was a not-so-veiled reference to their current situation. Crawford reflected, “Clearly we’re in un-chartered waters right now. I don’t think I’ve ever seen anything as turbulent in the financial markets as this… I don’t think anybody has. We go through economic cycles and they aren’t a bad thing. And we haven’t been in a downturn for some time.

“As far as business combinations, I don’t know how it’s going to impact them. For us, all we can do is run the company in the best interest of the shareholders. And the good thing about us is that we generate some pretty good cash. So we will have the flexibility to do things in the future that others might not have. We have plans that five years down the road we think will add a tremendous amount of value. They will be different than what we’re doing today — tangential — but different. We’re trying to find ways to grow the business at a faster rate.”

A mix shift

“Cremation is not a threat – it’s where the market is heading.”
– Thomas J. Crawford
President and CEO, Stewart Enterprises Inc.

I pointed out that, as he had mentioned, the death rate is on the verge of picking up. Crawford agreed, “It’s going to pick up, but then we have cremation that continues to grow.

“So we have a mix shift and we have to make sure we do what the consumer wants. Historically, this is a slow-to-change industry where you have generations doing it the same way.

“We track cremations by regions and locations so that we know exactly what’s going on. We could do a better job of taking care of families that choose cremation… we acknowledge that. That’s one of our challenges going forward.

“Cremation is not a threat – it’s where the market is heading.”

Regarding growth

I noticed that Stewart owned many more locations in Florida than, for example, New York. When asked about expansion and the role an aging demographic may play in those decisions, Crawford stated: “Some areas are more attractive than others from a legislation standpoint. New York is one of those areas we find it difficult to do business in.”

“We want our people to be entrepreneurial in what they do, but at the same time, we want the benefit of size and scale.”
– Thomas J. Crawford
President and CEO, Stewart Enterprises Inc.

Regarding growth prospects, he clarified, “Yes, we’d like to grow… but we’d like to grow organically by just being better with what we have.

“Historically, this whole industry grew rapidly through consolidation and a whole bunch of acquisitions. Both our company and SCI grew dramatically through consolidation. And there are two schools of thought…

“If you look at our friends at Carriage Services (NYSE:CSV), they try to be very decentralized in how they manage. They let their people make local decisions… and make sure they are motivated and have the incentives to do that. That can be very good and very powerful.

“We’ve taken a different tack. We want our people to be entrepreneurial in what they do, but at the same time, we want the benefit of size and scale. So we try to get more consistency in our procedures.

“We’ve invested heavily in better systems, better processes… our IT investment is incredibly high. We’ve got a great number of people processing a lot of information to eliminate waste and increase efficiency.

“If we do that, we think we can grow without having to go buy one more company… In the near term, the more we can routinize and standardize the processes, the more we can eliminate waste and inefficiency.

As we get our processes and systems right, our future acquisitions will be more valuable as we bring them into the ‘Stewart Way’.”

A new vision

The company learned much, said de Lauréal, when it had facilities (since sold) in Mexico and other nations. “That international experience opened our eyes and taught us a lot about the wide array of services we can offer with different choices… whether they be cremation, whole body internment or entombment.

“In Mexico, we owned a firm that did 5,000 services a year. More than half those services were cremation. This was for the top-shelf, crème-de-la-crème of Mexico — which is a conservative country and one of the most Catholic.

“It wasn’t about price… families would select what would be a $10,000 mahogany casket in the U.S. for a cremation. Then the cremated remains would be placed in a sterling silver urn that was put in a niche in the Basilica.

“It wasn’t about the money… it was about what the family wanted. And oh… by the way… that was a cremation. So what?

“For some, cremation may be viewed as a headwind. It has a financial impact – it’s a mix change – one is $2,000, the other is $6,000.

“You may initially have lower revenue per unit sold, but if you are serving your customers better with greater value delivering what they want, over time you can grow your average revenues and earnings.”

Consumer-driven

According to Crawford, in the end, it’s about helping families get through one of the most difficult experiences in life. On average, consumers in the U.S. will make that decision once every 17 years. They therefore have little experience or knowledge. He said, “That’s why we are not in that rut of how it’s always been done. Consumers will lead you to where they want to go if you listen.”

Crawford looks to both consumers and his on-site staff for direction. According to him, it’s the people in the field who see the changes first. Maybe try new things… “In the San Francisco area, they’ve pulled out the chapels because people are pulling away from chapels and moving towards reception centers.”

Ready for change

“We admit when we make a mistake. We don’t like to put a lot of spin on things. Our results — if they’re good — will sustain themselves.”
- Thomas J. Crawford
President and CEO, Stewart Enterprises Inc.

Crawford and his team seem ready to tackle the future: “We just hired a ‘cremation specialist’ with the sole focus of bringing to our system those goods, services and practices that are most valued by cremation-oriented families.

“We like to have a learning culture… and one with humility. We admit when we make a mistake. We don’t like to put a lot of spin on things. Our results — if they’re good — will sustain themselves.

“We’ve got this situation with our friends [SCI] hanging over our heads right now, but we’re still looking over the horizon five years.

“Stewart Enterprises is based on good fundamentals, good values and making a difference.”

“We try to do things with integrity, honesty, with an absence of spin… and that really last long-term.”

I can’t think of anything more for which investors could ask.

Disclosure: none