Don't Fear the Reaper...
If you have been following my articles, you will have noticed by now that I am very attracted to companies that have "inevitable" sources of business. The company I will be discussing today is engaged in one of the most inevitable businesses there is. As Ben Franklin once said, the only certainties in life are "Death and Taxes." One company that caters to the former is Matthews International (NASDAQ:MATW).
Matthews International operates in two different areas of business which I find to be attractive. The company has also steadily increased its dividend, has a long operating history and a low payout ratio. I believe that this company merits further investigation by potential investors, as there is a potential for several catalytic events that could unlock value. Though shares have rallied, I believe that Matthews International represents an intrinsically attractive business if purchased at the right price.
A Venerable Institution
Founded in Pittsburgh, Pennsylvania in 1850 and named after its founder, John Dixon Matthews - the company has a long history of operation. When I look for companies, I am particularly interested in ones which have been around for a long time. Companies that can not only survive, but thrive, for over a century often exhibit intrinsically attractive business characteristics. Having weathered depressions, world wars, natural disasters and other related turmoil - the age of these companies provides investors with important qualitative indicators of their viability.
Matthews' global business operates in six segments which are, in order of size: Graphics Imaging, Funeral Home Products, Cemetery Products, Marketing systems, Merchandising and Cremation. These six individual segments can be grouped into two broad subcategories: Memorialization and Brand Solutions
Comprising the Cemetery, Funeral Home products and Cremation segments, the Memorialization business accounted for 54.7% of Matthews total revenues in 2012. The company sells its products (including coffins, plaques, urns, mausoleums and specially designed display cases) in the United States, Europe and Australia. The company is also a leading maker of memorial plaques used in landmarks and building dedications.
In addition to the fact that death is inevitable, the Memorialization segment of Matthews International is very interesting to me because of the fact that its funeral products provide excellent product integration potential. Someone shopping for a coffin can also elect to have a mausoleum constructed, and get the plaque engraved - all from the same company.
While one would think that this area of business is extremely consistent, there are a few trends to be aware of. As one of the leaders in cast bronze products, copper prices can cause a significant impact on the company's margins. In 2012, the company reported paying the highest price in its operating history for copper - an important precursor to bronze - the classic alloy utilized in funeral ornaments.
Burial habits are also changing over time, as many people opt for a non-traditional burial or cremation. While there are numerous traditions surrounding burial traditions that are tied to religious or cultural belief, a rise in cremation has the potential to erode the earnings of the company. Caskets cost a significant amount per unit, and both a reduction in casket sales in addition to higher costs per unit due to copper prices could erode earnings power.
Even though cremation currently accounts for 5% of the company's current business, the fact that the company has established itself in the space and offers a complete package of comprehensive services indicates that it might be able to capture more revenue in the long term and offset the decline in casket sales.
Brand Solutions Segment
The remaining 45.3% of Matthews' business stems from a much less morbid source: Graphics imaging and brand management services. The company provides services such as labeling, embossing, engraving, design and the manufacture of corrugated or otherwise disposable containers to a variety of customers - with the business of the company operating in Europe, the United States and Asia.
While the company is not subject to the risk of increasing commodity prices in this area of its business, it is subject to currency risk as a large portion of its operations and sales are concentrated in Europe - as the Euro weakens, the company will report lower sales in US Dollars. Though this is a negative in the short term, a strengthening of the Euro over the long term has the potential to contribute a significant amount to the earnings of the company when they are converted to US Dollars.
In spite of the fact that the earnings of this segment have suffered as a result of currency risk, I believe that packaging is a very attractive business to be in. One needs to only glance upon the charts of larger packagers including the Bemis Company (NYSE:BMS) and International Paper (NYSE:IP) to witness the long term earnings potential of the paper and packaging business - however, caveat emptor, packaging and brand management is often tied with the overall health of the consumer economy and is subject to considerable volatility in times of economic crisis. I also believe that this unit of the company's business has the potential to be purchased by a larger operator in the packaging and brand management market, which would likely result in a special dividend or distribution to current shareholders.
The Numbers on Matthews
Currently priced just under $40 a share, against a book value of $17.88 and cash per share of $1.87 and paying a dividend of 1% - investors at these levels are paying a significant premium for the company. Insider ownership stands at 2%, something unsurprising given the age of the enterprise, and the payout ratio of the company stands at .20 - a low number, indicating that the company has room to grow its dividend payments - which it has, from $.07 per quarter in 2009 to $.10 per quarter currently.
In addition - the company was able to not only maintain but increase its dividend payments during the financial crisis - something that I often look for as an indicator of strength on the common shares of the company. The company also repurchases stock as a method to maximize total shareholder return - with slightly over one million shares repurchased in fiscal 2012 at an average price of $30.53 - under current repurchase authorizations the company can repurchase an additional 1.8 million shares.
Spin-off and Acquisition Potential
Anytime I encounter a company with disparate operating segments, I become very intrigued - as there is potential for significant value to be unlocked either through shareholder activism or management initiated spin-offs. I believe that given the considerable difference and lack of synergy between the two divisions of the company that there is a very real potential for a spin off - allowing investors to increase their exposure to a specific sector. While i would not advocate investing in the company with the specific intention of a spin-off occurring, I believe that investors in the current entity are provided with a free "call option" on this happening.
I also believe that the company has a potential to acquire companies engaged in the Funeral care and services sector, or be acquired itself. By acquiring a small and growing funeral home and cemetery operator such as Carriage Services (NYSE:CSV), I believe that Matthews could increase product synergies and market penetration.
The recent purchase of Stewart Enterprises (NASDAQ:STEI) by Services Corp International (NYSE:SCI) at nearly a 30% premium also indicates there is potential for future acquisitions in the "Deathcare" industry. With a market capitalization of $4 Billion, I believe that Services Corp International could acquire and retain the Memorialization segment of Matthews International to achieve a more thorough level of industry penetration while spinning off or selling the Brand Solutions segment and distributing the proceeds as a special dividend.
As discussed earlier, Matthews's funeral segment faces considerable risks due to commodity pricing as well a long term shift in burial behavior. Another area of potential demographic risk to the company is the longer life expectancy of the population - while death is inevitable, life is indeed getting longer, which could potentially lead to a constriction of cash flows for the company.
Currency and Europe-specific risk are also important areas for investors to be appraised of as a large portion of the company's Brand Solutions segment is centered in that area. In addition to a weakening Euro, political and continuing economic uncertainty in the Eurozone also has the potential to cause the earnings of this segment to deteriorate substantially.
I believe that currently, common shares of Matthews International merit further investigation by investors, however I would caution against overpaying for the company. Having appreciated over 30% from the levels at which the company repurchased its own shares, I believe that investors are best served by sitting on the sidelines and watching the company for any significant downward movement.
While I believe that the company is in a position to both increase its dividend and potentially liquidate or spin-off portions of its business, the current price levels of the company in my mind are too richly priced (despite the intrinsically attractive aspects of the company's business) to merit immediate investment.
I would also encourage fixed-income investors to explore the company's debt offerings as the dividend payment strength on the common, the sources of the company's business and long operating history in conjunction with their interest rate hedges indicate to me that the company is more than capable of satisfying its fixed charges.
Disclosure: I 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.