Carriage Services - The Stable Growth Stock You Need

Summary

• Carriage Services provides death-care products and services in the United States.
• The company’s Q1 2017 results have demonstrated strong growth, with sales growing by 7.6% compared to Q1 2016.
• Here we discuss the robust qualitative factors that are driving Carriage Services' growth, before providing a valuation on the business.

This post was written by Hamish Kumar, Integer Investments analyst.

Investment Thesis

Carriage Services' (NYSE:CSV) recent earnings release emphasizes the company’s strong qualitative factors and earnings power. With a strong industry outlook for death-care goods and services, we believe that the company warrants a "hold" recommendation.

What Does It Do?

Carriage Services is a provider of death-care products and services in the United States. The company operates through both funeral home and cemetery segments. The funeral home segment includes but is not limited to offering burial, cremation, consultation, and transportation services. The cemetery segment provides products and services such as the right to interment in cemetery sites. Additionally, Carriage Services offers death-care related merchandise, including urns, burial caskets and cremation memorialization products. As of December 31, 2016, the company operated 170 funeral homes in 28 states, and 32 cemeteries in 11 states.

Recent Performance

Carriage Services' Q1 2017 earnings were reported on April 26th. The company has had another strong quarter, with revenue increasing 7.6% and operating income increasing 36.1% compared to prior year results. This was driven by a combination of comparable funeral segment revenue growth and corporate expense savings. Funeral service revenues were primarily driven through acquisitions, whereas corporate expenses saving gains were attributed to unusually high comparable costs in 2016. A summary of the results is presented below:

Competitive Advantage

Carriage Services has two competitive advantages.

1) Although Carriage Services doesn’t have a particularly large market share (estimated 1-2%), the majority of death-care providers are locally owned and independent. The company is therefore larger than the majority of competitors. This larger size has meant that CSV has considerably driven overhead costs down through economies of scale. This has resulted in greater cash flows and the ability to further grow through acquisitions.

2) Carriage Services has the ability to provide a full-service package (merchandise, funeral services and burial/cremation) for customers. This means that the business can take care of all of the planning required for a funeral service to run smoothly. This is particularly appealing to customers, as it reduces both the stress and time involved in preparations. Although certain other competitors provide similar offerings, competition is location based. CSV may therefore be the only provider of this offering in certain regions.

Industry And Business Drivers

As stated in CSV’s annual report, although there are several public companies that own funeral service locations and cemeteries, the majority of death-care businesses in North America are locally-owned, independent operations. Given the sensitive nature of the business, relationships fostered at the local level build trust in the community and are a key driver of market share. While new entrants may enter any given market, the time and resources required to develop local heritage and tradition serve as important barriers to entry.

• The position of a single funeral service location or cemetery in any community is a function of the name, reputation, and location of that funeral service location or cemetery, although competitive pricing, professional service and attention, and well-maintained locations are also important.

During 2016, the number of deaths in the United States increased by approximately 1.3% following a 1.9% and a 1.1% increase in 2015 and 2014, respectively. We expect this rapid growth to continue going forward (expected growth of 1.6% to 2020), causing the industry to be well positioned for medium- and long-term profitable growth. The large baby boomer populations, which in 2017 are aged 53 to 71, are already impacting the industry today. This is primarily through demand for pre-need cemetery and funeral sales (pre-need: deferred revenue on services and merchandise). However, as this population category continues to age, we will also see a growth in at need sales. It is worth noting that currently 19% of total funeral segment revenue is derived through pre-need sales. For the cemetery segment however, this represents 45% of total segment revenue.

Specifically in regards to Carriage Services, the business adopts a decentralized operating model, enabling the business to further attract entrepreneurial talent in its industry. The company’s focus is to partner with the best of the remaining independent funeral home and cemetery owners in major strategic markets around the country, particularly where the potential for future revenue growth is the highest.

Long-Term Growth Strategies

Carriage Services has grown at a steady rate over the last several years. However, is this growth purely driven by the industry? In accordance with management, the company has several key growth initiatives. These initiatives are explained below:

- Acquisitions: The company remains acquisition focused within both the funeral and cemetery segments. Within the funeral segment, acquisitions would provide the potential for scale in areas with the highest return customer categories and market traits. With rising demand for cemeteries and cemetery services expected in the coming years due to demographic changes, making acquisitions in this segment now could prove to be lucrative for the business in the future.

• Carriage Services has a flexible capital structure, with no near-term debt maturity issues. Although the debt-to-equity of 1.22 seems high, this is quite characteristic of the industry, considering its stable cash flows and low correlation to the performance of the wider economy. We therefore believe that CSV can continue to take advantage of the low interest rate environment to fund acquisition related growth. Where necessary, the company has also acquired through retained earnings and additional equity issues.

- Pre-need Trust: Due to the business’s $159 million backlog of pre-need receipts, Carriage Services has invested a large sum of this money in investment trusts. CSV maintains a low risk investment structure, with relatively liquid assets in its portfolio. This is demonstrated by the fact that the trust currently only invests in debt instruments. The business also enjoys favorable terms with third-party insurance providers. Independent operators cannot easily duplicate these arrangements with third parties. This gives the business an edge in funding future growth and profitability over time.

- Decentralized Operating Model: As alluded to above, the business adopts a decentralized operating model. This enables the company to attract entrepreneurial talent to further grow the business. Incentive plans are also tailored to this goal, where managing partners receive a particularly large bonus every five years if their division generates a CAGR of 2% or more over the same period.

Risks

In fairness, there aren’t many significant risks associated to Carriage Services. The company has a strong balance sheet with no near-term debt due. The industry also isn’t strongly correlated to macroeconomic factors. The biggest issue for CSV however is the fact that the industry itself determines the revenue and profitability for the business. With industry demand currently increasing due to the growing age of the baby boomer population, what will happen in the future? Can growth be sustainable beyond the baby boomer generation?

Valuation

Company	Weighting	EV ($m)	EBITDA ($m)	EV/EBITDA	P/E Ratio
Carriage Services	-	783	64	12.25	21.80
Service Corporation International (SCI)	25%	9222	752	12.27	20.90
InvoCare (IVC)	25%	1757	112	14.52	22.63
Dignity PLC (OTC:DGNTY) (DTY)	25%	1738	118	14.73	21.15
Matthews International Corp. (MATW)	25%	2928	193	15.16	28.55
Implied Value				14.17	23.31
Implied Undervaluation				15.67%	6.92%

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We have done a simple multiples analysis to value Carriage Services. We used an EV/EBITDA metric to value the business. We used EV to strip out any capital structure differences. We also used an EBITDA metric to nullify any D&A differences between companies.

Carriage Services is slightly undervalued based on our multiples analysis. The company is trading at a price 6.92% lower than comparable companies based on the EV/EBITDA comparable. CSV is also trading at a P/E multiple 15.67% lower than its comparable companies.

Is this justified however? Below is a chart demonstrating the performance of comparable companies over the last year (TTM). Our analysis shows that CSV has generated slightly less growth than its comparable companies. Although this is not by a significant amount, we believe that this warrants a slight undervaluation based on the comparables analysis. We therefore believe that the market has fairly valued the business.

	CSV	IVC	DTY	SCI	MATW	Average ex-CSV
Net Revenue Growth	1.93%	3.34%	2.72%	0.95%	3.81%	2.71%
Gross Profit Growth	2.13%	4.15%	1.92%	2.07%	5.11%	3.31%
Operating Profit Growth	8.37%	6.68%	2.30%	3.13%	13.13%	6.31%
Net Profit Growth	12.76%	29.25%	3.19%	71.75%	4.54%	27.18%
Debt-to-equity Ratio	1.22	1.01	1.01	2.78	1.35	1.54

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Conclusion

Carriage Services is qualitatively a strong business that has plenty of growth opportunities moving forward. This is primarily due to the aging baby boomer population. We also believe that the company is fairly valued at its current share price of $26.96.

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Analyst’s Disclosure: I/we 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.