The Case For (And Against) Owning Shares In Carriage

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About: Carriage Services, Inc. (CSV)
by: Noam Ganel, CFA
Summary

Cremations, compared to funeral services, are less profitable. The growing preference for cremations will hurt any company in the death care business.

Because of the high fixed-cost nature of the business, if revenue falls, earnings sharply decline.

But I bought a few shares in Carriage. Management is shareholder-friendly, has done an adequate job in adding market value to common shareholders, and also in managing its debt.

And its founder, Mr. Melvin Payne, 88 years young , and I, 36 years old, have a similar taste in books.

Prologue

Over the past year, the common stock price of Carriage Services (CSV), a funeral home company, dropped by a third. In this essay, I will present the case why the decline in price was appropriate given two, long-term trends that are hurting companies in the death care industry. The increased amount of cremations and the high fixed-cost nature of the business. But I also bought a few shares in Carriage, and I will provide two reasons why.

The cremation trend

As a growing secular and environmentally-conscious society changes its burial preferences, the death care industry, whose business model depends on elaborate funeral ceremonies, is losing its tailwinds. The future of the death business is not what it was in the past because of two reasons. The first is that the number of burials in the United States is decreasing. It is estimated that there will be about 1.3 million burials in 2021, declining from 1.36 million in 2018 per Carriage’s most recent 10-K filing.

The second is that the number of cremations, a lower margin business compared to burials, is increasing. In the Risk Section of the 10-K report, management warns investors that, “the number of cremations increased by 5% in 2017, following increases of 4.3% in 2016 and 7.4% in 2015. As the Economist wrote in Great News for Dead: The Funeral Industry is Being Disrupted, "nobody is yet writing undertaking's epitaph but the industry will have to adapt."

The high fixed-cost nature of the death care industry

Once funeral home sales decrease, margin percentages decline at an even steeper rate. This is because the cost of fixed expenses such as staff, vehicles and cemeteries are impartial to declining sales.

Personnel costs, for example, are the largest component of the operating expenses, and these costs are incurred irrespective to how many services are performed. This is similar to the hotel business, where staff, property taxes, utilities and insurance are paid regardless of the number of guests.

And economies of scale in the death care industry are rarely found. The typical customer in the U.S. despises big brand names and prefers privately-held, preferably family-owned businesses. So, the industry has to carefully market each cemetery and burial home using the specific market's customer preference. This lack of scale, accompanied by the high fixed-cost business, is a double-edged sword.

Management as shareholders

So it was not for the industry's tailwinds that I bought shares in Carriage. It was for the personality behind its founder, Mr. Melvin Payne. Carriage's boss and president, owns 1.34 million shares, roughly 7% of the outstanding shares. He founded the company in 1996 with little background in the death care industry. He writes that, “After witnessing the noble work of the funeral director's daughter, especially in her sensitive handling of each family and their interactions, I told my brother and wife that I was highly passionately motivated to start a funeral company that, over time, became the best in the industry.”

Payne is also a Warren Buffett enthusiast. So buying back Carriage's outstanding shares is on his mind. Over the past five years, Carriage bought a total of 3.6 million shares at a total cost of $79.1 million, an average cost of $21.20 per share.

Besides buying its owns shares, the company had done well in increasing market value. If you compare the amount of retained earnings over the past decade to the increase in market price per share, you will find that for every dollar of retained earnings, Carriage doubled the market price of the stock.

In numbers: Carriage ended 2009 at $4 a share. It retained $7.6 per share over the past decade. Now the company trades at about $19 per share. To find retained earnings, I used the reported net earnings per share less the dividends per share.

2018 2017 2016 2015 2014
Earnings per share $0.63 $2.09 $1.12 $1.12 $0.85
Dividends per share $0.30 $0.23 $0.15 $0.10 $0.10
Retained earnings per share $0.33 $1.86 $0.97 $1.12 $0.75
Stock price range (rounded) $28-$14 $29-$23 $29-$20 $26-$20 $22-$16
2013 2012 2011 2010 2009
Earnings per share $1.0 $0.63 $0.38 $0.45 $0.40
Dividends per share $0.10 $0.10 $0.08 $0 $0
Retained earnings per share $0.9 $0.53 $0.30 $0.45 $0.40
Stock price range (rounded) $22-$12 $12-$5 $7-$5 $5-$4 $5-$1

Source: company's public filings and author's calculations.

Published in 2016, and available at Carriage's website, The Evolution of Our Learning Journey depicts how much Payne looks up to the Oracle of Omaha. On page 4, for example, he compares Carriage's performance versus the S&P 500, using the exact same format as Berkshire (NYSE:BRK.A) (NYSE:BRK.B).

He then openly discusses past mistakes. "I had absolutely zero idea how best to operate and consolidate funeral homes and cemeteries in June 1, 1991,". For me, it was worthwhile to own a few shares in the company just to support this kind of communication. When was the last time you heard of a CEO of a publicly traded company admitting to mistakes?

The optics of the debt level

Looking at the five-year balance sheet record is worrying. That is, at a first glance. In 2018, reported assets were $917.5 million and reported liabilities were $696.01 million. A 76% leverage ratio is high in almost any industry, but in a high fixed-cost industry, it signals bad times ahead. Five years ago, the leverage was just as high. In 2014, reported assets were $827.5 million and reported liabilities were $647.6 million, a whopping leverage of 78%.

But about half the reported liabilities do not represent a cash outlay. On page 53 of its most recent annual report, Carriage reports that out of the $696.01 million of reported liabilities, $262.6 million are deferred revenue, or funds held on behalf of customers. And if we remove these non-cash outlay items from the reported liabilities, Carriage’s leverage ratio falls to 47%.

The cost of debt has risen though. Carriage paid in 2017 a weighted average interest rate of less than 2%; in 2018, the company's weighted average interest rate was over 6%. Unsurprisingly, the annual interest expense went up by 63%, from $12.9 million in 2017 to $21.1 million in 2018.

This was also the biggest factor why reported earnings per share dropped to $0.63 in 2018 per share from $2.09 in 2017. But while the stock market was infuriated and discounted the value of Carriage by over a third, I thought management had done was to secure fixed financing in a rising rate environment. Not a bad business decision.

Epilogue

Successful stock investing requires more than financial analysis. Buying and selling stocks requires discipline (to carefully read how a business works) and courage (to buy a stock position when everyone else is selling it.)

While I read the 10-K filings from 1999 to 2018, thought about the funeral business model and observed how stocks in the death care industry traded for over the past 20 years, my purchase in Carriage was not because of unique discipline or courage.

I bought stock in Carriage simply because I learned that Payne, 88-year-young, and I, 36 years old, share the same enthusiasm for Peter Bevlin, who wrote A Few Lessons for Investors and Managers From Warren Buffett.

Disclosure: I am/we are long CSV. 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.