- Service Corporation International (NYSE:SCI) is the leader in the death care industry and expected to grow as demand for its services increase.
- Wide economic moat, strong pricing power, and cash flows make SCI attractive in the current market.
- SCI has continued to perform strong beating both top and bottom-line estimates in the third quarter of 2022.
Company Overview
Service Corporation International (NYSE:SCI) is the largest death care provider in the United States. The business is a global leader in its field with about 15% market share. It achieves growth through purchases of neighborhood cemeteries and funeral homes. Over the past 5 years, SCI has invested over $770 million into “growth opportunities” which include a combination of acquisitions, new builds, and event spaces.
SCI now owns 1,471 funeral homes and 488 Cemeteries across North America. The business generated over $4 billion in revenue as of the full year 2021, which is astonishing.
As the US’s elderly population grows, there will be a high demand for death care services. With pre-need sales, Service Corp. has a competitive advantage since it secures future market share in the sector and keeps clients away from rival businesses.
Age of Baby Boomers’ Coming to an End
The number of US deaths is expected to increase in the future. This trend is beneficial for Service Corp. because the demand for its services will increase. Whether we like it or not, there is money in death, especially with the aging US population. By 2030, the US demographic will come to a turning point as all baby boomers will pass the age of 65.
You can also refer to the exchange between an Credit Suisse analyst and CEO Thomas Ryan.
U.N projects for the death rates in USA is also expected to go on an uptrend. Although morbid news, this is a positive for SCI’s business outlook.
Financial Overview
Revenue has grown at a healthy pace since FY12, growing at CAGR of 4.9% while Net income has grown at impressive CAGR of 18%.
SCI’s has been generating strong free cash flows over the past several years, up 12% into FY21 and at $690.6 million in FY21. This provides management with the flexibility to pursue growth through mergers and acquisitions.
Service Corp. has unfulfilled pre-need funeral and cemetery contracts worth about $13.3bil in deferred revenue backlog. This amount is then managed in the company’s trust fund. The advantage of pre-need sales is that they collect cash before the service is rendered. This provides stability and predictability of revenue and cash flows. Earnings or gains/losses are recognized when the service is performed for the client.
3Q22 Results
SCI reported results for the third quarter of 2022 last week.
Diluted earnings per share excluding special items was $0.68 in the third quarter of 2022 compared to $1.16 in the third quarter of 2021. The decline of $0.48 is primarily due to an expected decline in gross profit related to decreases in COVID-19 related activity combined with higher inflationary costs and lower trust fund income impacted by negative financial market returns.
The numbers are below the prior year quarter. This because 2021 was materially impacted by the effects of COVID-19 (more deaths reported). Comparing back to the pre-pandemic third quarter of 2019, SCI have shown tremendous growth
SCI raised the midpoint of their full year 2022 adjusted earnings guidance by 20 cents to $3.70 and the midpoint of their adjusted operating cash flow guidance by $40 million to $815 million. This is because the management initially assumed that their performance would normalize back towards 2019 pre-COVID levels.
Based on their reported results, they expect higher than we anticipated levels of non-COVID funeral services in atneed cemetery revenues that their original base assumption. SCI management also believe these excess services are more permanent nature under a combination of aging demographics, higher risk, less healthy lifestyles developed during the pandemic, as well as certain geographic market share gains.
Here is an interesting takeaway from the earnings call that sort of explains the increasing demand of their services moving forward.
Preneed cemetery sales production grew $16 million or 5% in the third quarter. This is also 67% higher than the third quarter of 2019. This means SCI is growing preneed sales production at a 19% compounded annual growth rate over the three-year period.
Risks
1. Inflationary Headwinds
While overall funeral costs are not particularly discretionary, some of the major contributors, like merchandise, are. Customers are starting to make funeral savings in some cases. High end sales are still increasing, but SCI is observing some downtrading in the more discounted services.
SCI is a service oriented business and the largest headwind they face is wage inflation. SCI has incurred higher cost due to inflationary labour pressures. Again, we can refer to their earnings call on more information on this.
The CEO has assured that they will be able to pass the increase in costs to their customers.
2. Trust Funds are exposed to Market Conditions
Another significant point is that the stock market downturn this year has significantly reduced the value of their trust fund. This will have an impact on the income from the trusts. This is quite important as the profits will be spent beyond maintenance costs from the portion of cemetery sales that was set aside into trusts. The challenging stock market conditions and higher interest rates does not bode well for the company’s secular revenue. This is one of the risk factors of this company.
.3. Dependency On Mortality Rates In North America
If the number of deaths decline, cash flows and revenue may decrease. Revenue for SCI is influenced by the number of deaths in the US and Canada. Health care innovations may lengthen life expectancy. The company’s financial performance may change as a result of variations in the death rate.
Conclusion
SCI currently trades at EV/EBIT of 13.94 and is below the 5 yr average of 15.81x
SCI appears to be a solid business that should continue to do well over the long term. Revenue growth has been decent in the single digits over the past 10 years. Free cash flow margins are strong translating down from SCI’s net income. This also means that SCI is a business that is able to hold on to its cash flows. Furthermore, this industry is recession resistant with expected death rates to increase in the coming years.
If an investor is looking for an investment in an industry that will always be in demand, Service Corporation International is an excellent choice.
Note: The Moss Piglet is long SCI