Service Corp International (SCI) – Positive View on Funeral Homes

Disclaimer– This article is for informational purposes only and does not constitute financial advice.  Please consult with your financial advisor and perform your own research.  Please read full disclaimers here.  Author of this article owns SCI stock.


Current Price: $26.45; Potential Upside: 20%+

Background

SCI is the largest funeral home and cemetery operator in the United States with 1600 funeral homes, 500 cemeteries, $4Bn market cap, and $3Bn of revenue, which equates to roughly 17% market share.

Thesis

Given the relatively morbid nature of the business and tough funeral volumes in recent years, SCI has remained an under-followed company, resulting in attractive valuation levels for a very stable business model.

Due to the aging population of the United States, SCI is in the very early stages of benefiting from the growing funeral needs of the Baby Boomer generation.  SCI typically sees pre-need cemetery sales when individuals are in their 60s, pre-need funeral in their 70s, and at-need in their 80s.  The first Baby Boomers turned 60 in 2006 and are now 69, so SCI is starting to see a pick-up in pre-need cemetery and will be seeing a pick-up in pre-need funeral and at-need in the coming years.  Since the funeral business has large fixed costs, small pick-ups in volume result in large increases in cash flow due to an almost 60% flow-through margin on revenue.

In addition to the improving demographics, SCI has ample opportunities for immediately accretive free cash flow (FCF) investment opportunities through consolidation and share repurchase.  The funeral home industry is highly fragmented and largely run by mom and pop operators, who are nearing retirement.  Given the unappealing nature of running funeral homes, many of the independent funeral home owners are not able to pass on the family business to their children.  This has resulted in a buyer’s market for funeral homes with SCI being the largest consolidator of the industry by a large margin.   Funeral home M&A is highly accretive to SCI FCF per share as SCI acquires assets with a ~9-10% FCF yield at ~5% borrowing rates and typically realizes meaningful back office synergies on top.  In addition to M&A, SCI has the potential to repurchase 2-4% of its market cap per year.

Catalysts

In the near-term (2015-2016), SCI should return to FCF-accretive M&A transactions after digesting its recent Stewart transaction, providing upside to consensus expectations.  And long-term (5-10 years), SCI should see substantial increases in FCF as the at-need business begins to see an increase in volume.

Valuation and Target Price

SCI is likely worth $32+ based on 15x discretionary FCF/share.

SCI-March2015-Chart



Categories: Healthcare, Stock Views

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