Is it time to write the obituary for the death-care industry?
Once the darling of Wall Street, the stocks of publicly traded funeral and cemetery services have taken frightening hits over the last six months, losing anywhere from 41 percent to 64 percent of their value.
That’s because the hyperconsolidation that once fueled much of the industry’s healthy growth is now DOA. After years of acquiring smaller, mom-and-pop funeral operators, the four big players in the death-care business are bloated by debt; one of them is struggling through Chapter 11.
Two mild winters have contributed to what one analyst called an “outbreak of wellness”–fewer people are dying–and more of them want to go the less expensive route of cremation.
Bill Burns, an analyst with Johnson, Rice & Co. in New Orleans, said that death-care providers must “do a 180” if they want to survive.
“It’s brutal,” he said. “All of them have been hit pretty hard. All are having to change their business philosophy from consolidator to focusing on internal growth.”
Part of that growth, he said, can come from “preselling services” to the nation’s 78 million Baby Boomers who have already started turning 50, and will continue to do so in increasing numbers over the next decade.
Burns said 50 is the age when many people start thinking about buying a cemetery plot. They’ll start thinking about buying their funeral service when they reach 60.
“Baby Boomers are going to bail the industry out,” he said. “When I look at Baby Boomers, they don’t just have a phone, they have call waiting and all the other features. They can get to work in a Chevrolet, but they drive BMWs.
“They are the generation of marketers. I think they’re going to want all the choices.”
About 2.3 million people die each year in America and that number increases about 1 percent annually. But in 1997, that number decreased for the first time in a decade, with 445 fewer deaths recorded than in 1996.
“That’s unheard of,” Burns said. “It’s been called an `outbreak of wellness’ and is partly due to the fact that most people die in the winter, and we’ve had two consecutive mild winters.”
That doesn’t bode well for an industry that has extremely high fixed costs. Nor does the increasing popularity of cremation, which costs half the price of traditional burials and is expected to account for 35 percent of all funeral services in the next decade.
The death-care industry remains extremely fragmented. The vast majority of funeral homes are family-owned and -operated, handed down from generation to generation or from owner to employee.
Industry consolidation started in the 1970s when Houston-based Service Corp. started buying funeral homes and cemeteries. But most purchases have taken place in the last decade as the industry’s four publicly traded firms–Service Corp., Stewart Enterprises Inc., Loewen Group Inc. and Carriage Services Inc.–helped private operators turn generations of goodwill into hard cash.
Today, these public companies own about 13 percent of the nation’s approximately 23,500 funeral homes and 9,500 cemeteries; combined, these properties generate about 25 percent of the industry’s revenue. A few private companies, some with an eye to going public, have also launched buying sprees, accumulating anywhere from 30 to 60 regional properties.
At the height of this acquisition frenzy, consolidators were paying 8.5 or 9 times earnings before interest, taxes, depreciation and amortization to add these mom-and-pop death-care operations to their portfolios.
As domestic prices escalated dramatically, the consolidators started looking globally, where they were able to capture more reasonably priced properties.
“For the prime properties, there was a bidding war,” said Phil Pauze, president and CEO of the Pauze Tombstone Fund, a mutual fund of death-care stocks. “The public companies were typically the highest bidders. They had the capital and the resources to be able to offer the most money.”
These meant healthy growth rates and share prices for the industry’s Big Four.
Shares of Stewart topped the $55 mark, while Service and Loewen toyed with $43. Carriage Services peaked at about $28.
The first inklings of decay rose in 1998 after Loewen lost a lawsuit and was ordered to pay a staggering $275 million. The company faced an immediate cash drain, declining employee morale, a damaged credit rating and poor credibility among industry analysts–as well as a takeover bid by rival Service Corp.
Loewen rejected the offer and, in order to make itself less attractive, Pauze said the company cranked up its purchasing pace and amassed more than $1 billion in debt. The combined weight pushed Loewen to file for Chapter 11 bankruptcy protection in June 1999, pushing its stock into the 50-cent per share range.
Pauze characterizes that lawsuit as the sound of the “first shoe.” The other shoe dropped in January of this year, he said, when Service announced it wouldn’t meet its 1998 earnings forecast. Its stock plunged from nearly $40 to $15.
“In this market, when everything is earnings and P/E ratios and year-over-year ratios, two things happen when you announce something like that: The stock craters and you lose the confidence of the analysts,” Pauze said.
In August, ironically on Friday the 13th, Stewart also announced it would not meet analysts’ projections because of price competition from low-cost mortuaries, the increasing popularity of cremation and a shift by customers to lower-priced services. And in September, Service’s stock took another nose dive after again telling analysts it would miss its earnings estimate by the proverbial mile.
Fran Bernstein, first vice president with Merrill Lynch, gives Stewart, Service and Carriage stock a neutral rating for the intermediate term. The virtual halt to acquisitions means the trio, accustomed to growth in the 20-plus percent range, can expect slower increases: 5 to 10 percent for both Service and Stewart and 18 percent for Carriage, the smallest of the four public companies with $64.9 million in 1998 sales.
“Given their recent disappointments, there’s a lack of confidence,” she said. “I think the companies have to start hitting their earnings expectations out there. That would be an important factor.”
So, should shareholders simply pull the plug and leave the industry for dead?
Pauze remains convinced the death-care industry will begin to turn next year, provided management at these companies continues to take dramatic steps to reduce costs and to increase revenue through internal growth. He says it’s possible for the stocks to shake off their pall and return to their 1997-1998 highs, provided both analysts and investors regain their confidence and the market continues to do well.
The industry probably won’t return to its consolidation mode until around 2006, Burns said, when the death rate is expected to pick up.
“There are still a lot of uncertainties, but when you go look at the business, is the business fundamentally going away?” Burns said. “If anything, the demographics are coming toward you.”
