Service Corporation International Stock: COVID-19 Pull-Forward Over

Service Corporation International (NYSE:SCI) is a company we’ve covered some time ago, focusing on the interesting cash flow dynamics of the business and its secular trends. The changes since then have been the end of COVID-19 excess deaths, which has caused an anticipated decline in funeral revenues. Nonetheless, SCI performs well thanks to mix effects with cemetery picking up, and the data seems to show that soon we’ll be lapping the COVID-19 disruption once and for all, with secular trends likely to continue from here on out. While we like SCI, there is no competition between them and the Japanese funeral home picks that trade at much lower valuations.

FY Results

Let’s begin with the comprehensive segment reporting.

Let’s start with funerals, which saw declines anticipated with the end of excess COVID-19 deaths. Some cremation mix growth occurred, which is a secular trend and has negative mix effects. Nonetheless, pricing action managed to grow the average revenue per funeral by 4%, which offset the actual declines in the number of funerals occurring in 2023 compared to 2022. Overall decline was only 2% for the Q4 and quarterly volume declines were 6%. This mirrors the declines seen for the full year in terms of revenue.

Importantly, despite the declines in volumes, pull-forward effects from COVID-19 seem to be fading, as funeral figures have grown since the Q4 of 2019, before COVID-19 started having a more severe impact in the US. Compared to 2019, the growth was 10%, which is substantial but consistent with annualised demographic death rate growth that would have been expected over the last 3 years, signaling that the disruption is becoming lapped as of the Q4.

While funeral revenues declined, cemetery revenue grew. Part of the reason for this growth is that gains that are being made on cash held in trust are growing thanks to a higher interest environment and to some extent also a recovery in the equity markets. As services are rendered for interred remains, the gains that have been made recently become recognised as revenue driving some of that growth. Q4 YoY growth was around 8%, and it was unsurprisingly driven by preneed which has those gain effects baked in, despite lower velocity in the business due to underlying trends in death.

The growth in cemetery and decline in funeral creates a pretty substantial mix effect as the cemetery revenues are substantially higher gross profit, and actually gained in margin. Furthermore, there was quite a bit of fixed cost-cutting that supported income growth, with operating income rising overall.

The issue is that the company, as most did, underestimated the extent of rate hikes and higher rates have caused pretty substantial erosion of EBT profits by a little less than 8%. Of course, higher rates also helped recognise more gains in rolling over short term securities in the trusts, but the net effect is still negative. The company continues to buyback a lot of stock, consuming more than half of their operating cash flows to do so. They are not deleveraging, but we agree with the decision since their business produces so much cash that they could retire death whenever they feel like it by just dedicating cash flows otherwise spent on buybacks on deleveraging instead for just one year. The buyback yield is around 5%, and the dividend at 1.67%, which means a great total yield.

Bottom Line

We follow funeral companies in multiple geographies. While we like seeing substantial shareholder return, and acknowledge SCI’s superb business model, we can never choose to invest this company over the multitude of options in Japanese public markets that trade at much lower P/E multiples and have a more favourable demographic situation for the funeral industry. SCI trades at around 20x, while the couple of Japanese funeral stocks on the Standard and Prime market trade at P/Es between 10-12x, which is significantly lower, and otherwise have significantly lower valuations when considering large non-operating asset balances as well. Even against US peers like Carriage Services (CSV), which granted does have less cemetery in the mix, is significantly smaller in scale and much more leveraged, trades at a significantly lower P/E around 14x. It is lower multiple that it has been in the past, with 2019 PEs being 23x for SCI, reflecting the possibility that markets are still pricing in more run-rate declines, which is reasonable because it looks like this quarter is where run-rates have finally lapped pull-forward effects, with the former half of the year still elevated from COVID-19. Nonetheless, we are overweight the whole industry across developed markets on demographic considerations, and also on the data that COVID-19 pull-forward is subsiding.