2024-01-04 07:38:36 ET
Summary
- Carriage Services' financials show a high debt load, posing risks and lowering its intrinsic valuation.
- The company operates in the deathcare business, providing funeral and cemetery services.
- Carriage Services has been actively acquiring small funeral homes, which is its main growth catalyst.
Investment Thesis
I wanted to take a look at Carriage Services' (CSV) financials to see if there is some value to be had. The company has been very active in acquisitions, which is the main reason it was growing at a somewhat decent pace, however, the company still seems overpriced, given the fact that the company´s massive debt load poses some risks, which brings its intrinsic valuation down significantly. I assign the company a hold rating until I see vast improvements in its outstanding debt.
Briefly on the Company
The company is relatively unknown, and in a business that is not widely covered, which is the deathcare business. The company is a funeral and cemetery business providing traditional funeral arrangements, like cremations, burials, memorial services, and anything that has to do with death like pre-need planning services, grief counseling, and support services for families.
The company operates cemeteries, sells burial plots and memorials, and also provides catering and reception services.
The company has been very active in acquiring small funeral homes across many states in the US, which seems to be its main growth catalyst going forward.
Financials
As of Q3 ´23, the company had around $1.2m in cash and equivalents against a whopping $584m in long-term debt, that has been mounting over the last decade. This increase in leverage can be attributed to the company´s strategy of growing inorganically through acquisitions (I counted 20+ acquisitions in the last decade). I think the management went a little overboard here and now is in a lot of debt, which is 1.5 times its market cap currently. I don’t mind companies using leverage for strategic purposes; however, many investors tend to look no further than the debt numbers and decide not to invest their money because of the risk leverage carries. There are a few metrics I like to look at to decide whether the debt the company has is manageable.
The debt-to-asset ratio doesn't look too bad here for the company. It has been under 0.6, which I consider to be acceptable. As of the latest quarter, it stood at around .46 still, so that´s good. When we look at the company´s debt-to-equity ratio, this is where it´s beginning to look much worse. I am okay with the D/E ratio reaching up to 1.5, which means the company has more debt than equity on the books, however, this ratio has continued to increase to around 4.3 in FY22, only to come down to around 3.6 as of the latest quarter, which is an improvement, however, unimpressive. Lastly, the company´s interest coverage ratio stood at around 2 as of Q3 ´23, which according to many analysts is a healthy ratio. I´m more on the conservative side, so I believe that an interest coverage ratio of 5 is much safer and allows for bad years of performance, and still can pay its annual debt obligations. 2x is a bit too close for comfort. So, the company got 1 out of 3, which is not ideal.
The company is aware of its overindulgence of debt and came up with a plan to improve its position with the announcement of the High Performance and Credit Profile Restoration Plan , which focuses on paying down debt and reducing leverage to a more acceptable level. This has not reduced the company's debt position over the last year since it was announced however, most of the debt that the company has is in Senior notes that carry a 4.25% interest and go through May 2029. Around 30% of the outstanding debt will be affected by this strategy. I need them to focus on reducing the variable interest rate debt, as the payments have more than doubled from 4.3% to 9%.
The company´s current ratio has not been particularly healthy over the last 5 years also. It´s been under 1, 4 out of 5 years, and it is still under 1 as of Q3 ´23. This poses extra risks of liquidity but does not necessarily mean that the company has liquidity issues. The company has been operating like this for a while now, which makes it a little less worrisome, however, I would like to see this improving over the next while, say 2 or 3 years, but for now, I will be adding a larger margin of safety to account for this risk.
In terms of efficiency and profitability, CSV´s ROA and ROE metrics are mixed. The company´s shareholder equity has halved in the last couple of years, which brought ROE up considerably while ROA went nowhere. It seems that the management is not allocating the company´s assets very efficiently and ROE has been inflated because the company has been repurchasing shares in the last couple of years reducing shareholder equity. I´m sure ROE will be down in the next year or two. The company´s ROTC is around 7%, which if we compare to other companies in the deathcare business, CSV sits somewhere in the middle, which isn’t the worst, but there are better alternatives that may have more competitive advantage and stronger moat. Mostly because these companies are much bigger than CSV.
In terms of margins, these have been trying to recover in ´23, but so far have not managed to return to the most recent highs in ´21 but are heading in the right direction. It is a nice improvement from the lows in ´18.
In terms of revenue growth, the company managed to grow at around 6.3% CAGR over the last decade, which isn’t very exciting, and most of that can be attributed to the company´s strategy of inorganic growth. This may continue in the future as I don't think the company will stop acquiring small businesses to add to its portfolio.
Overall, the company seems to be a stable one, with unfortunately too high of a debt load, which makes me more cautious. If the company achieves its short-term goals and manages to reduce its debt significantly without adding even more of it due to acquisitions, the company could be holding value.
Valuation
The company isn't very widely covered on the Street, so I decided, as I usually do, to approach revenue assumptions with a conservative mindset. I assumed that the company was not going to stop its main growth strategy of acquiring smaller funeral businesses. This way the company may continue to grow at a similar pace as it has in the past. But to give myself some margin of safety, I decided to grow revenues at around 4% CAGR over the next decade, which is lower than its historical CAGR. To cover my basis, I also modeled a more conservative and more optimistic scenario. Below are those assumptions and their respective CAGRs.
In terms of margins and EPS, I lowered these for FY23 as it seems appropriate. Then over the next decade, the company will regain the profitability it saw in FY22 and then some. Below are those assumptions. This way my assumptions below will provide a little extra margin of safety as they would be easy to beat.
I went with a 7% discount instead of the company´s very low WACC of around 5%, due to the massive outstanding debt. Furthermore, I went with a 2.5% terminal growth rate. On top of these estimates, I also decided to add another 20% margin of safety, just to get that sleep-good-at-night feeling knowing that I did not overpay for a stock. The massive debt load and liquidity risks are the main reasons for the extra added 20%. With that said, CSV's intrinsic value, and what I would be willing to pay for it is around $16.60 a share, which means the company is overvalued for me right now and I will not be buying into it.
Closing Comments
The above valuation is very conservative, I know, however, I need to see the company paying down that variable debt much more aggressively. In the last year, the company only paid down around $3m of it. I need to see much bigger numbers here, otherwise, debt is going to continue to eat away at its free cash flow and this will affect its intrinsic value in my opinion. The intrinsic value of the company would change considerably once I see that the management is taking action to pay down debt. Until then, I will continue to follow the company´s finances and will update my model as needed to reflect the efforts of the management, if there will be anything to update.
The business is not going to go away any time soon unless we become immortal, and since there was a potential of a buyout, I don’t think that is out of the question in the near future, which could provide a nice pump in share price if the parties come to an agreement. A price alert is set closer to my PT, and I will continue to monitor the company´s situation going forward, albeit occasionally.
For further details see:
Carriage Services: Share Price Needs To Come Down Or Financials Improve