SINGAPORE (Dec 17): Two years ago, Nirvana Asia, the largest integrated death care service provider in Asia, was privatised. The US$1.1 billion acquisition of Nirvana Asia Ltd by CVC Capital Partners, a leading global private-equity firm, was done at a 22.4% premium above the prevailing price. At that time, Nirvana had a third of the market share in Singapore and Malaysia. Its services included the entire death care service value chain, and the company was a pioneer in pre-need death care services in Asia. Some of its financial highlights included a strong cash position with zero gearing (interest-bearing debt), an adjusted five-year earnings before interest, taxes, depreciation and amortisation (Ebitda) and net profit margin compound annual growth rate (CAGR) of over 30%, and a reduction of costs and expenses as a percentage of revenue by 10% within five years, indicating Nirvana’s economies of scale. Companies that provide death care services can be profitable even though death is a topic that is generally avoided, especially by the superstitious.
In life, only death and taxes are certain, as pointed out by Benjamin Franklin. The funeral and death care service industry is generally not a growth industry; however, it is particularly stable and sustainable. The value chain of the industry can be segregated into three main segments: funeral homes and services; crematories and cemeteries; and burial services.
The funeral homes and services segment includes embalming the body and conducting funeral-related activities such as organising the wake, transportation and interment. This segment also functions as retailers for the burial services segment, for example, through the selling of caskets. The crematories and cemeteries segment is mainly involved in dealing with the operating sites and structures of cemeteries, sale of interment rights, and cremation facilities. The burial services segment involves the manufacturing of burial and memorial products such as tombstones and urns.
Revenues from the death care service industry can be subdivided into pre-need revenues and at-need revenues. Pre-need revenues are derived from funeral services and plans made before the death of the particular individual, while at-need revenues are mainly sourced from services and plans that are made after the individual has died.
The only industry that is able to cheat death indefinitely
Simply put, as long as people are mortal, the funeral and death care service industry would thrive. The demand for death care services is usually very inelastic, which translates into higher profit margins and economic moats. The margins are further enhanced in areas where land is scarce, such as in Singapore, which tilts the pricing power in favour of death care service providers. The industry also requires low working capital and capital expenditure to operate.
Furthermore, government regulation and strong branding serve as strong barriers to entry. Government regulation includes land use rights for cemeteries, while branding includes personalised services for the deceased from recognised brands, which usually provide an array of packages ranging from affordable to premium-quality services. Hence, the death care service industry is innately sustainable and profitable.
Growth in the industry primarily depends on the birth and mortality rate. The rise in the population of ageing baby boomers enhances the prospects of the death care service industry in the short and medium terms. Chart 1 illustrates the addressable market for the death care service industry over the long term. Even if healthcare services are able to prolong the lifespan of individuals, death is an eventuality. This would only defer the at-need revenues of the death care service industry. However, restrictive procreation policies, such as the one-child policy previously enacted in China, can curb the growth of the industry. Intuitively, as long as public listed companies run the industry over the longer term, and as the world population approaches maximum capacity, burial land would become scarce, while death would become more exclusive, as only a certain number of people can and would be born within stipulated time periods. Hence, higher margins can be reaped by the death care service industry.
Industry-specific factors to consider in valuing the death care industry
Comparatively, cremations are usually cheaper than burials, and are therefore less profitable to death care service companies. It is also important to keep track of burial land costs and interment rights for burials, and the costs of niches, urns and keepsakes for cremations, to determine the margins for death care service companies. At-need revenues tend to be less profitable to the company, while pre-need revenues allow the company to invest the proceeds into perpetual care funds and trusts. The two main themes that thrive in the death care service industry are personalised services and convenience. Technological advancements, such as apps that allow for will-writing, organ donations post-death and choice of the funeral service provider will facilitate the provision of personalised services.
No two companies, even in the same industry, are identical. Companies in the death care service industry should be valued on a case-by-case basis. We have come up with a quantitative filter to segment the companies and identify the profitable, dividend-paying stocks. Chart 2 shows the historical performance scoring for globally listed death care service companies since listing. The four criteria used for the scoring, each with equal weightage, are the numbers of positive net income years, positive operating cash flow years, positive free cash flow years and dividend payout years. The green bars indicate that the companies have scored more than 80%, implying that they have performed consistently well based on income, free cash flow and dividends since they were listed.
Chart 3 shows the current performance valuations for the same companies. The y-axis shows the weighted yields, which is made up of earnings, operating cash flow, free cash flow and dividend yields. The x-axis shows the weighted valuation multiples, consisting of price-to-earnings and price-to-book ratios. A company that possesses high yields and low weighted valuation multiples is undervalued; and vice versa for an overvalued company. According to Chart 3, San Holdings (see “Bereavement stocks with good fundamentals” on Page 23) and Heian Ceremony Service Co are the two most undervalued listed bereavement companies. Both are listed on the Tokyo Stock Exchange. Heian is illiquid and hence, its share price is quite volatile.
Bereavement stocks with good fundamentals
San Holdings is the most undervalued stock, based on current valuations and historical performance, while Service Corp International and Fu Shou Yuan International Group are the two largest listed companies in the death care service industry. Though well-established companies within the death care service industry may possess stable and foreseeable prospects, it is important to recognise that sometimes markets do not accurately reflect the intrinsic value of the companies, as in the case of Service Corp International, which is currently overvalued. Ultimately, the industry, because of its nature, is more suitable for long-term investors, as affirmed by the consistent and high historical performance scores in Chart 2 above. Other companies, on the other hand, could be undervalued and attractive, as in the case of San Holdings.
San Holdings could be Japanese growth story
Tokyo-listed San Holdings has been in the funeral business for more than 80 years. The company provides funeral services, such as temporary staffing services for funerals, hearse services, and washing the corpse. It offers a variety of funerary service packages, ranging from premium individual funerals to low-cost general funerals, which makes it less susceptible to price competition. With more than 60 funeral halls, San Holdings currently hosts around 10,000 funerals a year.
Given the significant ageing population in Japan, San Holdings should be able to grow at a steady pace, as it has done over the past 20 years. Specifically, most of San Holdings’ funeral halls are concentrated across Osaka. The ageing population (above the age of 65) in the Osaka region is around 2.6 million. Chart 1 shows the growth in the company’s value against the growth in the price of the company. San Holdings’ historical value growth significantly exceeds its historical price growth, indicating that the company is strongly undervalued. Our margin of safety analysis, which values companies based on the quality of their assets, suggests a valuation of ¥2,930 per share; while our discounted cash flow (DCF) analysis suggests a per share price of ¥3,240. San Holdings is currently trading at ¥2,450 a share; which reflects that the company is indeed deeply undervalued.
Service Corp International is overvalued
New York Stock Exchange-listed Service Corp International is the largest public-listed death care service provider in the world, with a market cap of over US$8 billion ($11 billion). Also North America’s largest death care service provider, Service Corp is involved in the funeral services and cemeteries segments of the value chain, with operations in 1,481 locations and 481 cemeteries across the US, Canada and Puerto Rico. Service Corp’s 15% market share in North America overshadows its nearest competitor by almost seven times. This allows the company to leverage its interment rights and larger perpetual fund returns from its pre-need revenues.
The company’s economic moat is also well secured, with 20% and 30% operating profit margins in its funeral services and cemeteries segments respectively. Service Corp has performed consistently well for the past five years, generating a 12% CAGR in earnings per share (EPS) and 10% CAGR in operating cash flow before taxes. Service Corp expects a yearly EPS growth of 8% to 10% over the long term, mainly bolstered by the increase in the population of those above 55 years of age in the US, from 75 million to 120 million from 2010 to 2035, according to the US Census Bureau. Chart 2 shows that Service Corp’s historical price growth exceeds its historical value growth, indicating that the company is overvalued. Based on our margin of safety analysis, Service Corp’s fair price is US$27.60, while our DCF valuation indicates a fair price of US$34.20. Service Corp is currently trading at US$45, making it substantially overvalued.
Proxy to China: Fu Shou Yuan International Group
Hong Kong-listed Fu Shou Yuan is the largest death care service provider in China. China’s death care service industry is very fragmented, and Fu Shou Yuan has only about 2% market share. Close to 90% of Fu Shou Yuan’s revenue is derived from its burial services segment, while the other 10% comes from its funeral services segment. At present, Fu Shou Yuan’s business is spread across 20 cities in 14 provinces, with 20 cemeteries and 20 funeral facilities in operation. The company’s deep moat is reflected in its Ebitda margins, which have been close to 50% for the past five year. Fu Shou Yuan’s gearing ratio currently is a mere 4% and only 1.7% of its bank balances are in foreign currencies, making it less susceptible to foreign currency risk. Furthermore, the company has recorded a 29.4% CAGR for its Ebitda in the past five years, indicating strong profitability.
Recent measures taken by the Chinese government on environmental protection have allowed the company’s environment-friendly cremation machines to obtain a state patent. This enabled the company to win bids to supply cremation machines to state-owned funeral parlours. Furthermore, the Chinese government’s latest reforms regarding the separation of its supervisory role from its operator role strongly boosts Fu Shou Yuan’s position within the Chinese death care service market, as it enables the company to participate more in state-run burial and funerary services. Chart 3 shows that Fu Shou Yuan’s historical value growth exceeds its historical price growth. However, Fu Shou Yuan is fairly priced, based on our margin of safety and DCF analyses, which give a fair price of HK$5.60 and HK$5.65 respectively. Fu Shou Yuan is currently trading at HK$5.70.
