CSV-Carriage Services

[marazul]

Carriage Services (“CSV” or the “Company”) is a cheap, high quality business. Unfortunately, it operates in an industry that few want anything to do with: death care. 

 

Mel Payne founded CSV in 1991 and remains CEO. The Company operates 167 funeral homes (141 owned) and 32 cemeteries (28 owned) with 142,725 unused lots. The funeral home segment (75% of EBITDA) provides burial and cremation services. Also, sells items such as caskets and urns. The cemetery segment (25% of EBITDA) offers similar services but obviously in a cemetery instead of funeral home.

 

What is the opportunity here? CSV at current prices trades for approximately 10x FCF and 9.5 PF adjusted EBITDA. At these prices, the stock is very attractive and management knows that. They repurchased roughly 10% of shares outstanding during 2015 and authorized a new buyback of $25 million in February.

 

Why is the stock cheap?

 

 Leverage: Net Debt/EBITDA is close to 4.8x. I feel comfortable with this amount of financial leverage since the company operates in a stable industry and generates a significant amount of free cash flow. I think this type of business should be run with some amount of leverage in order to optimize the capital structure.

 

 Acquisitive/Roll-up: Investors fear that this will end up like many other roll-ups, in tears. The reality is that the company is consolidating the industry by buying often mismanaged family-owned assets. These assets have very similar characteristics to the ones they already own so this type of transaction involves little operational risk. This is very different from other roll-up stories that start acquiring companies in different industries and end up with assets that they don’t know how to operate.

 

 Historic Performance: CSV went public in 1996 and since then, the stock has generated no return. As some of you might know, the industry went crazy during that period. There was a massive push to buy assets at any price with debt. This wave ended in tears and management learned from that experience. They barely escaped bankruptcy and since then have focused on shareholder value and not just growth for the sake of it.

 

 Convertible Debt: CSV has a $143.75 million 2.75% convertible debt ($22.56 conversion price). Unfortunately, this is dilutive to us, the shareholders. Management argues that looking back, they might have gone with HY debt or TL, instead of issuing the convertible. In my opinion, this was a big mistake. However, the “in the money” value can be settled in cash and dilution is restricted to 20% of shares OS.

 

 Others: Death Care Industry is far from sexy & small company with no coverage.

Now that we know the stock is cheap on a multiple basis and have gone through all the negatives/concerns, let´s talk about the compelling aspects of the business.

 

CSV is run by a fanatic, founder Mel Payne. He is a value investor and a big follower of Warren Buffett. He has shaped the Company with some of Berkshire´s characteristics, such as extreme decentralization and shareholder focus. The interesting aspect of this business is that it generates tons of “FLOAT”! Yes, float. Many clients pay their services while they are alive. This money goes into a fund and the company is able to invest this capital, and generate a nice return from it. That is cost-free leverage and as you know, one of the ways WEB built his empire. In 2008, CSV started to manage these funds (before that, they used third-party managers). Since taking over, they have generated a total return of 163% (vs. S&P 500 164% and 128% HY Index). They are mostly invested in fixed income. Currently, CSV has discretion over $180mm. Punch line: business generates float that is invested by a serious investor and this is a powerful combination.

 

Apart from that, management is focused on consolidating the industry. Why? Well, the industry is very fragmented. SCI is the largest competitor at +10x larger than CSV. SCI has run into troubles with the FTC concerning monopoly issues (had to divest assets to close the STEI acquisition). So they will have to reduce the acquisition pace. Then the other player is StoneMor, which is a public REIT, and they are focused on cemeteries and generating dividends. Conclusion, the other two players are not in a position to acquire many assets going forward and CSV is the likely industry consolidator. Consolidate is exactly what they have done. These acquisitions are highly attractive. Most of them are executed at 6-7x EBITDA and sometimes at 8x depending on the quality of the asset. There are synergies in these acquisitions because the back office can be centralized. The math looks attractive once you take the multiples and synergies into account. Let´s use a basic example, say the acquired asset generates $5 million in EBITDA with 20% margins and CSV pays 7x. Once they acquire this asset, management might take margins up to 28% (current CSV margin is a bit above that). Now the actual multiple paid is 5x! because EBITDA increased to $7 million. At 5x, you can acquire business just with debt and current leverage ratio won´t move. This is very powerful. This is why rolling-up the industry is such a great opportunity at the moment.

 

What can we expect going forward? I think CSV will continue to do what is best for shareholders. When they get opportunities to generate value via acquisitions they will do so and when the stock is cheap, they will buyback stock as they did this year. Organically, the Company should grow at low single digits and there is some room to keep expanding margins. The large opportunity here is to improve the underlying performance of mismanaged assets after acquiring them at reasonable prices.

Having said that, the stock shouldn´t trade at 10x FCF. This gives no value to the high quality management team/owner-operator, defensive characteristics of the business, the float and the consolidation opportunities. This upside is just free and while the stock is this cheap, management will likely continue to shrink the equity to the benefit of the remaining shareholders.

 

[abitofvalue]

Looked at this one a few years back - so for what it's worth :

 

the issue I had was that they are very aggressve in their acquisitions.  Not as bad as STON which is ridic but quite aggressive none the less. Pretty much all the brokers I spoke with (the ones who deal with selling mom and pop funeral homes) said yeah csv is very aggressive - not nearly as disciplined as SCI.

 

Other than that seemed to be an OK company. Management basically is trying to build another SCI. But seems to me SCI is the better option as it already was built into what csv wants to be when in grows up (again this is old so not as sure re current valuations etc).

 

You are right re consolidation being an issue for a SCI due to FTC issues. However, most of the transactions are not large deals so this advantage may not be that material. SCI can do the one off acquisitions. My impression from meeting the various management  teams was the SCI folk were much sharper and had better data etc. They had down to the MSA level which were attractive geographies and who the main funeral homes in those terroritories were. For the right home they can be aggressive. The challenge for CSV is they seemed to be aggressive across the board with the idea that they can gain scale.

 

The trust funds are also a little different. I think you are overstating the value of the float. It's generally quite highly regulated and you have to typically keep it for the upkeep of cemeteries etc. The business also suffers from depleting assets. Once your cemetary is full its full... You still need to pay to upkeep it but won't be getting anymore revenue (that's what the trust fund or float) is for - in part anyway. Sure they get paid upfront before performing the service. But arguably they also take on pretty large upkeep and maintenance liabilities which aren't really disclosed.  Poor investment performance can also be a huge problem - this was why the first SCI - STEI merger came upart (STEI's trust fund was underperforming and SCI didn't want the massive potential obligation). So the trust fund is nice but not clear to me that it's cost less float.

 

Again this is all from memory and dated so take it with a grain of salt. 

 

 

 

[marazul]

Thank you very much. Good points and will for sure take them into account.

[knight933]

This stock is ridiculously undervalued; doesn’t make sense for a stable funeral home company to trade at a free cash flow yield of 10.9%. Management had a lot of courage to buyback almost 6% of the shares at $16 during the drop in Q4-18. That was a brilliant move that will pay off for years to come as they now only have 18 million shares, and with $38.5M of 2019 free cash flow, this is trading at 9.2x FCF, far too cheap. Listening to earnings, I thought management was being somewhat conservative on 2019 guidance...Probably want to earn back investor's trust. So I bet there's probably more upside to 2019 FCF of $2.14 per share.

 

[5xEBITDA]

The Trust is managed with fairly aggressive allocation to HY bonds and value equities - i.e., their RIA team are stock and bondpickers.

 

What % of annual cash flow is attributable to gains on the Trust? Does the accounting for this flow through the income statement, and if so how does that affect "core" EBITDA margins? I've briefly looked at the Company in the past but could never answer those questions, but I also didn't really spend a ton of time on it.

 

Basically, the leverage is fine if EBITDA is real and you are probably better off trading the convertible bonds if thats the case. But if EBITDA/cash flow is really coming from the investing activities of the trust I think theres a problem here.

 

I'm pretty ignorant of the accounting for how the Trust float works here, so I might be asking 101 questions.

[johnny]

I'm overwhelmed by the sheer quantity of guiding slogans and catchphrases that he embeds into his investor letters. It's like a combination of Michael Scott from The Office and communist propaganda posters from 1970s China.