Service Corporation International (NYSE:SCI) Q4 2023 Earnings Call Transcript

Service Corporation International (NYSE:SCI) Q4 2023 Earnings Call Transcript February 13, 2024

Service Corporation International isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the SCI Fourth Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I now like to turn the conference over to SCI management. Please go ahead.

Debbie Young: Good morning, this is Debbie Young, welcome today to our fourth quarter earnings call. We’re going to have some prepared remarks about the quarter as well as our outlook for this year in just a moment, but before that, let me quickly go over the Safe Harbor language. Any comments made by our management team that state our plans, beliefs, expectations or projections for the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in such statements. These risks and uncertainties include, but are not limited to, those factors identified in our earnings release and in our filings with the SEC that are available on our website.

During this call, we will also discuss certain non-GAAP financial measures. A reconciliation of these measures can be found in the tables at the end of our earnings release and also on our website. And with that, I’ll now turn it over to Tom Ryan, Chairman and CEO.

Thomas Ryan: Thanks, Debbie. Hello, everyone, and thank you for joining us on the call today. This morning, I’m going to begin my remarks with some high-level color on our business performance for the quarter, and provide some greater detail around our solid funeral and cemetery results. I will then close with some thoughts about our 2024 financial outlook. For the fourth quarter, we generated adjusted earnings per share of $0.93, which compares to $0.92 in the prior year. We were able to generate growth in earnings per share over the prior year as higher cemetery revenues driven by a 9% increase in preneed cemetery sales and a strong funeral sales average together more than overcame the effects of the anticipated funeral volume decline, resulting in a $0.04 increase in earnings per share from operations.

Below the line, the 280 basis point rise in interest rates on our variable rate debt and a higher debt balance increased our interest expense, reducing earnings per share by $0.08. This higher interest rate expense was partially offset by a lower tax rate and the favorable impact of a lower share count, as we accelerated our share repurchase cadence during the fourth quarter, utilizing $204 million to repurchase some 3.6 million shares at an average price of just above $57. Now let’s take a deeper look into the funeral results for the quarter. Total comparable funeral revenues declined $13 million or about 2% over the prior year quarter primarily due to an expected decrease in core funeral volume. Although core funeral volume declined 6% compared to the prior year quarter, we believe due to the COVID pull-forward effects volumes were in line with what we’d anticipated.

Notably, funeral volumes were about 10% higher than fourth quarter 2019 levels. Our core average revenue per service grew over the prior year quarter by an impressive 4%, even after absorbing the negative effects of a modest 50 basis point increase in the cremation mix. From a profit perspective, funeral gross profit declined by $8 million while the gross profit percentage decreased by 100 basis points to about 22%. Lower fixed cost and reduced incentive compensation expense over the prior year quarter slightly negated the negative impact from the revenue decline. Preneed funeral sales production grew an impressive $12 million or about 4% over the fourth quarter of 2022. Both the core and the SCI Direct channels experienced impressive sales production growth.

Now shifting to cemetery. Comparable cemetery revenue increased by an impressive $35 million or about 8% compared to the prior year fourth quarter. Recognized preneed revenue accounted for the preponderance of the increase growing by $33 million or 11%. This growth is primarily due to the growth in preneed cemetery sales production of $30 million or more than 9% over the prior year quarter. We also saw increased preneed merchandise and service revenue generated from higher delivered units and contract averages as compared to the prior year quarter. The $30 million increase in preneed cemetery sales production was generated from both large sales and from core cemetery production, each contributing about half of the preneed cemetery sales production growth.

While sales contract velocity was slightly down over the prior year quarter, we are still 8% higher than 2019 levels and production is being generated by a smaller, more effective and efficient sales team. Cemetery gross profits in the quarter increased by $17 million and the gross profit percentage grew by 110 basis points to over 34%, primarily due to the increase in cemetery revenue. Now let’s shift to a discussion about our outlook for 2024. As you saw in our earnings release, we provided a normalized earnings per share guidance range of $3.50 to $3.80 for 2024, or a midpoint of $3.65. As we explained last quarter, this is slightly ahead of our projections that we provided at our Investor Day in May 2022 after accounting for the unanticipated material increase in interest rates on our variable rate debt.

At the time, we had assumed the 2% rate would grow to 3.5% in 2023 and continue into 2024 based on the Fed dot plot at the time. Our current rate approximates 7.5%. So we were very wrong, but we did have a lot of company. As we think about comparing 2024 expectations to our 2023 normalized earnings per share, the midpoint we are guiding to is closer to 5% growth versus the standard 10% historical midpoint expectation. The waning effect of excess deaths, including COVID, impacts not only funeral volume but at-need cemetery revenue and slightly reduces the normalized growth expectation in preneed cemetery sales production as we talked about last quarter. This, coupled with a higher year-over-year interest rate backdrop, particularly in the early part of the year, will have a dampening effect on our annual earnings per share growth expectations for 2024.

We believe that in 2025, we should return to our normalized earnings per share growth expectation of 8% to 12%. We expect to capitalize on opportunities during 2024 by further utilizing our scale that should enhance the margins in both our funeral and cemetery segments into 2025 and beyond. We’re also excited about continuing to invest capital to grow our network. We are investing in our existing funeral locations, renovating and modernizing our venues to create a more celebratory and contemporary setting. We’re increasing our cemetery inventory options with both the casketed and cremation consumer to accommodate an increasingly diverse customer base that values a variety of unique memorialization offerings. The acquisition pipeline looks very good at this point, and we continue to increase new market share opportunities due to construction of new funeral home facilities and in certain instances, establish new cemeteries in our existing high-growth areas across North America.

Finally, we expect to continue to enhance shareholder value through growing our dividend and continuing our opportunistic approach to shrinking our equity base, while protecting our strong balance sheet by managing the debt maturity profile and leverage ratios. In conclusion, I’d like to thank the entire SCI team for all that you continue to do every day for our customers, our communities and each other. You are what makes our company great. With that, operator, I’ll now turn the call over to Eric.

Eric Tanzberger: Thanks, Tom. I’m going to start really where you just left off and begin my remarks as I usually do by expressing my gratitude and all of our gratitude to each of our 25,000-plus associates. Thank you for all that you do to provide outstanding service to our over 600,000 client families that our company served in 2023 during the customer’s most difficult and trying times in these situations. Thank you for providing superior service to both our customers and our communities. So with that, I’d like to say good morning to everyone on the call. Today, as usual, I’ll first discuss our cash flow results and capital investments for the quarter and the full year of 2023. I’ll then provide details of our 2024 cash flow and capital investment outlook and will include some comments on our financial position as we conclude our prepared remarks.

So in the fourth quarter, we generated strong adjusted operating cash flow of $278 million. This was $107 million higher than the prior year. This exceeded our expectations for the quarter, and enabled us to finish the year just above the high end of our most recent annual guidance range of $225 million to $275 million. The largest factors driving this year-over-year increase includes about $75 million of favorable working capital, primarily associated with stronger cash receipts on prior period installment sales and the timing of certain payables. Also included, though, in the $75 million, is the timing of a payroll tax payment that occurred last year, if you remember, related to the CARES Act of 2020 which resulted in just over a $20 million benefit this year to cash flow.

Cash tax payments of $4 million during the quarter were also lower than the prior year by about $33 million. We expected that. And again, that’s due to a tax accounting method change that I’ve discussed in prior quarters. These sources of cash flow more than offset $16 million of higher interest payments primarily caused by higher interest rates on the floating rate portion of our total debt. So on a full year basis, we ended 2023 with adjusted operating cash flow of $882 million at 7% or $57 million higher than the prior year. This additional cash flow was reinvested into our company, and also returned to our shareholders, which now I’ll touch on. So in the fourth quarter, we invested a total of $109 million into our current facilities, new growth opportunities and real estate.

So let’s go ahead and break this down. We invested $82 million of maintenance capital back into our current businesses, with $41 million of cemetery development, $31 million into our funeral and cemetery locations and $9 million into our digital strategies and other corporate investments. For the full year, we invested a total of $324 million, which was down $10 million from the prior year, but about $14 million or so above the high end of the guidance range that we talked about last quarter. And this really occurred because our cemetery development spend was higher than expected in this fourth quarter as we accelerated some spend during the fourth quarter to position our cemeteries with relevant high-return inventory as we enter 2024. We also invested $27 million of growth capital in the quarter towards the purchase of real estate, construction of new funeral homes, and the expansion of existing funeral homes and cemeteries.

This brought our total 2023 growth capital spend to about $94 million, which was up $40 million from 2022 as we identified meaningful opportunities to invest in future greenfield cemetery as well as funeral projects for the future. Turning to acquisitions. While we did not make any investments in the fourth quarter, we believe the pipeline again remains robust. We have been actively investing already this year in the first quarter with $14 million of acquisition investments in January, and we anticipate more investments in the coming months. In total, we ended 2023 with $72 million in acquisition spend and we’re very pleased with the quality of these businesses that have joined SCI and more importantly, have welcomed many new associates to our SCI family.

In addition to the investments in CapEx and acquisitions that we just talked about, we returned $247 million of capital to shareholders in the quarter through $42 million of dividends and just over $200 million of share repurchases. This brought the number of shares outstanding to just above 146 million shares. And as Tom just already mentioned, we purchased 3.6 million shares at an average price of about $57 during the quarter. So before I shift to the 2024 outlook, I want to make a brief comment about our corporate G&A expense during the quarter of about $45 million. This was higher than our expected range of $38 million to $40 million, driven primarily by higher incentive compensation expense which was specifically tied to our long-term compensation plans that, again, are based on total shareholder returns relative to a designated peer group.

So shifting to 2024, and you saw this in the press release, our 2024 adjusted operating cash flow guidance range is $900 million to $960 million, with a midpoint of $930 million. The midpoint of this range assumes the following. We expect our base case cash flows at the midpoint of our guidance to grow about $35 million, comprised of about $55 million of cash flow growth from our underlying funeral and cemetery operations offset by an anticipated $20 million headwind or increase from interest expense as higher rates and balances continued to impact earnings and cash flows. We anticipate having a more normalized use of working capital of $30 million to $50 million of use, driven by growth in preneed cemetery sales, timing of payables, partially offset by reduced incentive compensation payments in 2024.

We expect cash taxes to range between $25 million and $35 million, which is a decrease of just over $40 million from 2023, but about $150 million lower than normalized levels. This, again, is as a result of the tax accounting change I’ve discussed over the last couple of quarters. We also anticipate an effective tax rate between 24% and 25% in 2024. So shifting to capital investments during the oncoming year. We expect maintenance CapEx to remain flat at about $325 million. To break that down and give you a little bit more color, we expect to invest $125 million in our funeral and cemetery facilities, $165 million into high return in cemetery development projects and $35 million into our digital strategy investments and some other corporate investments.

In addition to this maintenance CapEx, we expect to invest $75 million to $125 million towards acquisitions and roughly $45 million to $50 million and new funeral home construction and real estate opportunities, which together, to remind you, drive low to mid-teen after-tax internal rates of return, which again is well in excess of our cost of capital. Finally, absent other high retirement opportunities we will continue returning capital to our shareholders through our share buyback program in a consistent and disciplined manner as you’ve seen us do over the years. So I’ll now conclude by making a few comments on our financial position. We have a very favorable debt maturity profile and have liquidity of right now around $900 million at the end of the quarter, consisted of approximately $220 million of cash on hand, plus approximately $670 million available on our long-term bank credit facility.

Our leverage at the end of the quarter remained somewhat consistent with the third quarter at 3.58 times net debt to EBITDA. We continue to have a bias towards the lower end of our usual target range of 3.5 times to 4 times, and I call that in the near term until we have more clarity as to exactly where interest rates will go from here. So in closing, our strong balance sheet continues to underpin our capital deployment approach, which gives us flexibility to execute on high-return investment opportunities. We are very proud of our team, most importantly, and the way we finished 2023. As we enter 2024, our solid balance sheet, great liquidity and strong and predictable cash flows will again provide opportunities to invest capital to the highest and best use and ultimately, to maximize shareholder value.

So with that, operator, that concludes our prepared remarks, and I’ll now turn it back to you to open the call up to questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from A.J. Rice of UBS. Please go ahead.

A.J. Rice: Thanks. Hi, everybody. Maybe a couple of quick questions here. First of all, I think you guys are mentioning that you see sort of a skew to the earnings quarterly progression and maybe some of that seasonality, maybe some other factors. I just want to make sure we leave the call knowing exactly what you are looking at, maybe first half, second half, first quarter? Any comment specifically on how the progression would play out over the year?

Eric Tanzberger: Sure, A.J. I think the most — for the most part, when you get out to the last three quarters of the year, our expectations would be that you’d see historically impressive growth. The challenging quarter is going to probably be the first quarter, and there’s two reasons for that. It’s one the most challenging as you think about from an interest rate comparison. I think it’s somewhere around it, again, depends on the level. But somewhere, call it, the $0.06, $0.07 of headwind as you think about interest expense year-over-year that you must overcome. The other thing that we would anticipate, and you’ll recall that completed construction projects on cemetery. And when you think of the comparison of this first quarter versus last year’s first quarter, that should be a negative effect because we’re going to have less completed project revenue.

So those are the two things that I think are going to cause a more challenging first quarter comparison. And as you get to the last three quarters, I think it looks really good quarter-over-quarter. And again, for the year, I think, some impressive growth factoring in some of the things we mentioned before which are slightly higher interest expense. And if this kind of continued pull-forward effect that impacts slightly both the funeral and cemetery segments.

A.J. Rice: Okay, thanks. Wanted to just ask as well, if I’m looking at the trend year-to-year in the at-need funeral versus preneed maturing. It looks like preneed maturings hanging there better on volumes than at-need. Is that — do you think some indication that maybe some of this lengthy investment you’ve been doing in preneed over the last decade is starting to drive market share and you’re getting an increasing percentage of people that are coming in that have these preneed arranged contracts in hand?

Thomas Ryan: We do, A.J., exactly. We watch that same metric, and we believe that represents your exact thoughts.

A.J. Rice: Okay. Maybe one last question then. I know it sounds like the year started out with some deals on the acquisition front. I understand that the 10-year standstill arrangement that you did with the FTC when you closed the Stewart deal years ago is going to expire in the spring. I wonder can you sort of size what that creates as an opportunity and do you think we’ll see a pickup in pacing on deals when you — when that FTC standstill agreement expires?

Thomas Ryan: We do, AJ. I think it’s hard to size it, but it is a significant amount of markets that we’ve been really precluded from participating in for the last two years by those prior notice agreements, which expire in May. So it’s very difficult to predict when or what. But we’re excited about it. We do think it kind of allows us to be a little more active as it relates to acquisitions and get back involved in some of those markets. So we’re excited about it. We think it will create some momentum. But again, I think deals come when deals come. So it’s hard to predict the timing and the size, but we’re glad it’s coming to an end.

A.J. Rice: Can you just remind us how many markets it involves and — or how much of a constraint it’s been? And then can you have discussions in those markets prior to the expiration? Or you have to wait for the expiration to have discussions?

Eric Tanzberger: Well, I think you can always have discussions about when you could possibly go to closing a contract. So again, we’ve always been active in these markets in the sense of developing relationships and not so much around the deal, but getting to know people, getting to know what their plans are. So it isn’t like we’re going to for the first time begin to talk to people. We’ve been out there just being a good neighbor. So again, as far as numbers of markets, I don’t have them in front of me, but think of them as being mainly in some major markets and my guess is probably somewhere that we’d be interested in 15 to 25 type of markets that are out there that we’ve not had the ability really to think too heavily as it relates to growing through acquisitions.

A.J. Rice: Okay, great. Thanks so much.

Operator: The next question comes from Tobey Sommer of Truist. Please go ahead.

Tobey Sommer: Thanks. I wanted to ask you about the rate of at-need activity in how you think about it having sort of mostly but not entirely normalized post COVID and maybe characterize what, if any, kind of headwind you think remains in the business?

Eric Tanzberger: Hey, Tobey. This is Eric. There continues to be a headwind as it relates to COVID. It is getting better every year, and you could see that in the fact that the total funeral volumes were down mid-single digits. And now we’re really calling it relatively flat. I mean I think the fiscal guidance is flat to down 1% or 2%, but let’s just call it flat for purposes of this explanation. What you’re seeing in the positive is the natural growth that’s occurring in North America. You can call that 1% or so per year in terms of just the growth of the population, and that population aging and that population needing services of this particular industry. Specific to our company, you have to also take into account acquisitions.