Investing in death is one of the most unconventional thoughts in the financial fraternity. In most cases, those who invest in death never get to enjoy the benefits. The beneficiaries do. However, there are a few companies which give investors the rare opportunity to enjoy the benefits of death. One of those companies is Stewart Enterprises, Inc. (NASDAQ:STEI). The company provides funeral and cemetery products and services in the death-care industry. Founded in 1910, Stewart Enterprises is one of the biggest death-care companies in the U.S. The company has operations in nearly half of the 50 states, running 217 funeral homes and 141 cemeteries, as of December 17, 2012.
Service Corporation International (NYSE:SCI) has offered to acquire Stewart for $13.25 per share, in a deal that would see the shareholders of the Jefferson, La.-based death-care company pocket a premium of 36% on top of the stock’s value as of May 28. However, this sale is subject to a challenge in court as the shareholders of Stewart Enterprises have the option of filing a lawsuit against Service Corp. in what could result in a better valuation. This company is on the rise based on its recent performance, and the valuation by the buyer seems somewhat to overlook this fact.
Quarterly results raise questions
In the quarter ended Jan 31, 2013, Stewart Enterprises, Inc. (NASDAQ:STEI) reported an 80% increase in earnings per share. This is an excellent start to fiscal year 2013, according to the company CEO Thomas M. Kitchen.
“Let me begin by noting that it’s an exaggeration to say fiscal year 2013 is off to a superb start. The significant increases in revenue and profitability continuing the positive momentum we generated during fiscal year 2012. This is an indication of good things to come in the remaining three quarters. The company generated $15.5 million or $0.18 per share for the quarter, which is the company’s highest EPS in 10 years. Revenues were up 9%, for a subsequent 27% growth rate in gross profit. This was an improvement of 340 basis points compared to the gross profit margin of the first quarter 2012.”
The company’s funeral business was also up to a great start for the new fiscal year, with an 8.5% increase in revenue resulting in a 14% rise in gross profit. Same-store funeral services were also up 8%, which was a major highlight in the funeral business. Revenue from the cemetery business increased by 9%, and improved the gross profit for the unit 63% from last year. The company is off to a great start with breathtaking growth rates with promises of increased earnings going forward.
Why 80% growth in earnings, compared to just 9% for revenue?
The key to Stewart Enterprises, Inc. (NASDAQ:STEI)’s massive 80% growth in earnings compared to just a 9% rise in profits year over year was improved cost management. According to Kitchen, the company’s improvement is also partly due to its focus on serving employees and customers. This has increased efficiency, helping reduce operational costs.
“We believe these strong results demonstrate the power of leverage in our business and the importance of continuing to effectively manage our costs. We produced a 9% improvement in total revenue, which led to a 27% improvement in total gross profit and an 80% increase in earnings per share compared to the same period of last year. By continuing to execute our strategic plan and maintaining our focus on employees and customers, we are well positioned to deliver stable, sustainable results over the long-term.”
The company also has a huge amount of cash and has no debt. Cash and marketable securities increased to $78 million after generating $11.9 million in the most recent quarter. Free cash flows were up by $3 million to $6.8, a further indication of the company’s efficiency in managing costs.
The company’s cemeteries and funeral homes are located primarily in the western, mid-Atlantic, southern, and mid-western states of the US.
The buyer looks to expand business
Service Corporation International (NYSE:SCI) is a personal services company based in Houston, Tex. The company has operations in 43 of the 50 States of America and runs 1,437 funeral service locations in the country. The company runs 374 cemeteries in the U.S, and has eight locations in Canada and 12 in Germany. This giant funeral services company is 52 years younger than Stewart Enterprises. The company’s quarterly earnings grew by 20% compared to Stewart’s 80%. The Houston-based Service Corp. also lags behind its counterpart in terms of profit margins with just 6.59% compared to Stewart’s 8.13%.
Stewart Enterprises, Inc. (NASDAQ:STEI)’s revenue is just over $500 million compared to Service Corp.’s $2.46 billion. The acquisition of Stewart would bring a net change of 12 percentage points in earnings growth, assuming the growth rates hold up for the most recent quarters of both companies. This means that the resulting growth rate for Service Corp. could be 32%. Based on the current valuations, 32% is an equivalent of 60% boost on Service Corp.’s earnings growth rate. Therefore, a valuation that places a premium of 36% on the acquisition is ridiculous, as it is giving the buyer a massive 24% discount to gamble on.
Additionally, the acquisition will see Service Corp. report revenue of at least $3 billion, accompanied by about $60 million in annual costs savings.
The combined market share threatens to monopolize the industry
The deal would result in Service Corporation International (NYSE:SCI) running 1,653 funeral homes and 515 cemeteries, with a combined workforce of 25,367 employees. The resulting market cap, based on May 30 prices, would be $4.95 billion. This is $4 billion greater than the rest of the combined market. The combined value of Carriage Services, Inc. (NYSE:CSV), and StoneMor Partners L.P. (NYSE:STON) is less than $900 million in market cap. However, the two small-cap rivals hold better gross margins compared to Service Corp. with 35% and 57% respectively.
Nonetheless, with a P/E ratio of about 30, Carriage Services is highly priced compared to the counterparts. Stonemor is not profitable based on the most recent quarter’s results. Stonemor has one of the best dividend yields, with both the trailing and forward annual yields, well above 9%. Carriage Services’ dividend yield is below 1%. Stewart Enterprises’ forward dividend yield is 1.8%, while the trailing 12-month yield is at 1.3%, which is almost similar to Service Corp. at $1.6% and 1.3% respectively. However, Stewart’s payout ratio is slightly lower at 33% compared to Service Corp.’s 38%, while Carriage Services pays at a rate of 16% of earnings.
The Bottom Line
Service Corporation International (NYSE:SCI) is setting itself up well to dominate the death-care market in the future. The acquisition of Stewart Enterprises, Inc. (NASDAQ:STEI) gives it access to virtually all the 50 states, with other operations in Canada and Germany. This acquisition could also boost its earnings growth rate by a massive 60%, something I feel was completely left out of the valuation before the offer. Service Corp. also stands to gain from Stewart Enterprises’ thrifty cost management practices, which should results in at least $60 million in annual cost savings. This gives the stock the potential to realize abnormal gains going forward. Therefore, this presents an opportunity to strike first and strike early, depending on what Stewart Enterprises shareholders decide.
Nicholas Kitonyi has no position in any stocks mentioned. The Motley Fool recommends StoneMor Partners. The Motley Fool owns shares of StoneMor Partners.
The article This Acquisition Is A Steal: Buy The Buyer originally appeared on Fool.com.
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