Is StoneMor Now a Compelling Value Play for High Income?
Simply put, I would say no. I would be surprised if StoneMor is able to restore its distribution within the next year (if ever). If anything, another cut might be even more likely. We are talking about a company that has failed to turn a profit under GAAP every year since 2008 and uses very complex accounting.
If I can’t understand how management is turning big GAAP losses into non-GAAP profits, I will not invest. There are too many other good companies with better transparency in the market. I’m not going to try and be a hero.
Furthermore, I think StoneMor’s lack of organic growth is a big deal to consider for the long term. If the rate of cremation exceeds the forecast issued by the National Funeral Directors Association, the majority of StoneMor’s revenue could be obsolete within 15 years. How much would you be willing to pay for a company with that type of outlook?
Overall, something just doesn’t smell right to me. Between the company’s complicated non-GAAP accounting, struggle to grow organic sales, numerous roll-up acquisitions, knee-jerk reaction to revamp its sales practices to force better growth, and the cremation trend, there are enough reasons for me to move on – especially for holdings in our Conservative Retirees dividend portfolio, which focuses on Dividend Safety and capital preservation.
StoneMor has already been badly burned, but there could be more to come. The company no longer has the luxury of issuing new units at an attractive cost of capital to fund its business and distribution. If the company is truly unable to make money under GAAP, this is a real problem.
If management is unable to hire qualified sales people and/or organic growth remains weak due to secular issues (e.g. cremation), StoneMor’s balance sheet could prove to be an even greater strain on the business as well (StoneMor holds just $9 million in cash compared to $283 million in total book debt).
When there is smoke, sometimes there really is a fire.
Lessons Learned from StoneMor’s Distribution Cut
Hindsight is 20/20, but examining painful events such as StoneMor’s distribution cut is critical to helping us avoid similar situations in the future.
I took away several lessons from this event. First of all, it’s critical that investors familiarize themselves with the top 10 most important financial metrics for dividend investing. With even a basic understanding of these metrics, a number of red flags would have been raised when looking over StoneMor’s key financials. Investors shouldn’t take management’s non-GAAP reporting for granted either. If something appears too complicated or confusing, it’s best to move on. That’s one of Warren Buffett’s top pieces of investment advice.
StoneMor Partners L.P. (NYSE:STON) possessed a number of characteristics that made it a risky dividend stock – even despite its 10+ year dividend growth streak, which shouldn’t be blindly trusted as a comprehensive indicator of dividend safety. The combination of negative earnings and cash flow, high financial leverage, declining revenue, and dependence on capital markets was dangerous. StoneMor’s recent growth struggles and poor sales team management were enough to bring its distribution into the danger zone. When some MLPs begin to show cracks, such as StoneMor’s sales team issues that cropped up last quarter, things can get ugly in a hurry.
Small cap companies are more volatile in general as well. Their businesses tend to be more concentrated by product, service, customer, and end market, and management’s major capital allocation decisions can make or break their businesses. Accessing capital markets can also be relatively more challenging for smaller companies.
There’s nothing wrong with selectively investing in certain quality MLPs, but investors should never buy any high-yielding, seemingly stable business without conducting some due diligence and remaining well aware of the risks involved. MLPs possess several unique qualities that can make them much more dangerous investments if management makes a big misstep, the macro environment unexpectedly deteriorates, and/or capital market conditions turn unfavorable.
Disclosure: None
