I’m sure you heard the phrase “No such thing as a sure thing, except death and taxes!” Take the former is a guarantee (depend on which way you look at it) money spinner and that where the UK-based firm Dignity PLC comes in.
Their main division provides funeral services to the families who lost their loved ones. For a lack of a better chart, this is the number of decreased in Britain per year:
(For reference purpose, please go to ONS.GOV.UK here.)
Given the country has 65m people (as of 2015), it represented less than 1% of the population.
If you want to read more on funeral services, then there is a good post from Money Advice Service website.
Now, back to Dignity PLC and below are 10 important things to understand the funeral provider business model.
Dignity PLC – Business Model
As mentioned, Dignity’s funeral service is the money generator out of the three divisions.
Funeral Services makes up 70% of total sales. If we look at the market share, then Dignity accounts for 12.3% of all funeral services in the UK and 9.8% of Crematoria.
The other revenue stream comes from pre-arranged funeral plans. This arrangement allows a person to pay the full lump sum or a monthly instalment towards the cost of a funeral. And sales growth in this division has stalled since 2014.
Here is more information on funeral plans at Which.co.uk.
Let’s look at some KPIs numbers. The number of funeral services performed has been stagnating, but revenue has doubled meaning revenue per funeral has increased. The same can be said for crematoria as the volume rose by 50% with turnover tripling.
Dignity’s cash margins
First, we start by assessing Dignity operating cash margins.
The company maintains quite a high margin of between 30% and 40% while seeing higher operating cash profit. It means it was able to generate cash profit that is in proportion with sales.
Dignity’s ROCE + ROCI
Looking at Dignity’s ROCE and return on net assets, we get a consistent performer.
Dignity’s ROCE number is in the mid-teens for a long period. This gives stability to a business model that is working. And it shouldn’t surprise investors because the number of deaths in the UK has been constantly in the range of 500,000 to 600,000.
The return on net assets has seen a steady increase in recent years (apart from 2014!). And management has been deploying the company’s assets more effectively to earn more profit.
N.B.: The net loss in 2014 was due to an exceptional charge of its old notes.
If you took operating profit from ROCE and measure it against current liabilities, it produces this trend:
Apart from 2012 and 2013, Dignity PLC’s operating profits covered short-term liabilities consistently. That reassured investors it has the earnings power to meet short-term obligations.
But has growth in earnings come at a cost?
On the surface, it hasn’t, especially when we look at free cash flow.
But the firm did make a series of acquisitions for expansion. So, by adjusting free cash flow to include net acquisition costs, you get this:
Since 2005, the adjusted free cash flow is £96.6m versus a normal free cash flow of £381m. That £280m discrepancy explains why Dignity PLC took on some debt. (See section “Dignity has high debt growth vs. revenue” for details.)
Dignity’s capital investment earns “inconsistent” extra revenue
One of the downsides on capital investment is the company’s ability to generate less than inconsistent “extra” sales.
If you look at capex (minus depreciation), then the incremental sales generated looks super impressive. That’s because it generates extra revenue with little capital costs (apart from 2010). When you add net acquisitions costs to the equation (see orange bar chart), then it looks inconsistent.
N.B.: In the interest of fairness, take 2005’s capex and see how much incremental revenue got generated in 2006.
More recently, the company invested heavily, but revenue has been less impressive.
Over the ten-year period, the incremental sales increased by £170.4m, while capex (plus net acquisition, but minus depreciation) totals £298m.
Dignity has high debt growth vs. Revenue
Looking at Dignity’s debt levels, there shouldn’t be much concern as operating profit covers net finance cost close to 4 times.
But, the worry is the cumulative growth of debt has been climbing faster than sales.
Overall, debts been growing twice as fast as revenue.
Also, looking closely at the debt graph (blue line), there appears to be a definitive pattern. That pattern shows three to four years’ where debt remains the same. Then there is a jump in borrowing. It occurs in 2009 and 2012 and 2013.
The two years of debt growth looks excessive, and we could see sales growth catching up to debt growth (like in 2009 and 2012) before Dignity took on more debt.
Let’s look at the composition of debt against net profit.
Despite net earnings covering interest, the debt multiple to earnings is at 10 times.
That multiple of debt to earnings would be problematic for a cylindrical company, but for a sustainable earner like Dignity, it looks fine at the moment.
Researchers may point to their equity value and say it is negative (meaning total debt exceeds total assets).
Although an important measure. It’s not the end all or be all! Buyers aren’t going to ask Dignity PLC for £3m (last year equity value) to take over the company. When it comes to valuing a business, it is important for investors to focus more on Dignity’s cash generating power.
Could the negative Dignity’s equity be down to maintaining the right value for its assets?
A look into asset turnover (minus the cash) tells this story:
The ratio has been consistent, but the trend is down slightly. Let’s say you took 2005’s ratio of 0.61 and replace it with 2016’s ratio of 0.48. How much does it affect Dignity’s asset values?
Revenue is £313.6m, whereas cash is £67.1m, and assume 2016’s asset turnover as 0.61, instead of 0.48. What is total assets?
0.61 = (313.6m)/ (Total Asset – 67.1m) becomes this (after re-arrangements): –
A. 313.6m/0.61 = Total Asset – 67.1m;
B. 514.1m + 67.1m = £581.2m = Total Asset.
In 2016, Dignity’s total assets were £715m, and “Hypothetically” would mean a £135m asset write-off.
The true reason for any write-off comes down to lower than expected earnings.
Watch Dignity’s goodwill and intangibles assets
Dignity has goodwill and intangibles of £350m, or more than one year’s revenue (£313m). That shouldn’t be a problem as long as the business is operating profitably.
It becomes a concern when Dignity PLC starts to miss guidance and profit targets. That would prompt it to write some goodwill, intangibles and PPE (Property, plant and equipment) values off to reflect their new business reality.
Dignity’s valuation looks full
Shares in Dignity PLC had a good run (See section “Dignity’s charts, for 11-year share performance). In this section, you will see three graphs highlighting the change in valuations.
First, is Greenblatt’s EV/EBIT (Enterprise Value over Earnings before interest and tax). The multiple is at an all-time at 18 times. It has beaten the previous peak of 14 times in 2007.
The shares were a bargain between 2009 and 2012 before seeing a re-rate.
Another chart shows two graphs of EV measured against cash balance and operating cash flow.
Both those graphs are on the high-side of valuation.
Onto the technical aspect of Dignity’s share price and we wiz right into its monthly chart pattern. The momentum indicators tell me that there is a potential of a “higher low” while the share price was making new highs.
That means a negative signal is building up for Dignity.
It’s looking like that Dignity PLC will see a correction because it will “triple-confirm” the higher-lows of MACD and RSI by breaking past £29.40/share. Even if it goes to £35/share, the momentum indicators are unlikely to make new highs!
Another direction Dignity PLC could take is a move below £23/share could trigger a permanent share price correction.
That correction is a bearish signal because the momentum indicator turns negative, especially the RSI. And the share price is likely to fall.
Given, the company high fundamental market valuation, a 20% to 30% correction is a probability.
Dignity PLC – Final Thoughts
At four times sales and 22 times PE, the market cap. is on the high side. Average earnings growth of 8% to 10% per annum for the last eleven years is too small to justify this valuation.
Greenblatt’s EV/EBIT ratio indicated that valuation is at an all-time high. Also, the annual income from Dignity (its dividend yield) is less than 1% and below the UK 10 year gilts of 1.22%. That’s another aspect of overvaluation.
Onto the fundamentals.
Apart from producing great cash earnings. The one thing I would keep an eye on is the rise in total debt.
Everything is fine, provided that earnings are growing and stable. I would like to add that the probability of producing stable earnings is 90%. The 10% off-chance that it fails to produce would be a mixture of competition and change/new laws from the government on funerals.
The value placed on Dignity PLC is on the high side. If you took the 11-year historical average of Greenblatt’s EV/EBIT it comes to 13 times or fair value. I would discount 20% a further for margin of safety, which takes EV/EBIT close to 11 times.
So, current year EBIT is £97m, and multiply that by 11 gives EV of £1,067m (currently it is at £1,800m). That is a fall of 40% and would value Dignity close to £800m or £18 per share.
Thanks for reading! I hope you enjoy reading about death.
From what you gather, do you think funerals are a guaranteed money-spinner?
Will high funeral costs cause the government to impose a price cap in the future? (as unlikely as this may sound)
Do you agree that Dignity PLC overpriced today?
Again, thanks for reading and remember to share and subscribe, if you are new.
The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.