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  Looking on the bright side of life with Stewart and Service

BENJ GALLANDER and BEN STADELMANN

Tuesday, May 8, 2012

The Danish philosopher Kierkegaard suggested that the awareness and fear of death is fundamental to human nature and underlies many of our beliefs and ways of behaving. He developed his ideas by confronting the notion of "The Absurd," which refers to the conflict between the human tendency to seek value and meaning in life and the inability to find any.

Meanwhile, the British comedy troupe Monty Python positively delighted in the absurd and employed much levity whenever presenting the subject of death in their sketches.

As contrarian investors, our approach was rather more concrete, and less existential or surreal, when we invested in giants in the North American funeral industry Service Corporation International and Stewart Enterprises.

SCI and STEI were purchased in 2001 and 2003 respectively, way too long a hold time for the majority of investors. Even by our average of about three and a half years, this has become like waiting for Godot.

Fortunately, our patience hasn't been for naught; we've collected dividends since 2005 and enjoyed some sweet capital appreciation. Service was bought at $4.51 and Stewart at $3.11. Currently, they sit around the $11.60 and $6.25 marks. That's a nice boost for those whose wallets have been exhumed to keep up with the rising costs of living.

The death services industry is not as staid as one might think. The competition is biting and there have been some loud takeovers. Even Service tried unsuccessfully to buy Stewart in 2008. Back in the '90s, banks were happily lending these players oodles of money to stuff onto their balance sheets. With little concern for price, the big boys bought up lots of independents and expanded into overseas markets, creating onerous debt tallies. Today, the debt levels are more manageable but still somewhat chubby.

Trends play an important role in this industry. The one that garners the most attention is demographic; the thesis being that a large and aging population will spur growth in demand. Though people are living longer and better, death is still a predictable outcome.

But there are also signs of a drift away from expensive and elaborate arrangements in favour of basic funerals and less costly cremations, which hit the bottom line. Plus, the business model has partially shifted to "pre-need planning", where the money is held in trust and earns a yield, and though the return in this economic environment isn't great, interest rates won't stay low forever.

Service had a stellar year in 2011, with sales hitting $2.3 billion for the first time since 2003. That was up by almost 6 percent over 2010's numbers. The bottom line grew 15 percent to almost $145 million, and operational cash flow improved by 9.5 percent. Their two divisions, funeral care and cemetery services, both performed well.

CEO Thomas Ryan wants to double the share repurchase program to $200 million. With the debt load sitting at $1.9 billion and shares selling at almost twice book, this strategy is questionable.

Stewart also had a decent 2011. Revenue was up by a mere 2.5 percent, but earnings rose by 24.5 percent and cash flow from operations was up a striking 37 percent. The yearly dividend was recently boosted from 14 to 16 cents, working out to a yield of around 2.5 percent.

While the most recent quarter was profitable, revenues were down from last year's period and the company announced a restructuring and workforce reduction. The combined savings are estimated at $10 million over the next two fiscal years, albeit a charge of over $2 million will be soon tallied.

The future of the death-care service industry remains secure. Investors in this space likely still have time to generate a respectable return. In this business, if you don't get them now, you'll get them later.


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