A Unique Investment (Part I)

Let’s test out the appeal to you of an investment in the following company, that:

1)    Provides an essential service that cannot be eliminated by time or country;
2)    Will benefit in coming years benefit from a tailwind rooted in demographic trends;
3)    Is led by a proven, effective management team;

• The team has demonstrated an ability to manage profitable growth through acquisitions that are   well-executed and effectively-integrated;
•  The team and board have also offered “shareholder value” through dividend payments and share buybacks;

4)    Is the clear leader in its industry on cost containment; uses its buying power leverage effectively;
5)    Has demonstrated steady, if not spectacular, growth during the past few years;
6)    For decades, it has proven to be recession-resistant (but not recession-proof).
7)    Much as with Buffett’s Berkshire Hathaway, it has $9 billion in “float” (unearned revenue) with potential for extra profit if investment managers exceed targets.

Sound appealing? I thought it might!

Now let’s test your ability of recognition (or “guessing”).  Without looking down the page (no cheating now), within what industry is this company involve?

a)    Pharmaceuticals
b)    Senior Living Housing
c)    Hospital Care
d)    Death Care

Oh, so you think “Death Care” is a strange term?  Strange or not, it is the “softer, gentler” way of referring to the funeral home, cremation, and cemetery space.  That pretty much gives away the identity of the company I described above – one of the few companies whose most often used referent (SCI) is also its ticker symbol: Service Corporation International (SCI).

Let’s take a look at the story currently surrounding Service Corporation International.  The “primary allure” of SCI is so obvious and simple that it is embarrassing! In fact, it is that allure that prompted a colleague to push me into analyzing and writing about SCI. That allure is rooted in the 1930’s, when the “Great Depression” and its sky-high unemployment rate of 25% led couples to realize they could not afford as many children as they had previously intended to have.  As the left foot follows the right foot, it was inevitable that a deeply reduced birth rate in the 1930’s led to the onset of a reduced death rate about 65 to 75 years later.  To offer a “big picture” view of the death rate since the beginning of the 20^th Century, here is some data:

U.S. DEATHS PER THOUSAND PERSONS [1]

1900               17.2
1910               14.7
1920               13.0
1930               11.3
1940               10.8
1950                 9.6

Note that the downward trend (resulting from advances in drugs and medical care—dramatically extending life expectancy) has already started to slow.  Continuing the trend, here are the most recent figures:

1990                 8.6
2001                 8.5
2011                 8.0

From this data, we can conclude the following:

1)    In recent years, the market base for the “Death Care” space has been very slowly shrinking. I say “slowly” because the rate of population increase has somewhat blunted the negative impact on death rate of an increasing life expectancy.
2)   Now that the U.S.’s largest generation ever, the “Baby Boomers”, have started to retire, elementary demographics make it certain that the number of U.S. deaths will begin to move back upward.

This trend, of course, is totally independent of SCI.  Separately, the mega-trend within the death care industry that is a central part of the “SCI story” is that of “consolidation”. 

During most of my professional life, I have blended ministry with financial administration. I mention this because I served as a church pastor for over 20 years – officiating at an untold number of funerals. Consequently, I came to know numerous funeral directors along the way. They operate in an industry that has high fixed costs (they each know precisely how many funerals they need to do each year to break even), is extremely customer-service intensive, and depends a great deal on reputation and trust (ie. “good will”). My first funerals were during the 1970’s, and that was coincident with the beginning of the industry’s trend toward consolidation.

You may or may not like that trend; however, it was inevitable.  Some corporate entity was bound to develop a business plan through which to consolidate pieces of this heavily fixed-cost industry in order to create economies of scale. Examples include: the utilization of joint purchasing power to push down costs for products (caskets, burial vaults, embalming fluid, etc.); the development of staff networks through which to share staff time across nearby locations; the leveraging of awareness and market share through brand development, and the standardization of resource management (such as the unearned revenue from “prepaid services”).

Since the 1970’s, SCI has been a leader within industry consolidation.  Such consolidation grew slowly at first, then picked up pace in the 1990’s, when so-called “experts” were early in projecting the profits to be made from the anticipated “baby boom” bump.  Combined with relatively easily obtained credit, the consolidators went overboard.  As happens under such circumstances, the result of such excess burdened the industry for many years thereafter. Excessive consolidation drove purchase prices for homes steadily upward – to and beyond unsustainable levels. That eventually led to a collapse in both demand and prices. The tumultuous impact on the industry of this boom/bust economic cycle is dramatically illustrated in SCI’s price chart (below). Note the steepness of the trend lines (each way):

To help you grasp the dimensions of the boom/bust, contemplate these price points:

a)    At the beginning of 1995, it was priced at $13.45;
b)    June 1998, it stood at $41.64 – an upward move of 210%!
c)    By December, 2000, it had crashed to $1.75—a downward crash of 96%!

In Part II we will offer you details about SCI’s recent performance, a key development in May, and interesting forward-looking statistics.

Submitted by Thomas Petty MBA CFP

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