For this week’s bond review, Durig Capital looks at a company providing an essential service – one potentially needed by everyone at some point in life. Stonemor Partners is one of the largest providers of funeral and burial services in the United States. After completing an accounting review in 2017, the company is back on track as evidenced by its latest quarterly results for the three months ended September 30, 2017.
- Q3 revenues were up $3.3 million over Q3 2016, totaling $84.0 million.
- Year-to-date revenues also increased, up $15.0 million to $252.9 million.
- Year-to-date cash operations were up $6.2 million, for a total of $24.7 million.
Stonemor Partners has a massive amount of deferred income – latest figures put this at just over $900 million. Although technically an accounting liability, this represents income to be recognized in the future (backlog) with little or no additional sales effort required from Stonemor. In this context, deferred revenue can also be considered an asset. Stonemor has taken on new management (as of mid-2017) who are focused on improving the company’s sales and marketing practices, along with improving Stonemor’s balance sheet and liquidity. While there are changes taking place in funeral services, Stonemor provides services in an industry where there will always be a need. In light of these considerations, the company’s 2021 bonds, couponed at 7.875% and with a current yield-to-maturity of about 8% make an ideal diversification candidate for Durig Capital’s Fixed Income 2 (FX2) managed income portfolio, the recent aggregated performance of which is shown below.
Q3 2017 Results
In late January, Stonemor Partners released its result for its third quarter 2017 (three months ending September 30, 2017). After coming through an accounting review during 2017, the company’s third quarter results are encouraging.
- Revenues increased by $3.3 million over the prior year period, coming in at $84.0 million. Year-to-date revenues (as of September 30, 2017) also showed an increase, up $15.0 million to $252.9 million.
- Year-to-date cash provided by operations were $24.7 million, which were $6.2 million over the same period in 2016.
- Deferred revenues as of September 30, 2017 increased from $866.6 million in the prior year period to $903.9 million.
Stonemor installed new management in the CEO and CFO positions in 2017. Paul Grady (CEO) and Mark Miller (CFO) are now committed to “living within the four corners of the balance sheet, meaning all working capital, capital expenditures and acquisitions must come out of operating cash flow.” This move will help Stonemor reduce its current leverage and increase liquidity.
About the Issuer
Stonemor is one of the largest providers of funeral and burial services in the industry as well as the second largest owner and operator of cemeteries in the United States. Based in Trevose Pennsylavnia, the company owns 316 cemeteries and 97 funeral homes in 27 states and Puerto Rico. The company’s cemetery products and services are sold on both a pre-need (before death) and at-need (at death) basis and include burial lots, lawn and mausoleum crypts, burial vaults, caskets, memorials and all services which provide for the the installation of this merchandise.
Stonemor Partners – Recent Events
During 2017, there were a few significant events for Stonemor Partners. For anyone who has followed the company, probably the biggest event was the delay in the company reporting its 2016 results, which involved a review of income reported for 2014, 2015, and 2016. The company completed the review in September of 2017. As a result of the review, the company restated its financial statements for 2014 and 2015. During the course of the review, Stonemor Partners also appointed a new Chief Executive Officer (Paul Grady) and Chief Financial Officer (Mark Miller).
Mark Miller, Stonemor’s CFO commented on these adjustments, “As we have previously stated, during the normal review of financial results for the fiscal year ended December 31, 2016, management discovered that the Partnership had under-reported cemetery revenues and over-reported net deferred revenues in prior reporting periods. Specifically, we discovered errors in a number of data entries associated with the servicing of customer contracts.” In essence, the adjustments changed the timing of revenue recognition, which led to adjustments in deferred revenue and partners’ capital.
Directly related to Stonemor’s accounting review, was management’s decision to suspend its regular dividends for shareholders. Initially, the company suspended the dividend in the second and third quarters of 2017. The financial review incurred one time, non-recurring costs for legal and accounting expertise. This temporarily increased expenses. Company management has stated that its goal is to increase liquidity and decrease leverage. To that end, management expects the dividend suspension to continue a few more quarters.
From an accounting standpoint, deferred revenues are a liability. These are revenues that have been collected for a product or service to be delivered in the future. A good example might be an annual software license which is paid up for twelve months in advance. The software company collecting this fee would recognize the revenue as each month passes signifying the delivery of the product to the customer.
On Stonemor’s balance sheet, there is an extremely large number under “deferred revenues”, just above $900 million. These are funds paid to the company by consumers in advance of the need for funeral and burial for loved ones. While this number technically represents a liability for accounting purposes, it also can be viewed as a significant backlog of business as well as pre-need billings that will flow through Stonemor’s income statement in the future with little or no selling effort on the company’s part. Hence, this large cache of funds should also be viewed as a positive for investors.
Trends in the Funeral Industry
The U.S. funeral market generates over $20 billion per year with an average of 2.4 million funerals held each year. This number is projected to increase as the number of Americans age 60 and older is increasing. According the the United States Census Bureau “Between 2012 and 2050, the United States will experience considerable growth in its older population (see Figure 1).2 In 2050, the population aged 65 and over is projected to be 83.7 million, almost double its estimated population of 43.1 million in 2012. The baby boomers are largely responsible for this increase in the older population, as they began turning 65 in 2011. By 2050, the surviving baby boomers will be over the age of 85.
Perhaps the largest development in the funeral market is the rise in cremations over the traditional funeral. A study from 2016 indicated that 50.2 percent of Americans chose cremation in 2016, up from 48.5 percent in 2015. Furthermore, the trend from burial toward cremation is expected to continue over the next 20 years, with cremation rates expected to reach 78% by 2035. Although cremations produce less revenue, this is offset by increased margins, up to 90%. With the growing number of cremations, Stonemor, and its competitors, have an opportunity to transform their offerings to better suit the changing preferences of the customer.
For the nine months ending September 30, 2017, Stonemor registered net cash from operating activities of $24.7 million. From this amount, it covers the company’s interest expense from the same period of $20.4 million. As mentioned earlier, Stonemor had additional one-time costs related to its accounting review, around $30 million for the first nine months of 2017. As the company begins 2018, most of these costs will have been discontinued, so operating income should increase. In terms of liquidity, as of September 30, 2017, the company showed cash in the amount of $8.5 million and $3 million available under its credit facility. Stonemor management has indicated one of its main goals in 2018 is to improve the company’s liquidity.
The risk for Stonemor bondholders is whether the company, led by new management, can improve its balance sheet in the short term, as well as remain competitive in an industry that is undergoing significant changes. The new management team has made a prudent decision to continue the suspension of the dividend in order to focus on improving liquidity and leverage. With the costs associated with the accounting review now in the past, the company can move forward this year with less administrative costs and more cash flow to devote towards these goals. Stonemor has a long history in the funeral and burial business. The company is in the process of improving its sales and marketing processes which should begin to yield results this year. With the move toward more cremations, Stonemor’s presence in the many communities it serves should continue to provide opportunities to serve those looking for end-of-life services. Stonemor’s 2021 bonds are an excellent diversification piece for investors. The 8% yield-to-maturity does appear to outweigh the risks identified.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Stonemor Partners provides services in an essential industry. Everyone will die, and those left behind desire to memorialize and / or pay tribute to their deceased loved ones. Regardless of whether that means a more traditional funeral and burial, or a memorial and cremation, the bottom line is that cemeteries and funeral homes play central and ongoing roles in our lives. Stonemor’s most recent quarterly results are showing year-over-year improvements. With the accounting review now completed, new management and the new emphasis on improving its sales and marketing strategies, the company looks to a more profitable 2018. For bond investors, Stonemor’s 2021 bonds, with a current yield-to-maturity of 8% are an excellent diversification piece and make an ideal candidate for addition to Durig Capital’s FX2 managed income portfolio, the recent aggregated benchmark performance of which is displayed above.
Issuer: Stonemor Partners
Ratings: Caa1 /
Yield to Maturity: ~8.05%
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Disclosure: Durig Capital and certain clients may hold positions in Stonemor Partners 2021 bonds.
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