Weekend Watcher: Investing Lessons From the Grim Reaper

 | Jul 07, 2012 | 4:30 PM EDT
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Let's say it's 3 a.m., and you're watching an overseas-based stock analyst or portfolio manager explain why they like a stock. Most of the musings are the run-of-the-mill gibberish: Stock sports a low price-to-earnings multiple compared with the sector average, company is a market-share thief, it's the cleanest shirt in a filthy stinking batch of clothes, blah, blah, blah. Then, all of a sudden, the usually tightlipped stock direction predictor signs off with "the company operates in an unsexy sector." Hmm. You wonder, "Well, kind friend, didn't you just tell me how amazing an investment this stock was?" Then you catch a bit more shuteye.

I will actually side with the analyst here, though I rarely do so, as such a stock could indeed be one that you should investigate further after a couple heart healthy morning egg whites -- and I say "investigate" because you can't buy a stock off a hold rating. The only thing is that, instead of considering a sector as "unsexy," think of it as "slow-growth." In order to prevent having your ego handed to you on a silver platter, one must appreciate the attributes of investing in slow-growth sectors. They include the following:

● The market the company calls home is mature, or it tends to grow over a long stretch of time -- not in a single quarter due to a raft of amazing life-altering products or services.

● Pricing power is hard to come by, so any evidence of it would be a significant positive to an investment thesis.

● Management does not have to reinvent the wheel -- it only needs to target strategies to bring hard-fought top-line gains to the bottom line more thoroughly.

Of the all the sectors this smiley, energetic fella could analyze, "death stocks" were a choice of mine recently. Man, what a morbid topic to research, but it reminded me that attention to detail in investing is paramount, most acutely in slow growth sectors. I was not dazzled by the pure financials of companies Service Corp. (SCI), Stewart Enterprises (STEI) and Carriage Services (CSV). But, after doing the work, I was dazzled, because the winners and losers become abundantly clear.

So I'm giving props to the Grim Reaper for helping to forge this weekend's investing lesson.

Why the Funeral Service and Cemetery Business is 'Slow Growth'

● In 2011, the number of deaths fell by a low-single digit percentage.

● The Census Bureau estimates the number of deaths will only rise by 1% a year to 2025.

● There are high barriers to entry to the industry.

● Who would want to put venture-capital money into an industry devoid of the ability to innovate? In other words, there are no startup funeral service and cemetery companies overhauling old industry practices and making a ton of money from doing so.

● There are currently three industry behemoths duking it out with the remaining independents in key "growth areas," what I call the "prime death zones" of California and Texas.

Note that the spirit of these factors could apply to other sectors deemed slow growth.

Being fully aware that the sector is unsexy but offering of opportunities to bank money, I present three strategies to win.

Fun Oddities

To find fun oddities, I am sorry, but you must read through the company's 10-K form with the SEC. I am on the prowl for points of differentiation that stand to drive unappreciated future value. These are a couple fun oddities in my death stocks.

Service Corp.: Owns 89% of its real estate and buildings (while Stewart owns 77% and Carriage owns 80%), and the founder is the company chairman.

Stewart: The firm has lease agreements with local churches to construct and operate funeral service facilities on land owned by the church. In plain English, this means less capital-intensive expansion model and opportunities to develop long-term relationships with the local community. The Chairman, meanwhile, owns 35% of the voting stock.

Carriage: Lacking in fun oddities.

Common Threads

After uncovering fun oddities, I am off to dig up the common threads between the companies to establish a base for who is winning and why.

● All have grown through acquiring smaller independents.

● All are attempting to sell more services as a means to bolster revenues -- think having a service for a person getting cremated.

● All are in love with extracting expense savings from the operating model, a key goal of any managers in a slow growth sector.

● All are still feeling the competitive pricing heat from independents.

● All have highly leveraged balance sheets, so cutting expenses is vital in order to pay down debt.

Choose How You Want to Make Money

When I think slow growth, a necessary exercise is finding the largest company and learning if it's using that size to its advantage. Service Corp. has a 13% market share position through its 1,423 funeral service locations, dwarfing the operations of Stewart and Carriage. Furthermore, Service Corp. is out executing Stewart in terms of same-store revenue and profit margin. (Note that Stewart's first-quarter financials were below management's plan.)

Service Corp. ultimately strikes me as the long-term play -- but, with Carriage, there is a twist. The valuation on Carriage is well below that of its two competitors, and a new acquisition should boost adjusted earnings before interest, taxes, depreciation and amortization until comparisons become tougher in the first half of 2013. Given this, there is the potential to trade Carriage around its earnings releases for a pop. I admit I am not enthused with Carriage's relative fundamentals -- however, my interpretation is that the market is starting to focus on near-term earnings upside borne of acquisition instead of the soft underlying dynamics.



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