Service Corporation International (SCI) Earnings Call Transcript & Summary

Good morning. Welcome to the 41st Annual Raymond James Conference. For those of you on the webcast, I am staring at a packed room. So that's good. So not everybody stayed home and bathed themselves in Purell. And one thing I want to mention is the corona bump. Let's not shake hands. Let's just do the corona bump like this, fist bump or the leg bump. So let's -- we've got plenty of Purell out there. Let's not contribute to the problems. I'm happy to introduce Eric Tanzberger. I've covered the stock long enough to remember when the stock was $1, and the company was burning $60 million a year in free cash flow. In 2008, it traded at a 20% free cash flow yield. Now it trades at about a 4% to 5% free cash flow yield, depending on how you count the numbers. The company has done a remarkable job. It's been one of the great turnarounds. They might even said to you that Houston Community College business school has a case study in turnaround. It has been one of remarkable turnarounds. And I think very much attributed to the discipline and focus of management. And the last thing I'd mention, I think if yours truly is worried about something long term, it's just the migration of the funeral -- a lot of the funeral home into celebration of life events like country clubs and valued members getting buried in their Harleys looking over the Pacific. So I think the long-term generational shift is, I know, front of mind for management. But the company has been able to navigate lots of headwinds, conventional crisis, cremation rate, et cetera. So with that, I'll turn it over to Eric. Thanks.

Thank you, John. Thanks for everyone for being here, especially the -- in the morning. Been here a long time, as John just said, and we love this conference. We appreciate John and Tom and all of Raymond James having us every year. So I'm going to start off by, I guess, the forward-looking statements on Page 2. We all know that, what that is and what that means, and I'm going to start with the company overview. And we'll go through these slides maybe for 20 minutes or so, 15, 20 minutes and then love to take some questions from the audience as well. And I think we have a breakout after this down in a room, 1 floor down. So those of you that don't know us, we're the largest company in the funeral and cemetery business. It was founded by 1 gentleman with 1 funeral home, believe it or not, in Houston, Texas. And Mr. Waltrip is still alive today and is doing well and has seen the company flourish, although he is no longer a member of our executive team or our Board at this point. About 15% to 16% revenue share. Very highly fragmented industry is one of the characteristics of it. So even with us being 15% to 16% and being, by far, the largest consolidator in the business. The other consolidators have about 3% to 4%. So think of consolidation of about 20% and then a highly fragmented business, very localized, about 80% of the business. We have about $3 billion in revenues. And it's interesting. What's interesting on the left part of this slide is preneed sales and backlog. So what does that mean? We are actually selling products and services on a preneed basis prior to individuals actually needing that, meaning that a death has not occurred. And those are the individuals that are prearranging their own funeral or buying cemetery property on a preneed basis. We have a couple of slides here related to that, that we'll get into. But ultimately, we first touch a consumer when they're in their low 60s, early 60s, call it 62 to 63 years old. And the first thing that the consumer does in the United States is buy a cemetery property on a preneed basis. The next time that we interact with that consumer, they're in their early 70s, which is primarily when they prearrange their funeral. And that's what creates the backlog of $12 billion. So we have $12 billion of future revenues that is either funded through a life insurance policy, where ultimately, the funeral home is the beneficiary, or about half of that is that, and the other half is invested in the form of trust funds. And there's fiduciary trustees involved in that and a lot of state regulations involved in that as well. But it's an unusual situation for this industry to have that. You can also see that, when you look at the map on the right-hand side, first of all, we've got 2,000 locations at SCI across the nation. But what you can really see is that we're heavily concentrated in the retirement areas, and that makes sense. Heavily in the Carolinas, this state in Florida, Texas, and then all the way over to the retirement centers on the West Coast, whether that be Vegas or Phoenix or those types of locations. As John mentioned, we've had a very strong track record of growth over a period of time. I think this takes you probably for the last 6 or 7 years. You can see the top part of Slide 5 is adjusted earnings per share, which is a nice double-digit percentage CAGR over this period shown. And then the bottom part is our adjusted operating cash flow. So very strong cash flow business. And it's unique in that sense that it really generates a tremendous amount of cash flow, which we have enjoyed deploying that cash flow for the benefit of our shareholders over a long period of time. What's interesting about the lower part of this slide is, you'd see the cash flow in the navy. But what you really see is in the lower part of that slide are recurring cash taxes. And what you'll notice about that is it's kind of ebbed and flowed. And you'd see that in 2019, we paid $66 million in cash taxes, which is not a full cash tax burn. And so what we do have this year is a headwind related to cash taxes. We expect to spend about $55 million more in cash taxes to our total of $120 million. And when you take that against the true cash flow pretax at the funeral homes and cemeteries produced at $735 million, then you get to the $615 million at the bottom right-hand corner, which is the center of our guidance for this year. Again, beneath the $635 million that we produced in 2019, but again, that's the $55 million of cash taxes being offset by the EBITDA growth of the business. We've also -- John also mentioned this, too. We're proud of how we've outpaced the S&P over time, 3-year, 5-year as well as the 10-year as well. We think that we do a good job kind of staying concentrated with a lot of clarity in terms of what we do in the funeral and cemetery industry and not getting into other businesses or adjacencies. And I think we do a -- this has been a reflection also of our capital allocation policies, deploying capital to the highest relative return opportunities and have been very, very disciplined over the last 20 years related to this, and I'll get into that a little bit as well. So let's talk about our key areas. When you start thinking about this industry, this is really the key slide today if you're new to this. This is the demographics. This is U.S. Census data. And what this shows is very clearly the aging of America, what you've seen in terms of the baby boomer generation, affecting health care to some degree, now affecting other industries but will, at some point, affect our company as well. We have it color-coded as well. We have the lighter blue being the age 55 to 64; the darker blue, 65 to 74; and then the yellow, age 75 plus. And the reason why we do that is to show the legend at the top of this slide and really just to reemphasize what I've already described to you in terms of when do we first interact with the client families, with the consumer. So the first thing we do in the early '60s is that consumer buys the cemetery property. So therefore, the baby boomer generation has already crossed over that. And therefore, that has generated a nice top line growth characteristic of our cemetery segment. Ultimately, the baby boomer generation is just starting now to cross over and get to the early 70s, which is when the consumer, on average, prearranges their funeral. And then, ultimately, there's an at-need consumer that we interact with, on average in the U.S. is about 83 to 84 years of age. That has not occurred yet. The baby boomer generation that's differentially impacting our business in terms of volume hasn't reached that age yet. And therefore, we have not had a revenue growth characteristic in terms of the demographics yet in the funeral industry. But as you could tell from this slide, that is definitely something that will come. So another thing that John mentioned is that we've been somewhat paranoid about really remaining relevant with the consumer. In other words, what we were not doing as a management team is prearranging consumers and then doing nothing and waiting around for the event to occur and not really understanding where this is going. And it's interesting in the U.S., this is changing. Just like I mentioned, the baby boomers, they've essentially changed everything that they've touched, and they're changing our industry as well. And I think I've been at this -- I don't know how long at this conference, probably 15 years presenting. And I think probably the past 7 or 8, I've used this term about remaining relevant with the consumer. And what that means is being ahead of the changes of what those consumers want, and particularly, the baby boomers. And as a very general statement, what I would say is the traditional type of mourning of the deceased and a church service and those types of things are what are changing. And it's really going towards an event like a celebration. And we call it the celebration of life. And it really is turning into where we will need event planners and we will need physical capacity or space or infrastructure to be able to hold these events. And you can see on Slide 9, this is the catering, for example, at one of the events that we've had. So we're very good at being in front of new and contemporary products and experiences that the baby boomer desires. And we feel very strongly about that because if we don't, then I think, to some degree, the service component of the industry could be left behind, or particularly, for our company. So we've worked very hard at doing that. Some of the other things that the consumer has wanted is make things simpler, make things quicker, and that's technology. So you could see on this slide, we also talked about technology. We talked about customer-facing technology in the actual arrangement room, which is using videos and pictures to really generate ideas with the family in the arrangement room on specifically how they want to celebrate the life of their loved ones. And I know John was a little kidding, but we are doing things like Harley Davidson rallies and barbecues and things along as such. That's really where this is going. It's a little bit geographically differently -- different. So the Northeast isn't there. But in this state, you would see those types of celebrations as well. Here's the customer experience through innovative technology. And this is what I was really talking about. On the left part of this slide is HMIS+. HMIS+ is the ability to interact with the consumer in the arrangement room, using technology such as computer screen and TVs and such and really walk them through everything that we can do for the family to celebrate the life. And it starts off with videos use an example, pictures use an example. And it also makes the experience more contemporary and a little bit more streamlined and efficient as well. Beacon to the right of that is taking that concept and shrinking it from a TV in the arrangement room at a funeral home down to a tablet. And giving that tablet to the preneed sales force and having them, the preneed sales force, which we have 4,000 sales counselors, which again are producing about $1.8 billion to $1.9 billion of preneed sales per year, which is growing that $12 billion backlog that I described to you at the beginning, and able to take that technology -- contemporary technology into somebody's living room or somebody's kitchen while they're prearranging. And it also, again, makes it simpler. It's one-stop shopping. Credit cards can be taken right there using the technology. And it's really been a nice impact from a consumer perspective for our company. The preneed sales, I've just mentioned that, the $12 billion backlog. $1.9 billion essentially of sales, $1.8 billion, $1.9 billion of sales a year. You could see on this slide, it's bifurcated between cemetery and funeral. And again, going back to what I said earlier, cemetery is growing differentially from the funeral segment, and that's because, again, the baby boomers has crossed over that 62- to 64-year-old age, and that has caused some nice, we call it, mid-single-digit type top line growth. It's also a high fixed cost structure business. And so when you're able to put top line growth of 4% to 6%, you're also going to have some margin expansion. And so the cemetery segment that has grown now for about a decade ultimately used to be a 13 -- kind of a low-teen type gross profit margin business. And today, it's about 28% to 30% margin business. So that margin expansion has occurred as the throughput has occurred as well. The bottom is funeral. Again, the baby boomers are just starting to impact that. And so it's not growing to the degree that the cemetery segment is growing. But what I would also say is that, that is also deferred into the backlog. So we're not recognizing that revenue until we deliver the products or perform the services as well. One advantage we have at SCI that I've already described to you, being 15%, 16% of the industry and the consolidator is only being 20%, is just using our scale. We could do it anywhere from the supply chain with purchasing power, to having the ability with $6 billion being managed to get the best situation financially in terms of the portfolio managers and everything that you're doing there and everything in between. And so the scale is a real advantage for us, for our company, we believe. So again, talking about what I said at the beginning, in terms of our success that we've been able to have. A lot of it, in my opinion, is because of the capital deployment, and it's a balanced approach but it also is going to the capitals being deployed to the highest relative return opportunity. So we split it up on Slide 13 into growth capital, and growth capital is really M&A and new builds. So this year, for example, we think we'll spend about $125 million on that category, and it's probably going to be somewhere around $75 million of acquisitions and about $50 million of new builds as well. And that can ebb and flow. For example, the acquisitions this year were just over $50 million. But 2 years ago, there are almost $150 million. And so it can really ebb and flow depending on which sellers come to the market. We also pay a dividend. 30% to 40% of after-tax net income is kind of the metric that we use on that. And then we've done a lot in terms of share repurchases as well. And again, we will ebb and flow on share repurchases based on the relative value of what we believe our shares are compared to the intrinsic value of the company. We started this back in 2005. And at that point in time, we had just under 350 million shares outstanding. And today, we've got 180 million shares outstanding. So a very significant decrease in equity that we've had over this program over a long period of time. So here is kind of the guidance as it relates to the capital deployment. And again, this is going to be consistent with what you've seen for us for many, many years. I've already talked to you about the adjusted operating cash flow guidance of $615 million. And then notice how we split it with the color codes between maintenance, growth and returning to shareholders. And then, of course, on the right of this, you can also see even more specifics as it relates to this. Maintenance CapEx, capital leases, but then you have cemetery property development. The acquisitions and new builds should be about $125 million that I described to you. And then dividends, about $135 million. We just raised it to $0.76 per year, and so that's about $135 million spend. And then we're kind of defaulting in this metric the way we're doing it to the $85 million of share repurchases. The other thing that I would mention to you about this, though, is that this -- we also will maintain leverage of about 3.75, 3.5 to 4x. So this $615 million, there's also going to be probably another, do the math, $150 million of capital that we will have to be able to deploy because we will take on some leverage each year to maintain that leverage because the EBITDA has grown. So that will be in addition to be able to deploy it in addition to the $615 million. In terms of leverage, I mean, a nice, clear runway, and I've already talked about our target of 3.5 to 4x. Really no meaningful maturities until 4 years from now. And our current leverage is right at the middle of that 3.5 to 4x. In terms of what we believe we can grow, as a very general statement over the long term, we think we should be able to grow 8% to 12% from a per share basis. Not every year because you're going to have events that ebb and flow in the industry, such as cemetery sales or such as the number of funeral services being performed. Obviously, you can't control that demand. But as a general statement, we've been able to do this. It's the base organic business growth of 4% to 6%. That's primarily coming from the cemetery top line growth that I described to you earlier; and then M&A and tuck-in acquisitions, M&A and new builds as well as the share repurchases is the other 4% to 6%. Those 2 components will get you to the 8% to 12%. And then lastly, what's key to this business is service excellence. The second that you're not doing everything possible for that family at-need, at one of the worst times of their life, that's when you'll really hurt your business and affect market share. So one of the things that we're proud of is the J.D. Power's President's Award, which I believe is only given to about 16 to 17 companies in their 50-year existence. And we did receive that award, and that really tells you the culture of what we're about in terms of serving the consumer. So then lastly, to wrap it up, we believe for all those reasons we're very well positioned to succeed. I think there -- again, there's growth in this industry coming organically from the demographics on the slide that I showed you earlier, and we believe that we're very well positioned to capture that over the long term. So John, I'll turn it over to you for questions.

Sure. So if we think about just -- you mentioned the 8% to 12%. So just tactically for 2020 versus 2019, what sort of things would you call out for people to think about on the comparison side, both good and bad?

I think we'll have a little bit better year on cemetery sales. I got very nervous with John behind me. Did you notice that?

I won't come on you.

Ultimately, I think we'll have a little bit better year on cemetery sales. I think some things occurred structurally that we did in our cemetery segment this year for the long-term benefit of that revenue stream. We use Salesforce as our CRM system and we kind of forced the remaining sales counselors that weren't using it in that. We adjusted some compensation as well. And then lastly, which wasn't under our control, was the Chinese consumer on the West Coast, which is very significant to us and very significant to our West Coast businesses, really shut down related to the tariff situation and the ability not to get money in any significance out of China, and that's primarily in Vancouver and L.A., where we saw that affect us. So we think that will rebound. What I don't know is how will funeral volume be based on the number of services, number of deaths that occurred during the year.

Right. A couple of other questions. If you think about long term with your asset base, 1,500 funeral homes, do you ever foresee a day 5 years out or so that you might have the wrong asset mix just based on where the venue of services is going? And if so, what would be a theoretical plan to address that?

I can't -- I'm going to answer your question this way. I cannot see that in the next 5 years, but I think it's very possible, what you said. But I think the industry doesn't move that quickly. I'll say -- I think you walked out of the room. But what I said is, if I've been presenting for 15, 20 years here, I think for probably the last 8 to 10, I've been saying remaining relevant, remaining relevant. And that's where John is going in terms of what we already talked about. This consumer going to the celebration of life and do we have the infrastructure to do that? And can we capture that consumer as well? I think you mentioned country clubs before when you first started out, and that's key to us. I mean it's a key strategy for us. The good news is that we always have the first interaction with the client family. They have to come to us. And so you have the ability. What you need are the right people and the infrastructure to serve that family in the existing homes. Now what you will notice is that we've done a tremendous amount over the past 5 to 7 years in terms of renovating and putting capital in the infrastructure itself. So if you go to 1 of our funeral homes, you are more than likely going to see a large event center, if not several type event rooms that lends itself to a celebration of life. Now at some point -- does it go to the point where you don't have the funeral homes, you have event centers? I don't know. We'll have to wait and see. I will tell you this, though, in Florida, for example, we have businesses that have the event centers and actually have event planners on staff, and we are testing that in 9 other markets. And I think that's ultimately where this will go. I think we have the ability to capture the consumer and have them celebrate with us. I think we have to have the right event planner there in front of them as we go further. But even with all that said, it's just -- it doesn't move that quickly in terms of the change.

You used to say the accounting is complex, the cash flows are not. You used to say that every 1% move in the trust funds was roughly $1.5 million of EBITDA. Now numbers have changed. Is that -- but is that still a decent proxy for how to think about the downside risk to your trust fund exposure?

It is, all else being equal. That's what we've said over and over again. So what John is talking about is like during the financial crisis, what we said is there's going to be a very muted effect in terms of our trust fund's act in our cash flow. If you think of it this way, if you think of the average life, let's do the math to make it easy, is 10 years where the contract is in the backlog and you lose x amount of money in your trust funds, in other words, like an unrealized loss. That unrealized loss should go through 1/10 every year for 10 years, all else being equal. So if you have an unrealized loss of $100, you should be affected $10 per year for $10. So it's a very muted effect to cash flow, and that was proven out during the financial crisis. John has mentioned a metric that we tried to come up with to really statistically quantify it for you. And that's true, all else being equal, but that did not occur during 2019, where the trust funds were up. And it's primarily because the duration of the contracts got a lot shorter. What was coming out of the backlog was much shorter than what it had been historically. And I'm not sure that we know if that's a trend yet or not. So again, it's a good rough metric but be very careful with that, and we'll see, all else being equal, if CFO hold up.

Lastly, for me, the ASP out of your backlog on the funeral side. In other words, the funerals that are presold that come at-need. They used to be something like $300 less than your average at-need. Now they're a little higher. Is that trend going to level off now that you're lapping the 10-, 15-year-old upsell of dignity? Is that spread between backlog ASP and at-need ASP going level off in the future, do you think?

I think it's possible that it could level off. I mean -- but I think our sales force does a good job doing what the at-need environment does, and that's now using Beacon as opposed to HMIS+ and using the technology to really make sure that, that family is seeing all the choices that they could possibly do. And I think if we continue down that path of getting better and better and better at that, there's a good indication that maybe that spread still exists over the long term.

Okay. We have about 3 minutes if anybody has a question. And you can stay in your seat, I'll repeat the question. Yes, sir?

Yes. For me, 2 [indiscernible] following a little bit on the bottom left piece. So I think [indiscernible] mean, a down, not at [ 20 ] years or so. [indiscernible] that cemetery network. But what does that mean for the cemetery sales going forward? I mean we're seeing [indiscernible] there? Or is there any limitation that would impact…

So the question is about the flattening of the 55 to 64 cohort applications for cemetery sales.

Yes. And I think it's still got a ways to go. It's the first thing I would tell you, the baby boomer generation is a very long 20-year situation. And I think we've got a good ways to go in terms of that. The cemetery segment, in our opinion, would still grow. And the reason is, is because the other half of the cemetery business is at-need, not preneed. And so now you're starting to get into all of these demographics in the cemetery segment as well, whereas where the funeral segment would be impacted positively based on the Asian-American, ultimately, the number of deaths, the cemetery at-need environment will also be impacted. We also have a good amount of merchandise and services in the backlog of the $12 billion related to preneed cemetery that has not been delivered and, therefore, has not been recognized. So what you're going to see is a little bit of shift away from preneed property towards the recognition of merchandise in the cemetery segment when it's delivered. And then you're going to see the at-need situation have a positive effect in the cemetery segment, just like it has a positive effect in the funeral segment. So at the end of the day, we still foresee growth there for us, yes, at the end.

All right. Let's head to breakout. Thank you, Eric.