Service Corporation International (SCI) Earnings Call Transcript & Summary

Good afternoon, everyone. Thanks so much for joining us for the third day of the Bank of America Healthcare Conference. So it's my pleasure to now host this session with Service Corp. They are the largest provider of funeral services and also the owner of cemeteries in North America, largely in the U.S. And today with us, we have Eric Tanzberger, the CFO of the company. And I'm going to go right into some questions, but also a comment to the audience.

There's a little box that says Ask Questions. So don't be shy, utilize it and send a question, and I'll be happy to pass it along to Eric here. So I guess, Eric, thanks for joining us today on this beautiful day, it sounds like behind you. So I wish we were in Vegas actually because there would be even nicer view. We were...

[indiscernible] Thank you very much. We're good. And the view would be much better than Houston, Texas.

Right. So just turning back to the business. And I guess the very topical question is, obviously, the death rate very high in last year in 2020 and early this year. Now we're seeing the numbers coming down. So kind of how do you think about your business in terms of the impact to volumes after the pandemic rate? How much really of the volume was pulled forward and what the impact would be to growth rates after the pandemic?

Yes, that's a good question. To level set, normally, Joanna, we're performing somewhere in the ballpark of 320,000 funeral services a year across our 1,500 funeral homes in North America, and that's U.S. and Canada only. Ultimately, utilizing the best statistics that we can from death certificates and input from families directly into our field organization with our front customer-facing employees or associates, we kind of backed into, we think we did about 40,000 extra funerals during 2020. We were up somewhere around 360,000-ish, in that ballpark, which, again, is kind of the math of that 40,000 incremental funerals that we had performed. We think some of that, some degree, based on what we've looked at and looked at the underlying data, tried to study it as best we can and tried to mix that study information with what we're hearing from the field directly from the families, we think probably 5,000 or so of that 40,000 would have probably occurred in 2020 anyway. Those are the elderly people that are in nursing homes and such. They probably just wouldn't have passed away related to COVID, but probably some other cause within that term. So that leaves about 35,000. And the question is, okay, you definitely pulled that forward for some future years. What do you think? We dove into the CDC data, and they give you a lot of good information about high, medium, low type in terms of seriousness, preexisting conditions and percentages of the COVID deaths that they had and such. And we looked, took a conservative approach and said, at the end of day, we probably think COVID is impacting this company for the next 3 years. So we kind of called it COVID for us is 2020 through '21, '22 and '23. And absent, knock on wood, some other event and some other variant, and us starting this whole thing over again, we think that's probably the lion's share of what we're talking about. So we really believe then to be conservative that we probably pulled those 35,000 cases forward equally from '21, '22 and '23, which, as you know, then, gives you roughly somewhere of the 12,000 to 13,000 case pull forward in each of those years. The truth to it is, I think in reality, the tail's probably a lot longer than that, and it's going to go out a little bit longer from an immaterial perspective, though. And so we just think it's the best course of action to call it that way, maybe 1/3, 1/3 and 1/3. So we've kind of then tried to talk and give guidance around what does this COVID period look like? And what does it look afterwards? And your specific question is on volume. And so I think volume would have naturally been growing for us, let's call it, flat to up 2% per year, maybe 1% to 2% a year. So now that you're absorbing that headwind, I think we're not going to have that type of growth in terms of just volume in isolation as I'm describing it. Ultimately, if you run through this math through the models, what we're kind of predicting or what we're kind of seeing is that we think that the end of this period that I described to you, so call it the end of 2023, we think 2023's funeral volume probably equates back to 2019's funeral volume on a same-store basis. And again, that is -- 2019 is kind of the pre-COVID benchmark that we've been using, as you probably know. So subsequent to that from a volume perspective, I think we're back into that 1% to 2% type growth, free any type of effect from the baby boomers, which is going to occur. That generation, as you know, has already started affecting, in a positive way, our cemetery segment in the form of who needs cemetery property sales when someone's in their early to mid-60s. While affecting our funeral segment is a little different. That needs to have products and services delivered, which means a death has occurred. And so in those situations, eventually that baby boomer generation is going to affect us post -- we think it's post 2023, to be honest with you, we don't have that in our model. But we think at some time in the near term after '23 that we potentially have that baby boomer effect that will again make volumes move a little bit more than probably what I have been describing to you, what I've been describing to you in isolation away from COVID, kind of in that 1% to 2% kind of metric.

Yes. That's very helpful. And I guess, the baby boomers clearly are coming in a bigger way, I guess, at some point on the funeral side. Because to your point, the cemetery segment has been seeing, I guess, the aging demographics reflected in the numbers but funeral segment, not yet. But -- so then when you think about -- when you kind of get there eventually, what kind of growth rate would you expect for the funeral segment?

I think one thing that we haven't talked about to answer your question, what you have to take into account is the ASP, or the average sale price. I think, first of all, near term, you are going to see some pretty significant growth in the ASP just because of the easier comps from 2020. Remember what happened during the pandemic where a lot of the service offerings that we would normally be able to provide to our families and they would be able to pay for, were precluded from being able to be serviced or provided for because of the individual city, jurisdiction, municipality, state laws, those types of things. And so ultimately, I think ASP will be a driver for us in '21. And then I think it kind of goes back down to more normalized levels into the 1% to 2%. So if you then are taking volumes in the flat to up 2% and ASP in the 1% to 2%, you're going to have some type of pre-baby boomer growth on the top line in where we characterize as kind of a low single-digit percentage growth. I think when you think about the funeral segment, the growth in our SCI Direct segment, which is a more sales-oriented direct cremation segment, will also have a little bit of movement to it and help push that top line a little bit in terms of our funeral segment. But ultimately, when you think of growth, that should drop then to the bottom line. You see that we are a 70% to 80% fixed-cost structure in that ballpark. And ultimately, you saw when we put extra throughput through this fixed-cost structure, you have margin expansion because you have a significant amount of incremental margins, driving the bottom line. And there's no better pressure test than we had than during this pandemic itself that we proved that. And in fact, the incremental margin theory dropped to bottom line of fixed cost… [Technical Difficulty]

Eric, we lost you for a brief moment.

Did you lose me then?

Yes. I guess you were talking about the incremental margin.

Okay. So in addition to what I was describing on the top line, I think the other thing that we'll have on the bottom line for the margins for funeral are cost efficiencies. We just learned a lot to be a more efficient company. And I think that bodes well for margins. Now do I think -- the margins grew 1,000 basis points during this quarter. That's unsustainable. That's purely related to the additional throughput with the incremental margins. But funeral has also been an 18% to 20% margin business, and we probably don't view it that way. We probably view it to more like a 20% to 23% margin business, and that's pre-baby boomers, perhaps when I say that. That's some of the efficiencies that we gain in terms of promotional expense, lead expense, leads for our sales force, those type of expenditures, marketing expense, leveraging technology so much better. Span and control related to our market directors and our middle to senior management was going to take out noncustomer-facing costs, labor costs themselves. I think we're a very metric-driven organization and we had a tremendous amount of FTE metrics and things like that. But I think this acute test that we had during this pandemic, we even learned that our labor could probably be a little bit more efficient than where we even anticipated from an FTE metric perspective. So there's a lot of good things that I think are going to bode well for the margin expansion. And that is, again, pre-baby boomer. When the baby boomers do affect the funeral segment, Joanna, I think you start having a little bit of incremental margin effect.

Right. And to that end, the company previously talked about the EPS growth, I guess, the bottom line growth in 2022 and beyond to be towards the end or even higher than kind of your long-term target growth of 8% to 12%. So can you kind of, I guess, flesh it out again for us, what gives you confidence in this robust growth? I mean you've mentioned some of these cost efficiencies that are -- that should be driving margins. And I guess, it sounds like that growth rate that's been discussed before that's actually before the baby boomers driving even higher throughput. So kind of just can you step back and kind of flesh it out? What gives you confidence in being able to actually outpace the historical growth after 2022?

Yes. It's a good question. I mean I think the first clarification that I just want to make sure that everybody is clear on is that what we have been trying to describe is takeaway this big bump in earnings that we've had and provide some clarity. So what does the COVID situation look like for the next couple of years? And I've already described what that situation will look like in the next couple of years and it affects us to some degree through 2023. So when we are talking about the effects that we've had, and you go back to 2019 pre-COVID $1.90 per share, and you grow that 8% to 12% [indiscernible] chance that we're above that. And that's where we've described that. If we're in that approaching $3 range, as Tom has mentioned on the call, we're probably more at the high end of that guidance. We're probably in the 11% to 12% type CAGR range during this period of 2023 over pre-COVID of 2019. If we exceed that, like we said on the call, above $3, that's when you start exceeding this 8% to 12%. And if you approach $3.25, for example, now, you're looking at profit and probably some growth, that's probably in the low-teen percentages from that perspective. But I do want to make it clear that what we're really [ talking about ] 2023 coming out of the final pieces of COVID versus pre COVID 2019 levels. Ultimately, the question is beyond that, we're not saying right now, at least it's way too far in the future that we grow above that 8% to 12%. I think that [indiscernible] it's fair to say we probably, for right now, think we return back to that 8% to 12% type levels post-2023. So what could change that? Obviously, if we're a little bit more successful [indiscernible] and what we're planning on now, a lot of the things that we're trying to do in terms of leveraging technology related to [indiscernible]. I think that could potentially be more of a positive effect over the long term. And then maybe our efficiencies are even better than what we probably anticipated. But the real movement, as you know, Joanna, would be when the baby boomer generation affects us in a positive way beyond '23, affects our funeral segment specifically. And I think we've now pressure tested and proven that when we do have more throughput, through our existing fixed-cost structure that we do have margin expansion. I think we proved that. And I also think we've proved that we don't necessarily have to add or change the fixed cost structure itself to take on more incremental volume or more throughput. I think we proved both of that during the pandemic. It was a good pressure test to our theories and good pressure test to our company and our system.

All right. And just to follow up on one of the things you mentioned before in terms of the average funeral revenue per service, right? It was under pressure. And you clearly saw some improvement already, right, in the quarter. Because markets are opening up. So can you kind of talk about any incremental data points you have on trends, I guess, after March and how quickly do we expect really to come back to the pre-pandemic level in terms of the ASP? And then it sounds like you continue to expect kind of to stay at 1% pricing growth after that so just confirming that.

Yes. I think we definitely saw some movement back to, I guess, I could describe it, pre-COVID normalcy, if you will, in the latter part of the quarter. And I think that continued, Joanna, post the quarter into April. What we said on the call was that the March average, so just the month of March, the ASP for funeral was very, very close to the pre-COVID levels from a sheer dollar amount of average in the January, February 2020 time frame. So we've already kind of come back, we think, to pre-COVID levels. The question is, will it grow from there? And the answer is yes. We think we will. I think we will continue to push through inflationary type price increases. But I also think there's a good amount of our network that is not open and is not completely open for business. We can take California, for example, which is a big piece of our network. We're still doing funeral services outside in tents. Does that lend itself to a complete service with full ASP? Maybe in some cases, but there's still got to be a little bit of drag to that, I think, when we get back to complete normalcy in that state. Canada, which is easily 10% of our business, is really relatively shut down. They still haven't come the long way that the U.S., when you compare the 2 countries, have come. It’s relatively still shut down. So there's room here we think, even though we're back at pre-COVID levels, to have a nice healthy growth even off of, if you're going to compare it to pre-COVID 2019 levels.

Right. And on the pricing side, right, the other dynamic is around cremation. So clearly, these trends held up surprisingly, right? I mean, there's, obviously, very short period of time where the mix a bit shut up because of the shortage of space, so I guess the abilities to provide the services. But nevertheless, when you look over the last couple of quarters, it seems like cremation wasn't really a change -- market trend hasn't really changed because of the pandemic. So kind of how do you think about this going forward? How much there is still room for cremation to continue to shift? Are we thinking about the next decade and at some point, it's going to kind of stabilize? So can you talk about kind of the near-term outlook but also long-term outlook for cremation shift?

Sure, sure. Yes, I think you're right. I think what is a key point, I think, to all of our stakeholders is that one of the risks that could have occurred to the industry that didn't occur was there was a massive movement towards cremation during the pandemic. And that just simply didn't occur. It happened in isolation in certain hotspots for very short periods of time, primarily because the infrastructure around those hotspots were just shut down. People were told to stay home and people did. And that lent itself to kind of a direct cremation opportunity that probably normally wouldn't have happened. We still expect the normal 100 to 150 basis point movement towards cremation. You're right, in the first quarter, it was very light. It was only about 20 basis points. And look, sometimes, this thing ebbs and flows, depending on the mix of who needs our services, frankly. And remember, we have a $12 billion backlog of future services where people have already signed up [ contractually ] and funded it. And it kind of depends on the mix of who needs our services coming out of that backlog and whether they're traditional or cremation, and that can kind of ebb and flow. And so that's a big component of that. Long term, we still expect that 100 to 150 basis points. At some point, I think you're right, Joanna, I think it slows down. We don't necessarily know where that is. I think there's other associations in the industry that think something that's around 50% now peaks out at 65%, in that ballpark, maybe 70%. So I think the long-term answer is you probably still have this trend for another 8 to 10 years in my opinion.

Right. And so how is the company prepared, I guess, for that shift in terms of discontinuation, which is going to be with you for quite some times, though?

I think we're very prepared for it. I mean I think cremation is nothing new. I've been at the company now for 25 years and have seen this 100 to 150 basis point shift and we've had to obviously change dramatically to stay relevant with the consumer. There was definitely a time where we did not have the proper cremation products, cremation services, cremation packages in front of consumers. That was probably 15 years ago, to be frank. We've had those products and services that they are asking for. We have packages in front of them. And most importantly, you just had to break through with kind of our internal associates. The traditions of, well, a cremation consumer doesn't want to celebrate the life of their loved one. That's just not true for our 1,500 funeral homes. Now there is a direct cremation component that our Neptune brand, that our SCI Direct business is working with and that's a much lower spend. It's much more of a commodity. So when you're talking about the cremations, which are significant, 150,000 plus a year that we're doing through our 1,500 funeral homes, those are families that are no different and want to celebrate, want to memorialize their loved one and want to celebrate the life of their loved one. And they just are moving along like every other consumer in North America and want to do it differently. They want it very specific to their loved one. They want much more of a celebratory event, kind of bordering on a party, frankly. In a lot of these cases, this is where it's going that the cremation consumer at the end of the day wants to do that, they just ultimately or their loved one wanted to go be cremated as opposed to go to the cemetery and be interred. And of course, as you already know, we've developed a lot of business on the cremation side in our cemeteries as well. We don't have any cemeteries that don't have cremation product, whether that's cremation gardens, niches, mausoleum niches, glass-front niches, et cetera, and that's come a really long way, Joanna, probably in the last 10 years.

And to that point about the cemetery segment, we didn't touch on that one yet. So clearly, the surprise was that the pre-need sales were very strong in the latest quarter. So can you talk about these dynamics, kind of how do you see it normalizing? Is it -- I mean obviously, partially driven by the very high at-need activity that you had in the quarter. But it seems before, it went well beyond that. So can you talk about these dynamics and what it means for the future? Are people kind of more interested in preplanning, both the funeral services, when they kind of think about purchasing the cemetery property? Are you seeing kind of the flow-through from the pre-need cemetery to pre-need funeral services with the high activity that you see there?

Yes. Great question. There's no doubt that pre-need cemetery when it grew 67% during the quarter, $130 million, is something that is obviously being affected by COVID, right? Not only just radiating off of at-need funerals, but radiating off of at-need cemetery business as well. And families are then buying adjacent property. And in total, just like in pre-arranged funeral, as you just mentioned, there's an aperture of this consumer that's very open. I mean this stuff is top of mind, front page on the media, everything that's been occurring has gotten to the point where it's affected people in a way where they just said, I really want peace of mind. I want to be adjacent to our family at this cemetery. I want to -- I've had my parents prearranged, I want to prearrange my own funeral. Whatever the situation has. When you look at that $130 million in cemetery of growth, what we said on the call, and we were just kind of backing into what we've been able to hear and figure out, we think probably $75 million of that $130 million is probably related to that COVID and that top of mind for that consumer. $55 million, which is kind of mid-single-digit percentage growth, call it, 6% to 7% for the quarter is probably the more sustainable metric. And we, again, go back to this '19 to '23 period that we're trying to figure out and give the best guidance that we possibly can, cemetery is really the driver to that. It's not funeral, as I just described to you, because of the funeral volumes because of the headwinds. There's certainly some tailwinds in funeral related to the ASP and there are certainly some cost efficiencies in funeral. But the real revenue growth driver is can we sustain growing cemetery the way we've been describing and not at COVID levels, not growing 60% to 70%. But certainly, when you start peeling away, peeling that back, getting to the normal part of the growth being mid-single-digit percentage, the answer's yes. We think we can do that. And we've gotten better. We've gotten more efficient. We've gotten more productive. Our sales costs have come down. Our digital leads have increased as a percentage, which are much more efficient leads for us. We've gotten much better at direct mail, utilizing technology and all of our CRM system has been utilized like it's never been before. All of those efficiencies have made us much more productive. And when you take that, coupled with all the other tailwinds that are going, I think we could probably grow pre-need cemetery from a CAGR basis in this COVID period I've been describing to you in these mid-single digits. And when you do that, as Tom mentioned on the call, that's going to be a significant driver of earnings per share. When you couple that with our growth factor, our growth capital, whether that be M&A, new builds, share repurchases, you're getting to the point where that's when you're approaching the $3 or piercing through the $3 in 2023 and you're getting to those elevated growth rates above and beyond the 8% to 12%. So cemetery is a big driver from that perspective.

Yes, clearly. And to this last point, can we just touch base on your outlook for deal activity, right? Are you expecting kind of a pickup in activity because of the pandemic and the disruption that created to some of the smaller operators? Are you active? What kind of multiples do you expect to pay? Is there any kind of view that multiples will be going higher or lower because of these dynamics?

I hope multiples won't go higher. We certainly haven't paid them. The vast majority of these families are very long term in nature. And whether this pushes them over the edge and they decide they want a liquidity event, we'll have to see. We do have a nice, healthy pipeline right now. There are a couple of those families that are saying, hey, liquidity event based on my 2020 EBITDA, and that's just not going to happen. I think the industry is disciplined. That will be normalized out, frankly. And I'm not seeing pressures on multiples from that perspective, Joanna. But again, we're going to take our long-term relationship approach to our M&A program, and we're going to wait for these families to raise their hands and decide they want a liquidity event. But in the meantime, we're going to spend a lot of capital, $50 million to $60 million on new build opportunities, which are very specific to certain areas and allow us to have the infrastructure that's perfect for what we're trying to do related to event planning and having the event facilities.

Yes. I think that this is all the time we had for now. Hopefully, we will see you in person next year in Vegas. And everybody, thank you so much for joining us.

Thank you, Joanna. Thank you, everybody.