Service Corporation International (SCI) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us today. I'm Scott Schneeberger, the Senior Business and Consumer Services Analyst at Oppenheimer. So our pleasure to have Service Corp here today to speak on the company's investment story. We're drawn to SCI's leading position in the funeral services and cemetery offerings industry, its opportunity to capitalize on the favorable demographic [ cell ] an aging baby boomer population and its strategy of providing preneed contracts to gain advanced market share and garner a backlog to build its trust fund portfolio. We have with us from Service Corp., Chief Financial Officer, Eric Tanzberger. We'll be using a fireside chat format. I'll ask management some high-level questions on front to get us an overview of the business. And later in the session, we'll open it up for questions from the audience.

So I'm going to get started with a general overview question. Eric, thanks for being here. Could you please discuss your overall business model and strategy? Thanks.

Well, thanks, Scott. Thanks for having us. And just as an overall answer to that overall question since I can't see anybody, I'm going to assume that we maybe have some newer investors, so hopefully, in our shares as well. So maybe I'll go into a little bit more background in depth. Scott already covered the basics funeral and cemetery business, 1,500 funeral homes, 500 cemeteries. You can see a lot of this in a slide deck presentation that has a tremendous amount of background in the history of the business and our company in our Investor Day deck, which was May 6 of this year, so very fresh materials as well. Generally, we grow earnings per share in the 8% to 12% range. We started that, we became the management team in 2002. We've been able to do that really since we began our platform for growth in 2005 for probably the last 17 years. When you go back and do the math, the CAGR is actually a little bit better than that. So when you think of our company, think of it as a 10% grower as earnings per share as we move forward. I think Scott mentioned M&A a little bit, I think, in your short introduction there. A good amount of that is organic growth coming from the sale of cemetery property on a preneed basis. And some of that is M&A and new build growth. So nonorganic growth as well as we continue to spend roughly $100 million a year as a general statement in M&A acquisitions and continue to grow the company that way. The funeral segment is a 19% to 20% margin business. It's a very solid business. It has great cash flow characteristics. It's not growing substantially at this point in time affected by the boomer, the baby boomer generation, excuse me. The top line growth are low single-digit percentages at best. We worked very hard on a fixed cost structure, which is pretty significant at 70% fixed cost structure business. The good news is that lends itself to very high incremental margins as you put more throughput. You've seen that in periods of time during flu pandemics. You've seen it in a period of time during the COVID pandemic, where that 19% to 20% margin expanded to the mid-20s to the high 20s and such as we move forward. This industry, that part of our company is poised for growth as the baby boomer generation gets older and ultimately affects it. The cemetery segment, Scott, is a little bit different. It's been the growth engine for us that has generated that 8% to 12% earnings per share growth over a period of the last, call it, 17 years, coupled with some sizable M&A acquisitions. The situation here is this is the first time we, as an industry, touch the consumer. And that's usually the age of low 60s to mid-60s. And the first thing a consumer does is buy cemetery property in our cemeteries. That's the lot, the long crypt, the mausoleum crypt, the mausoleum niche for cremated remains, et cetera, and they buy that on a preneed basis in their early to mid-60s. We construct that property, we deliver that property. So not only is that a cash flow growth play, it's also a P&L growth play. And because the baby boomers have crossed over that 62- to 64-year-old sweet spot in terms of those sales, that has allowed us to generate some nice positive growth -- organic growth in the cemetery segment, which has been predominantly the driver of the growth that we've had over the past 15 years. Pandemic was tough on us. We did about 110,000 extra funeral services over a 2, 2.5-year period. There was a big aperture from the consumer in terms of wanting to buy products and services on a preneed basis, which show preneed cemetery sales. Our EPS peaked just above $4.50 during 2021. There will be a transition period here as we come off of that COVID pandemic that's built into our guidance of 2022 of about $3.50. And then we have extensive stuff in this Investor Day in terms of how we believe we can continue this growth from this platform now of the mid-$3 range of earnings per share. So quite a lot. A little longer summary than prior to which you're looking for, Scott, but I wanted to also get all that out there in front of people for new investors potentially on the call joining us today.

I thought that was an excellent overview, Eric. So what we're going to do, the next questions I go into are going to be kind of top line and covering that. There are a few of those. And then we'll get into more of kind of current events. Obviously, inflation is on people's minds. So that will come after. But jumping into the top line, looking closer at atneed funeral and cemetery business. Growth has been elevated during COVID as you mentioned, please discuss funeral volume trends. Now that the pandemic appears to hopefully be waning as well as sharing perspective on the broader timing of the demographic tailwinds you mentioned? You covered that pretty well, but maybe 1 or 2 additional lines.

Yes. So as I've already said, related to the funeral volumes, they were significantly impacted. We generally do 315,000, 325,000 funerals a year in our particular company in our network. That grew by about 110,000 funerals over a 2-year period. So very significant. I mean we had quarters that had 20%, 30% volume growth, unfortunately. The good news for us and for our consumer is that because of the scale and size of our business, Scott, we were able to service that consumer and stay open. We're able to move personnel, anything that we needed to certain areas, hotspots of the country and essentially keep the doors open to serve that consumer. But from all that, there's a sizable portion of that 100,000 that's going to be pulled forward from future years. At first, we thought it was very acute early in the pandemic, meaning like we pulled forward '21 volume into 2020. Now as the dust settles, we find that that's really not the case. We have a very long tail, going out 8, 10, 12 years easily of deaths that would have occurred well into the future that did occur in that 110,000 incremental COVID deaths that we did in 2021. So there is a pull-forward effect. Part of that is the reason why we're going from [ 4 50 ] and '21 to [ 3 50 ] in terms of that volume, but that's built into that. And ultimately, once we get through and settle this in 2022 at the [ 3 50 ] level, we think we can grow again off of this volume in the flat to low single-digit percentage ranges in terms of volume growth as we move forward.

Thanks, Eric. I appreciate that. We'll go quickly on this next one, but I think it's very interesting. The funeral revenue per service has rebounded strongly post the days of social-distancing-related disruption. And this metric has recently been trending above 2019 levels. If you could discuss the drivers and provide long-term perspective of what's occurring there.

Yes. I think you have to understand is that as we all know, the country was shut down. And when the country was shut down, it precluded people from having the closure and the celebration of life as a general statement. We are very unique in the way we did it. We use technology to do it. We had all kinds of different situations where we celebrated from a distance and a cemetery and, et cetera. But for the most part, as you said, Scott, the ASP was hurt to a significant -- to a significant amount because people were not spending money on catering, celebrations, flowers and such because people weren't physically there. That's, as you said accurately, that has rebounded to a large degree, and we're really kind of back to where we expected. From an overall perspective, when you look at it compared to the pre-COVID growth trajectory, we are a little bit higher. And a lot of that has to do with us continuing to train our personnel, but to service what the families want and that's the celebration of life. We spent a lot of capital going into our funeral homes in terms of getting the right venues, the good, better, best venues. We'll continue spending that capital. But what it is, is that we're the first -- we have the first opportunity to interact and work with a family at their time of need. And that gives us an advantage, frankly. That allows us not only to do the basics of what that family needs at their time and need, but to then immediately enter into a discussion about how do you want to celebrate your loved one's life. And with us having the capability, the personnel, the event planning expertise and the infrastructure in these venues at each one of our funeral homes, that has allowed us to probably grow a little bit above the levels that you would have normally seen pre-pandemic as you take that trajectory level as you described from 2019.

Recognized cemetery preneed sales have historically been a P&L growth driver for Service Corp. if you can please discuss the drivers of the strong growth you've experienced over the past couple of years with apparent. But provide perspective on we should anticipate the trends over the near to intermediate term there from what has occurred over the last 2 years.

Yes. What it really did in the preneed cemetery and what it missed, the pandemic is what I mean by that, is it just accelerated our confidence that we can roll out customer-facing technology. And the reluctance to that early on is that you're dealing with someone that can be 70 years old, 80 years old, somewhere in that ballpark. But clearly, when the business is shut down and the world shut down, we had no choice but to utilize technology, whether it's Zoom like we're doing today or WebEx or what have you, Documentum, using our online tools, sales tool called Beacon, which virtually can walk the consumer through the process, utilizing pictures and videos and all the choices that you could do. Now some of those were precluded in the individual laws during the pandemic as the country was shut down. But we learned a lot, I guess, is what I'm generally saying. So when I think of what we learned and what gives us confidence in terms of printing cemetery sales go into the future, I think technology, I think we've revolutionized leads in terms of digital leads. I think we've gotten so much smarter in terms of sales effectiveness, in terms of reducing turnover, using our Salesforce, CRM system, which has just given us an unprecedented level of stability into that Salesforce of 3,500 to 4,000 sales counselors. And the last thing that you just can't overlook in our business and in our 500 cemetery specifically, is the inventory itself. Years ago, as you go back 15 years or so, the cemeteries when you walked in were homogenous inventory offering. It was an acre of land and it was here are the homogenous plots, pick which whenever one you wanted. We have completely turned that upside down into really a real-estate-type mentality, a real estate inventory play, where you walk into a cemetery now, you have very high private family estates and semi-private family estates and lakefront properties and views and all the way down to you get to that original homogenous offering. And I'd point everybody to Michael Johnson's slides on our Investor Day deck, which walk us through that in a big way that has increased the spend, all of that, the technology the digital marketing and digital leads that we put capital behind and learned during the pandemic the sales effectiveness, everything that we've learned and will continue to learn with our sales part CRM system, coupled with that inventory is the real answer to your question, Scott, during the pandemic as well as we move forward into the future.

Great. I think let's move into kind of current events and this inflationary environment that we're in. If you could please address cost inflation across the company, both the funeral segment and the cemetery segment and what your ability is to mitigate cost inflation via price increases?

Let's talk costs first, and then we'll talk about how we can pass that through in terms of the top line. Our largest cost by far are going to be personnel. We have 25,000 associates for our $3.5 billion, $4 billion in revenue. That's a lot of associates across a very dispersed geographical area. So you're talking $650 million to $700 million of our cost structure as per personnel alone. The majority of that, probably 2/3 of that is in the funeral segment, and 1/3 of that is probably in the cemetery segment, but we've seen wage pressures in this inflationary environment. Interestingly, I think it's very noteworthy to mention that our industry is a little bit unique and a little bit different where we have funeral directors that are licensed funeral directors, that are in a very specific industry with a very specific license, with a very specific kind of personal calling to serve the consumer and celebrate that family's life. That's not a transient employee. Now that may jump from one funeral home to the other maybe. But for the most part, we have kind of an underlying stability to our industry that lends itself to not have the transient associate, which ultimately drives cost inflation in the employee or associate environment. We do have a little bit of that in our cemetery segment. When you start getting into taking care of 500 cemeteries, you're going to have some cost pressures. Most of that is outsourced for us, but we've had vendors come to us with mid to high single-digit percentage increases as it relates to those types of cost pressures. And we'll work through that. Ultimately, now what kind of inflationary pricing power do we have? That exists in this industry. In my career, I have not been through a high inflationary type environment and see really how it's going to work. But we feel very strongly that we do have some inflationary pricing power in our industry, both in the funeral segment, specifically, as well as in the cemetery segment. In fact, I'd probably characterize it, Scott, as more in the cemetery segment because the funeral segment is very competitive. We're going to have independents competing with us across the street, et cetera, et cetera. The cemetery segment is a unique situation where there's no new cemeteries as a general statement being created. And there's a moat around the existing cemeteries when you think of barriers to entry, therefore, into that segment. That lends itself to having probably more pricing power than what you would normally see in an industry and what you'd normally see when compared to the funeral segment. How we're going about it is very, very specific to locations and to markets. There are certain places along the network that are somewhat stable, even though there are some cost inflationary pressures. But we are now -- you're not going to see us come through and say, like some companies have had to do in the retail industry, everybody now is going to have this raise or everyone is going to have this new compensation and such. We are handling it very location specific, very market-specific without location or market leadership. And we are, therefore, finding a way to pay for it, so to speak, through some pricing initiatives or some other initiatives in terms of expanding the average sale per customer and such. And that's true across our network for both the funeral and the cemetery. So Scott, that's how I described the current inflationary environment out there, at least for our company.

Great. And just if you could kind of by segment again, and this is works in cost inflation as well, but you really saw a spike in margins to margin question during the pandemic. Obviously, a lot of leverage from elevated business activity. But could you speak to how we should think about margins going forward? Because you've made the comments that you still think you can exceed pre-pandemic levels as we come out of it. But obviously, there's a lot going on out there. So just some high-level discussion of margin and by segment if possible.

Yes. I think, first of all, let's talk about the baseline. The baseline in the funeral segment is probably 19% to 20%. That's a good go for margin. You're going to have some ebb and flow during specific quarters. The third quarter, for example, is the lowest funerals that we will perform. And again, with a 70% fixed cost structure, the margin is a component of throughput. And so when you have very low throughput seasonally in your third quarter, you may only have mid to high teens type margins. But as a general statement, you're going to have a 19% to 20% margin in the funeral segment. As you said, that grew during the pandemic. You were putting a tremendous amount more volume or throughput through that fixed cost structure. Margins are 25%, 27%, 28% in that area, that's going to come down. Now that we're kind of, knock on wood, for the most part through this pandemic. I have to tell you, though, we continue to see a good amount of incremental services being performed that are a byproduct of this recession. That stuff is real. When you start talking about mental health and suicides and delayed health care because people didn't go to doctors to get checked during the pandemic and such. We are still seeing that effect. You've seen people talk about that in the health care environment. And I do think, for the most part, that's real. The punchline is in the funeral segment, it's going to take some incremental volume throughput, whether it's continuing to gain market share through our preneed funeral backlog or the eventual take of -- the eventual impact of the baby boomers to really push those margins up in the funeral segment. Cemetery segment is different because I've mentioned to you earlier in the introductory part, it's been growing. That top line is not 1% to 2%, 1% to 3%, that top line is 3% to 5%, 4% to 6%, something in that ballpark because of driving preneed sales. Funny, Scott, I ran across about a week ago. It was a press release or conference call remarked 20 years ago. And I was just curious to look through it. And our cemetery segment had margins of 12.5%, while our cemetery has margins of 30% today as we speak that are sustainable, they increased into the mid to high 30s during the pandemic with the incremental throughput. So we're very proud of that. We're very proud of everything that we've done from the real estate play of the inventory to making our sales more efficient to really driving a totally different level of preneed cemetery property sales than what we saw many, many years ago. So the model works as we put more throughput through this, you'll continue to see margin expansion. You're already seeing in the differentiation between cemetery and funeral. But as the baby boomers continue to affect cemetery, in the atneed part of cemetery, which people forget, that's a growth driver. You saw that during the pandemic. As well as in the atneed environment in the larger funeral segment, that's where the opportunity is, we think, as we move forward in terms of margin and expansion with more throughput.

Great. Thanks, Eric. Tying this together at the recent Investor Day, you provided expectations. Obviously, there's guidance for this year, but expectations for EPS through 2025. Please remind us of your outlook or your view on the long term. And what are the puts and takes that get you there?

Yes, we're very positive on the outlook. As we've described to you. I mentioned before, we think we can grow it to 12%. I think we call it 10%. When you look at the past track record of 17 years, I think we've overproduced that in terms of what the initial guidance was of that 10% in terms of the CAGR over the last 17 years. Guidance is only in 2022 if we want to get very specific or technical about it. But ultimately, what we said is, look, we think we can continue to grow off of this new foundation growth in that mid-3s earnings per share growth in that 8% to 12% range as we move forward. And I think that's important to know because we've done it in the past, and we kind of had an elevated pop during the pandemic. That's come down from the [ 450-ish ] area in 2021 to the [ 350-ish ] area that we think is sustainable now, which, by the way, if you go to the Investor Day, you'll see me walk you through how if you did the 10% CAGR from 2019, you'd only be at about [ 250 ]. And so a portion of that [ 350 ] that I'm describing, about $0.30 of that is current COVID pandemic during the first quarter of '22 to be fair. But there's still $0.65 a of learnings that have increased the base of where we can grow from here, and we think we can grow from it on the 10%. The interesting thing that we also did at the back of the Investor Day presentation, is -- and again, this isn't guidance, but with this because of the timing of it. But what we really tried to tell you is, look, there's a lot of things that we're doing strategically. When you invest in SCI, you know that you're going to have demographic tailwinds come this way. You're also going to see a lot of improvements and I've already seen a lot of improvements as the way we approach digital marketing and sales and technology. You're going to have that cemetery inventory that's going to continue to be a powerful growth driver. You're going to have a pretty backlog of $14 billion. That's going to continue to be a growth driver as we move forward. And you're also going to see us continue to put capital in use, whether it be M&A or share repurchases. So when you put all that together and you say you've been growing 10%, what happens when you get a little bit more out of it because of these 4 pillars as I've described to you and are described in that presentation. And you say, let's just take an example of an extra 200 basis points growth above and beyond current trajectory in both the funeral and cemetery. That's when you do the math and you start seeing the power of the model, the leverage that's inherent in the model that now all the sudden, instead of growing 10%, you could be growing upper teens, 20% in terms of that. That's what excites us. It's not specifically guidance because we don't know the timing of a lot of that. Specifically, I'm describing demographics in terms of when the baby boomers affect the funeral segment, but we really want to go ahead and show everybody out there that this is going to continue to grow at a nice cliff, but, boy, can really be powerful when we get demographics on our side. And we're excited about that, Scott.

Excellent. That sounds good. Just on about 5 minutes remaining, Eric. I'm going to touch now on really -- the business generates a lot of cash flow and SCI has historically returned capital to shareholders via dividend and share repurchases. Could you speak about the capital allocation plans at this juncture going forward?

Sure. You've seen our cash flow guidance out there that's generally in that $750 million to $800 million range. We have to pay cash tax. This is off half of that. So you're going to have $180 million, $200 million cash taxes. But then you have an incredible amount of free cash flow. I think the first thing that we do with that capital or that free cash flow is pay a dividend. And we want the dividend to be 30% to 40% of our net income in terms of a dollar amount of a distribution and we want it to grow as the company has grown. And now we're up to about $1 per share per year, and we're proud of that because I remember when we didn't have a dividend of 15, 20 years ago as well, and that's about $150 million of capital, by the way, that we're spending. So you still have $400 million to $500 million of free cash flow, and you really have a little bit more than that because the EBITDA is growing and we want to maintain our leverage as well. So we have a little bit more room to kind of incrementally lever up, but you got that math to create even more opportunity of capital to spend. We're going to deploy to the highest relative return opportunity. That has traditionally been first, M&A. M&A can return anywhere from 12%, 15% in that ballpark after-tax type returns. We also have a big program that we described. John Faulk described during our Investor Day related to new build opportunities. We're continuing to put a lot of capital behind that. I remember when we spent $2 million to $3 million on that, we're now spending $50 million on that in terms of new builds and refurbishment of existing facilities as well. That's going to be a growth driver. It doesn't quite have the high returns that the acquisition does because you have a period of the first few years where you have to build up that EBITDA organically in the marketplace. But hey, it returns a nice healthy 12%, 13% return. And that's a great use of our capital. We've also been huge proponents of shrinking our equity as we have tried to get ready for many, many, many years for the big movement in our industry as the baby boomers touched this industry and create those types of 18% to 20% returns that we described at Investor Day, the power of the leverage that it's inherently in the model, but we will continue to shrink our equity. And I remember when we had 340 million shares outstanding. And today, we have 155 million to 160 million in that ballpark of shares outstanding. So we shrunk the company more than 50%. And we think at times, it's a tremendous use of our capital. We think at times it's a great, sometimes only a good use of our capital. So you're going to see us relatively throttle up and throttle down that share repurchase program. but that will continue to be a good use of our capital as well, Scott, as we move forward.

Eric, following up on that, the M&A part. You're a leader -- the leader in a very sizable fragmented $22 billion industry. You recently increased your target annual spend at the Investor Day for M&A from $50 million to $100 million a year, up to $75 million to $125 million a year. So could you please discuss your approach to M&A and the opportunities you see, particularly in the near term. How active is the pipeline right now, which is an interesting question, considering we're just coming off of pandemic?

Yes. The pipeline is very robust right now. I think people are tired. I think people are -- got through this pandemic, but it basically saying themselves on tired and I don't necessarily want to do this again. The -- it's forcing them to look inward to their families and to themselves and say, what does this business look like 5 years, 10 years from now? Where do I want to be personally? Do I want to be retired? Do I want to do whatever? And so that has created a little bit of a robust pipeline and giving us the confidence to say, look, I think we're going to do $100 million a year of spend. What's not baked into there are valuation increases. In other words, this isn't because you're spending more for each property. It's still a very disciplined approach, getting the right returns. This is just we think that there's more deals that are out there. We'll stay disciplined in terms of the valuations and the type of returns that I just described to you. But for the most part, we think it's a great time for us. It's a great time to join our company. I think we're very good at integrating these acquisitions, whether the former owner wants to leave and retire or if the former owner wants to continue to be involved to the utmost extent of their desires to be involved in the business and, frankly, be a bigger part of SCI and grow him or herself or their daughters or their sons grow with it. They have now a huge company with a tremendous amount of opportunity for their families in terms of joining our companies, in terms of upward career movement and more and incremental responsibilities as well, which we think is a big asset we have at SCI when we enter that M&A arena with the independents.

Excellent, thanks. I think we have to wrap it up there. I see that we've run out of time, and that's probably a good place to leave it. Really enjoyed the conversation very informative, Eric. Thank you for joining us today and sharing them.

Okay, Scott, you take care. Thanks so much for having us. .

To Likewise. Take care. Thanks, everybody. Bye-bye.