Service Corporation International (SCI) Earnings Call Transcript & Summary

For our next presentation, we have the team from Service Corp. International. And speaking about company is Aaron Foley, Vice President and Treasurer. And I will turn it over to Aaron to just give us a quick overview, and then we'll get into Q&A.

Here we go. Sorry about that. SCI is the largest death care services provider in North America, the U.S. and Canada is what we term our North American market. We have about 1,500 funeral homes, 450 cemeteries. More recently, our revenues run about $4 billion, $4.1 billion, obviously, impacted by COVID over the last several years. It's been definitely an interesting period that we've -- the entire world has gone through, but very much a learning experience for SCI that I think us, like many other companies have actually come out of it stronger through a lot of the learnings during this period, but really, really happy to be here.

[indiscernible] can manage that technology. And could you just maybe give us a broad overview kind of the quarter and the guide and so forth in your comfort levels going to the rest of year? And even as you look at the '23, kind of your thought process around '23 and what it's been obviously coming out of the COVID environment? The metrics are a little bit different than they were going in. So maybe just throw it over to you on that.

Sure thing. This year, as the past 2 years has been a little bit of a roller coaster. And it's been as difficult on our side to really peg and model, as I'm sure, as it has been on your side. I'd say over the last 4 or 5 quarters, we've expected the next quarter to finally be the one where COVID finally abates. Obviously, mid- to late last year, we saw delta come through strong late last year and early into this year, we saw Omicron coming in. And so we opened the year with the guidance, and I'm going to use an EPS guidance expectation for 2022 of $3.30. And initially, we had an expectation of cemetery preneed production to be down about 5% year-over-year and funeral volumes to be down somewhere close to 15% year-over-year. Fast forward to May, when we had our Investor Day, which we have a presentation out there that I think has a lot of good information and details, if you're interested in digging into that more. But the first quarter came through. Obviously, volumes because of Omicron came in a lot stronger than our expectations. Cemetery preneed actually, from the first quarter, we came in a lot stronger than our expectations there as well. And so we updated our funeral volume expectations to be down in the low teens and then cemetery preneed production actually to be up 5%. And so updated our guidance to $3.50 during that May Investor Day presentation. Now fast forward to the third quarter. I think we are finally seeing the expected decline in volumes as a result of COVID slowing down finally. But what I'll tell you is the funeral volumes that have come through over the past 6 months have continued to be very strong, even absent the COVID impact that we've seen on our business. And the CDC has mentioned these as excess deaths that we've been seeing coming through. It could be related to the deferred health care where stage 1 cancer could have been caught early had the screenings taking place. But unfortunately, now that's occurring and it's being found at stage 3 and 4. So we're seeing the impacts of deferred health care during the COVID crisis. We're seeing the impacts of psychological impacts such as suicide, drug overdoses, alcoholism. All of that is going to what is driving these excess deaths over and above what we would have expected. So when we look at the May $3.50 guidance to where we kind of stand today at $3.70, I'd say that we grew our volume expectations were really the biggest driver. Cemetery has generally been about flat on a cemetery preneed perspective, but those volumes coming through have really benefited our business by the tune of about $0.40 of that $3.50. But what was not contemplated back during the May Investor Day was the turmoil and impact in the financial markets and the impact on our caskets. And so I'd say that, that's probably about a $0.20 headwind on that versus that $3.50 expectation. So we're looking at about $3.70 for 2022. Incorporated into that is about $0.40 of an impact of COVID that when we look forward to 2023, we expect to go away. So our normalized base for 2022 is sitting at about $3.30, and I apologize for throwing out so many numbers, but just trying to lay out all the dynamics that we've mode. So that $3.30 kind of normalized base, excluding COVID from 2022, we kind of expect to be back at a normalized 8% to 12% growth rate to 10% on that, that gets you to the $3.60 guidance expectation as we look forward to 2023. Now keep in mind, that includes increases in EBITDA and earnings from our base business, but it also includes a headwind of about $50 million as a result of increasing interest on our floating rate debt.

And your revenue [indiscernible] a couple of percent. I know the trust funds play into that cremation rates so far. Where do you see that playing into kind of that guide, if you will?

So during the third quarter, at the base business, our average was up about 4.7%, I think it was. And that, I think, shows the pricing power that SCI has from an inflationary cost perspective. We really look at our pricing on a regional type basis and where our regions may be encountering some pricing pressures. Whether it be from labor, whether it be from other costs utility or whatnot, our teams are able to go into each of those areas and say, okay, how are we going to pay for these increases in cost. And so that's what really drove that 4.7% increase in sales average coming out of the system and then the headwinds of cremation and PFI then brought that average down to the 1.6% or 1.7% that you saw. But looking forward, I'd expect our expectation is that's going to continue at about that low single-digit percentage type increase range. This is my first inflationary period to be living through and experiencing at SCI. And we'd always heard that SCI does have the pricing power to be able to overcome that. And we're kind of seeing it come to fruition. And so as we look forward, that continues to be our expectation.

And how challenging has it been? The labor, I know you've talked about fuel and labor, really the 2 inflationary impacts. How has that -- can you just give us an idea of how that's played out what you've seen kind of over the past -- really the past 1.5 years.

Yes. I mean I think we're seeing what pretty much every other company is seeing out there. I'd say that 2022, we probably witnessed the brunt of it. I think we're seeing some of those impacts abate to a certain degree. The openings that we have out there are definitely coming down for open positions. So I think it's being managed and monitored very, very closely. So as of right now, I feel like we're in a pretty decent business place.

Okay. Can you also touch on cremation trends? I know it's topical and it's always been something we've talked about for years. But are the trends unique today from where we were kind of pre-COVID or you kind of seeing that same a little bit of a headwind, if you will, as that continues to be a headwind.

Sure, Larry. So I'd say during COVID, right at the beginning time period when everything was shut down, we definitely saw an increase in our cremation mix. Historically, that has run between 100 to 150 basis point shift from burial to cremation every single year. During the early parts of 2020, we saw increases of 250% to 300% but that was because people just weren't able to have their interments and the burials take place. It was interesting during 2021, though we saw many quarters that were either flat or down as things had opened up. And finally, we were able to get back to normal. Looking year-to-date, as of 9/30, the cremation mix is about 160 basis points. And so that's really kind of in line with where we'd expect. It's been very consistent of a shift over the last 20 to 30 years. If you go back 20, 30 years ago, we were probably 25%, 30% cremation, the balance being burial. And today, we're probably around 61% in total for the business when you include our SCI Direct business. And so we're already the largest cremation provider really out there in the U.S. kind of a rule of thumb that we put out there given our current volume. For every 1% shift in our cremation mix from burial to cremation, it's about an $11 million EBITDA headwind. And when you look at SCI kind of on a normalized EBITDA basis where we stand today, that's on a $1.2 billion type EBITDA base. And so while it's a headwind, we really kind of view it as a manageable headwind.

You've talked about recently more particularly on the quarterly call about investment in technology and its opportunity, I think, both on a kind of a customer and a noncustomer basis. Can you talk about that investment and what opportunity that presents?

Sure. I'd say about 2 to 3 years before COVID really came about. We've already been incurring a lot of cost into Beacon, which is our kind of preneed selling tablet or technology that we're able to give to our 3,700, 4,000 sales counselors. And as COVID came about, we found that, that was really a big impact for us and a really positive as our counselors were able to, in a remote basis, really work with families who weren't comfortable meeting in person, which obviously took about a year, 1.5 years before people really started getting more comfortable in getting in front of people. And so we had a tool that the families could easily sit at their computers across virtually from a counsel and walk through the entire sales process. And all the services and products that we had to offer to be able to really help drive those sales. And I think that -- so that was a piece of technology that we'd invested in that's really impacted both our funeral and cemetery segment that we were able to benefit from during COVID that we were able to capitalize on that some of our competitors don't. Another item that really kind of evolved during COVID was our usage of salesforce.com, our CRM system. Prior to COVID, our counselors really were using it more as a database, just to capture, hey, these are the leads, but it was really only being utilized maybe 50% to 60% of the time. Fast forward to today and really during COVID, if a counselor wanted to get paid, they had to make sure that, that lead within salesforce.com to be able to earn that commission. And what that's given us is just a wealth of information about how the sales process matriculates and which counselors may be more effective at managing, let's say, seminar leads or which counselors may be more effective at managing direct mail leads and so on and so forth. And so we're able to really direct those leads to the more effective counselors who are out there really driving the sales. And it also has given us the ability to identify training opportunities within our salesforce as well, where one counselor may not have as good of a track record at setting up an appointment or actually closing point. We're able to do spot training with those counselors to really improve on those metrics. Kind of fast forward to kind of looking at the investments in technology that we're doing today, we're really trying to -- we look at it from an end-to-end type perspective. We've got this initiative going on called Reimagine where we're really trying to look at the entire process from both the counselor perspective but also from the customer perspective to make it just a much more contemporary process and as painless as possible for everyone involved. And so there -- because of the regulations, there's so much paperwork that's required from these locations and these funeral directors to manage body, just making sure that all the compliance and all the controls are in place and being followed properly, we're trying to put in place a process that makes that as seamless as possible and then as well from the customer perspective, from the time that our locations received the initial call to the final call that the location or counselor is making to the family to make sure that everything wins smoothly and well as possible to try to make that as seamless as well.

In the industry, I would guess that your technical innovation is probably some -- I want to call it some unique, but I mean you're largely competing in many respects with the mom-and-pop industry, right? I imagine I would guess your steps ahead in terms of your deployment of capital to technology and the opportunity it presents in terms of ability to gain market share, I guess, ultimately, is what drives.

You're exactly right. I'd say it's not only the mom and pops, but even the other consolidators out. They're just not able to deploy the capital that we have into this technology. Obviously, we're a business that you can't just go buy off-the-shelf technology to really help us because of the unique needs of our business. And so that's an area that we're really trying to differentiate ourselves and really honestly just trying to make sure that the families are able to have as good of an experience.

Okay. Are there any questions in the audience? Well, go ahead and ask yourself.

What's the ability to raise prices once you kind of effectively consolidate an area?

So there are about 22,000 funeral homes in North America between the funeral -- between U.S. and Canada. And so it's definitely a very -- it's a nice tight out there. And so we can't go out there really and increase pricing tremendously. We really have to watch the markets and really from a regional perspective, kind of see where we price relative to our competitors? What is the quality of our service offering, our facilities, our labor that we have on hand as compared to everyone else to make sure that we're not pricing ourselves out of the market. We saw that over in the U.K. with Dignity PLC. They were just increasing pricing just tremendously each and every year in the mid- to upper single-digit percentage type range until it kind of finally came back and bit them. If you look at our track record of increasing pricing, it really has been in the low single-digit type percentage range. And so I think that while in this inflationary environment, we are seeing the ability to drive pricing. I think that for the most part, we're going to kind of be limited to driving that pricing much more than that single-digit percentage, low single-digit...

What's your ability to take cost out to consolidate and to do shared services and how much margin can you bring down?

It's definitely is when we're doing an acquisition, I'd say that in a normal mom-and-pop type acquisition, we're probably paying an 8 to 9x EBITDA multiple. I'd say within pretty immediately, we're able to achieve about a turn reduction on that multiple because of purchasing synergies. And then over the balance of the next 12 months, 18 months or so, achieve another turn as there is attrition at that location. And as we are able to consolidate and centralize more of those back-office functions. But I wouldn't say a tremendous amount of that increase in synergies is really from pricing on the funeral side. I would say on the cemetery side, it may be a little bit more differential. Every year, we're spending between $100 million to $120 million on cemetery development activities where we're going into cemeteries and identifying opportunities if the market will sustain it, to anywhere from building a 3 or 4 story mausoleum on the West Coast that overlooks the Pacific and essentially being able to provide more tiered inventory offerings versus just a homogenous plot but offering, let's say, a private estate offering lakefront property, where we dig out and create a lake and then build lots around that. That's where we're able to come in and incur some capital, but really drive some tiered property offerings to drive up average more on the cemetery side. And again, there are just a lot more barriers to entry on the cemetery side. There really just aren't very many cemeteries being built in population centers. And so for the ones that we have, that's where we're just identifying these development opportunities to help drive some of that average increase.

Aaron, just to follow on your comments that you referenced on kind of acquisition opportunities, and you talked about the dynamics of multiples and so forth. What is the -- obviously, we love the fact that your leverage profile is very contained, great shape, generated a ton of cash. How do you view the M&A environment right now? I know mom-and-pops tend to be a little bit of a headwind. But you had mentioned a handful of small consolidators. Do you find opportunities? Are you seeing opportunities? Is anything different kind of pre post COVID today in terms of that environment?

I'd say that we see on the horizon some good opportunities. I think a lot of these mom-and-pops have just gone through as we all have an extraordinary time because of COVID, and they're just hired. Everyone's been worked extremely hard to make sure that they're there for the families. And I think that as we've gone through COVID, where the acquisition opportunities have availed themselves some difficult conversations have had to have been made where they want to be valued on their, let's say, 2020 or 2021 volume when we, on our side, expect that there is going to be a drop in volume, which we're seeing come to bear. And so I think as we get further into this more normalization of a volume perspective, there may be more opportunities that do avail themselves from the exhaustion that's out there from seeing the dropping in volumes. Right now for 2022, we still maintain our $75 million to $125 million acquisition target. Coming out of the third quarter, year-to-date, we'd only spent $14 million or so shortly after quarter end, Eric did mention on the call, we did a $40 million acquisition. And we do have several targets that we're expecting to close on here in the fourth quarter to achieve well into that target range. I'd say as we look forward to '23, we are hoping that there will be more opportunities to come. We don't want to get into a position that we're going to pay up to get those opportunities. Obviously, acquisition deployment is our highest and best use of capital, but we're only going to do so if we're able to model and target that 11% to 15% IRR.

I presume with the -- that the North American market, they would not past you've been an international footprint a little bit more of an international. That would not be something that would be on the table.

Right now, the international option is probably not on the table. Back in the '90s, I'm sure many of you all know, we were in about 23 different countries, but that was under a different management team, and it was really a different strategy. It was an EPS accretive roll-up strategy, no focus on return on invested capital. I think right now, the synergy opportunities from an international acquisition just aren't there because you have to leave a pretty sizable management team in place. And so I don't think that, that is on the horizon right now.

So are there more sizable assets getting outside of the $75-plus million target? Are there bigger assets that you could target.

There are definitely chunky assets out there. I mean in 2018, we bought Gibraltar, which was $150 million plus type acquisition. And so they're out there, we have about 600 to 700 target list there, maybe $1 billion to $1.5 billion of revenue that we are looking at potentially acquiring at some point out there cultivating these relationships. But it really until they're willing to have that conversation until they're interested to sell. We're kind of just waiting for that point. And another question that kind of comes on the heels is what about the consolidators? The [indiscernible] and so on and so forth. You just have to keep in mind, a lot of those businesses were born from our acquisitions that we've done in the past with FTC required and mandated divestitures. And so any acquisition that we do of a consolidator right now in this FTC environment, it would be an extremely difficult transaction to make financially. That makes sense.

Any other questions, if not, I'll wrap up with one last. Volumes, I know it's certainly been topical events, if you will. When do you see it normalizing, if you will, if there is such a thing? I mean, is there a time frame or a mindset around when you think it will kind of normalize?

So there are several different factors that are driving volume right now. I don't think anyone really has their head around exactly what they all are. We've got the excess desks driving. We've got baby boomers that are coming at some point. I don't think -- we don't have them in our guidance the expectation of an increase for baby boomers in the next 4/5 years or so, but expect that those will come forward. Market share is a hard one to peg as well. The data out there just really isn't all that great. I'd say that during COVID, where there were opportunities for us to pick up market share where some of our competitors may have been shut down either because the volume was too great or they just didn't have the people there to support. We did have the resources to shift around the country to be able to accommodate for that. And I think we believe that on the cemetery side, where we have a combo location, if a family may have buried a loved one in one of our cemeteries during COVID, where they weren't able to go to their local provider. We think that some of that market share gain is probably more sticky than if they had to drive across town to go to just a funeral home of ours because their local funeral home wasn't there that I think that, that market share is probably a little less sticky. So I think in our modeling, expecting market share to remain constant. I think we're expecting some amount of excess debt to continue into '23 and maybe start dropping into '24. But I the third quarter was really the first big quarter of a volume decline. I think you're going to see another 2, 2.5 quarters or so of volume decline. And really, in 2023, I think it's going to be kind of the new normalized annual basis there from a volume perspective.

Okay. Unless there's any questions, I think we'll go ahead and wrap up. Thank you, Aaron.

Thank you, Larry. Thank you, everyone.

Thank you everyone for joining.