Service Corporation International (SCI) Earnings Call Transcript & Summary

Good morning, everyone. Thank you all for joining us today. I'm Scott Schneeberger, the Senior Business Services Analyst at Oppenheimer. It's our pleasure to have from Service Corp, its Treasurer and Director of Investor Relations, Aaron Foley, to speak on the company's investment story. We're drawing the Service Corp's leading position in the funeral services and cemetery offerings industry, its opportunity to capitalize on the favorable demographics of an aging baby boomer population, and its strategy to provide preneed contracts to gain advanced market share and garner a backlog to build its trust fund portfolio. We're using a fireside chat format, and I'll ask Aaron some high-level questions upfront to get us an overview of the business. And then later in the session, I'll facilitate audience questions. So feel free to send me in your questions, and I'll get those to Aaron toward the end of this.

But getting started now. Aaron, could you please discuss Service Corp's overall business model and strategy?

Thanks, Scott, and good morning, everyone. Thanks for having me here. When I think about just at a very high level, our strategy is really kind of 3 things. It's grow revenue, it's leveraging our scale and it's allocating capital. And kind of those 3 strategies, which I'll get into more really help create the foundation of our 8% to 12% earnings growth framework that we've really had in place since the mid-2005 or so type range, all the way through our current outlook for the next several years. Obviously, '21 and '22 have been impacted by COVID. And so those are driving some more normalization back to a normal trend. But kind of getting back to your question. Specifically growing revenue, really trying to identify ways to provide our customers with the products and services that we believe that they want. While this is an industry that has been around for eons, it still is in the process of evolving and trying to make sure that we are doing what we can to remain relevant with our consumers. And part of that is really helping to drive those preneed sales, as you mentioned earlier, creating -- we've got a sales force of about 3,500, 3,600 counselors who are out there meeting with families and really trying to put in place plans for their end-of-life planning. That's a strategy. Part of it, too, is on the funeral side predicated on something we can't even control, and that's really around [ inter ] volumes. Pre-COVID, that had been trending probably in the low single-digit growth rate. During COVID, we've seen just huge increases. But as we see some moderation in that going forward, we kind of expect to be back in that low single-digit growth rate as we look to '24 and beyond, really driving the funeral revenue top line there. On the cemetery side, it's really a lot more of a preneed business, if you will. And so that's really where we've got a lot of our sales counselors focused on selling the inventory -- the cemetery inventory that's being created, the tiered property strategy that we've been putting in place at our cemeteries over the last 15 years or so. And that's really what's been helping us to drive average, honestly, on the cemetery side. Our entry-level consumers are able to come in and purchase a homogenous [indiscernible]. That's what they're looking for, but we've got all the way up through private estates and bench estates, hedge estates. We've got all the way up to private mausoleums that families can come in, and we can construct for them. And so we've put a lot of capital behind developing the tools for our counselors to be able to use that you've seen over the last several years, whether it be through digital, through back-office technology to just all contribute to helping to grow off of the elevated cemetery preneed base that we're currently operating with. So that's really growing the revenue. Leveraging our scale means that we have the capital in size to be able to deploy that capital to those tools and technology to help us increase that growth. We've got the capital to -- or the size, if you will, to get the best pricing on casket purchases, marker purchases, outer burial containers. We've got some of the best pricing on vehicle purchases for limousines and other type vehicles out there. Not only that, also with this preneed that we're driving, we've got the scale to put in place on the trust side, some LLCs to be able to pool funds to be able to generate better returns because of lower cost structures that we have in place because of the amount of assets that we do have under our trust portfolios. Similarly, with our insurance provider that we work with, we're the largest preneed insurance consumer, if you will, selling to our customers. So the general agency revenue that we're able to earn as well as the accretion on those contracts. The combination of those economics are going to be some of the best in the industry as well. So that's really helping to drive that 8% to 12% earnings growth framework through the efficiencies that are gained there and really helping to drive margins. And kind of all of those components then come together into how we're allocating that capital. And we're then to drive that 8% to 12%, and we've got a history from 2005 to today of shrinking our equity by more than half over that time, buying back our shares and some have kind of deemed it a slow LBO type approach that we've been following and really trying to allocate the capital to reduce our equity to a point to really be able to take advantage of the demographic wave that we expect to come through when baby boomers really begin to impact our business. We've also been in an acquisition type mode over the last 15 years as well. We bought back some of our largest competitors over that time, Alderwoods in 2006, Keystone in 2010, we've also -- Stewart Enterprises was our last biggest acquisition that we did back in December of 2013. And kind of since then, we've been identifying mostly mom-and-pop operators to really drive acquisitions. You've also seen us increase the capital allocation towards new build opportunities as well, new [indiscernible]. And more recently, you've seen us really even expanding a little bit more into the new build of new cemeteries. And so all of that combined really has helped to establish that 8% to 12% earnings growth framework. Really from 2005 to 2019, that earnings growth was -- trended higher than that. I think on a compounded basis, we were between 14% and 15%. Again, as I mentioned earlier on, COVID's created some volatility over the last several years. But with 2023, we're guiding to $3.60, stepped down from 2022, which was still being impacted by COVID. But as we look forward to '24 and beyond, we think us following this strategy is going to help us get back into that kind of 8% to 12% earnings growth framework.

Great. Thanks for the overview, getting us started with that, Erin. Let's dig in a little bit in specifics. It's looking closer at atneed Funeral and Cemetery businesses. Growth has been elevated during COVID or had been. Please discussed recent Funeral volume trends as well as share perspective on the broader timing of demographic tailwinds now that we've moved past COVID.

Sure thing. Thanks, Scott. So in February, we kind of came out saying our expectations for Funeral volumes for '23 were going to be down in the mid-single digits. We have our crystal ball, which I would say is no better than really anyone else's crystal ball, but the way that we kind of came up with that expectation was we took our 2019 volume that we had in place kind of in our last normal volume year. We grew that really at around 1% of those volumes. We added in acquisitions that we've done since that time. We took out divestitures that we have done during that time. Those are the 3 kind of numbers that we kind of have, I would say, stronger parameters around that and comfort with as well as actually COVID figures during that time. The historical COVID figures, we had a relatively good sense of what those COVID amounts were. We then, particularly for '22, had 2 other components that were a little bit more difficult to wrap your head around completely. And one is pulpboard and our estimation and pull forward for those deaths that have occurred in 2020, '21 and '22 that were above normal. Those had to have come from somewhere in the future, and we modeled that out to be, I think in '23, we're expecting -- or in '22, we've modeled about 17,000 or so, '23, we're modeling probably closer to 19,000 or 20,000 of a pull-forward headwind. And then the last component relates to these excess deaths that we keep hearing folks talk about, CDCs define them as such using that terminology. But these are the deaths because of a lack of mental health or a lack of physical health, where during the pandemic, people were less inclined to go to doctors to get checked out. And so Stage 1 cancer discoveries may have been made, have they gone during this time. But unfortunately, when they go to the doctors now at Stage 4, Diabetes has gotten more out of control. Heart health has really gotten out of control as well. On the men's health side, alcoholism, drug overdoses suicides, that has all been on the increase as well. And then I'd at least driving around Houston here where we're headquartered, it just seems that on the roads, people are driving so much more aggressively. So it's just a different dynamic that's out there that based on our modeling and kind of putting all these pieces and parts together and then seeing truly where our volume was in 2022, we got spinout this excess death component, which is driven by those factors. As we were thinking about 2023, we said, well, we expect at some point that those excess [ test ] factors will begin to moderate that people will get back on track with their health care that they being back in society, hopefully, more in line and mental health issues will abate to a certain degree. And so while we expect them to come down, we don't expect them to come down to 0. So we kind of came -- we landed somewhere right in the midpoint of -- on those excess deaths for 2023. Those are all the components that we pulled together to come up with our full year 2023 numbers. Looked at some more normal seasonality, I would say, in the volume expectations for '23 kind of comparing back to 2019, 2018. And as we saw the first quarter unfolding, I would say that our expectations were exceeded on the Funeral volume side during the first quarter. I would say that our mid-single-digit decline expectation for the full year, 2023 remains. But I would say versus February, it's probably moderated some to the better as a result of the activity that we saw in the first quarter. Now you also mentioned the baby boomers and the impact of those and when are we going to see those coming through our numbers and anecdotally, talking to some of our funeral directors, they'll say, this volume feels different. We do feel like it's baby boomers. As you look at that generation, the oldest baby boomer right now is 77 years old. And the average age of death that occurs is around 82 years old. And so looking at the person in the U.S., looking at immigration from other countries, kind of where these cohorts stand associated with the most recent census data that is available and kind of seeing how that trend of the baby boomer generation increased in first. It really -- in the first couple of years of the baby boomer generation, they really hadn't ramped up to that kind of really high level that you think of with the baby boomers. But all of that pulled together, I would say it's kind of our expectation that the baby boomer impact is really not going to start happening until the latter part of this decade, probably closer to 2029, 2030 type range. And at that point, I wouldn't expect that you're going to see a hockey stick go from low single-digit growth up to 6% or 7% growth per year. I think that low single-digit growth may trend closer to low to mid-single digits. So 1 to 2 percentage points higher than what we historically had been seeing. But then I think that, that dynamic is going to exist in this industry for about a decade that you're going to see that elevated growth on a year-over-year basis occurring through the end of 2030 to early 2040s. And obviously -- not obviously, but what we have been doing at SCI, as I mentioned, is allocating capital to reduce that size of that equity. Going into our facilities and making sure that we are structured in a way to be able to handle the volume as it comes through, I do think that the COVID experience that the world has gone through really went to go pressure test, that there in the model that we've got in place. And I think that our system and our structure really kind of passed that with flying colors. And so I think that we're ready. We're going through -- every 5 years or so, we go through a customer segmentation analysis just to make sure, again, it remaining relevant to our consumers that we're providing the type of service that our families are looking for and making sure we're in front of them when they need us most.

Yes, Funeral revenue per service, Aaron, that rebounded strongly post the social distancing era of COVID. And this metric has been trending above 2019 levels for the past few years. Can you discuss the drivers and provide long-term perspective on where you see this metric going?

Sure. So I would say that the rebounding strongly in 2021 and really moving into 2022 to a certain degree, was really us getting back to providing the level of products and services that had existed pre-COVID. And so during COVID, as you mentioned, there was a period where -- because people weren't able to come in, they weren't able to use our facilities. They really didn't need the flowers. They didn't need the catering. And so we really kind of saw that drop off on both, of the burial and the cremation side of things. And fast forward to today, that's kind of all back in line. That's really kind of been in line for the past year, year or so. I would say what we've been seeing really towards the latter part of last year and through this year, and honestly, we expect it to continue to a certain degree into this year or some inflation pricing power that exists in the business. Since I've been here, I've always heard that the business has inflationary pricing power. I don't think most of us have ever really seen an inflation environment that we're living through now, but it's coming to fruition. And so as you look at the first quarter and really the fourth quarter, this dynamic occurred as well, but the average at our funeral home location kind of coming out before taking into account anything related to cremation mix or trust fund income or currency movements, that figure has actually grown in a mid-single-digit kind of space at maybe 5% to 6%. And whereas pre-inflationary environment that had been growing at maybe 2% to 3%. And so we're seeing an elevation in the amount of price increase from an inflationary price perspective. And that is being driven by the environment that we're in, and we have a centralized team here at SCI, a pricing team, who goes out to each and every -- and touches each and every location that we have once a year and evaluates the market that they're operating in, of course, taking into account the level of facility and products and services that we're providing versus the competition and evaluating to say, are we priced at, above or below kind of where we should be. And we will make pricing changes accordingly. And kind of what we've been seeing too over the last year or so is with the inflationary environment that we've been in, if these markets are seeing pricing pressure, they're coming to this pricing team and saying, "Hey, look, this is the environment that we're in." And we say, "Okay, that's fine, but we've got to figure out how to pay for it." And you're seeing that the pricing power exists to accommodate that. So that 5% to 6% growth is though being haircut by the cremation mix that we're seeing during the first quarter. I would say that the cremation mix shift of about 200 basis points was probably a bit higher than normal, and that really is more relating to an anomalously low first quarter of last year. If you look at the second, third and fourth quarter of '22, it's kind of more back in line and more in step with what we saw during the first quarter of this year. Another thing is the currency mix in Canada. The U.S. dollar got stronger. We've got about 7% of our business up there. And so that's creating some amount of a headwind. And then finally, the trust fund income. We've just during 2022, saw some volatility in the markets. And the impacts on our trust funds are helping to create some headway to that pricing increase as well. And so I think as we look forward to 2 through 4Q, those headwinds, particularly from cremation, I think as well from both, currency as well as cross-fund income will go to -- will be abated to a certain degree as well. And I think some concern maybe to how elastic or inelastic is the consumer to these price increases. And what you have to keep in mind is the U.S. funeral market, there are 22,000 funeral homes out there. So it's a very competitive market, and they're generally relatively low barriers to entry into this market. And so I don't think that we feel like we've got the power in the funeral market to really push pricing, however, we like. Hence, the discipline that we had over the last several years and only growing at the low single-digit type percentage. But the inflationary environment that we are seeing, the rest of the 22,000 general home operators are also seeing. And so we're kind of all in this environment of having to manage to these cost pressures, which is what is giving the opportunity for us to increase prices like this.

Sounds good. Let's discuss funeral preneed sales. That's been trending strongly. Please address the drivers of recent performance. Discuss how you're positioned competitively to gain advanced market share via preneed sales. And then provide a long-term perspective on growth in this category at Service Corp. and maybe some discussion of reversion from the pull forward as it has been strong, might we see this significantly [ solid. ]