Service Corporation International (SCI) Earnings Call Transcript & Summary

Thanks for joining. I'll give you a quick introduction of team from Service Corp International. Aaron Foley, who's Vice President and Treasurer. Thanks to you, and thanks always as always, for joining us at our conference as you have for many years, dating back to when Eric and Tom were here. So I always appreciate you coming. And thanks to Debbie for always help setting it up.

I thought maybe just a follow on, maybe just a lead into what we had as a starter. The discussion we're kind of having on the floor there is the environment has obviously been a volatile environment, really dating back to the days pre-COVID. Can you just walk us through -- I think about the context of when do we -- I don't know if normalized is the best word, but when do you think we get past kind of the volatility? And it's like December getting closer, getting towards that end. But when do you think about the context of when we truly normalize and become -- kind of put COVID in the rearview mirror, if you will?

Sure. Thanks, Larry, and thank you for all being here. COVID obviously has been a whirlwind that the entire world has been going through over the last several years. And it's impacted us. In fact, from an earnings per share perspective, in 2019, we reported $1.90 earnings per share. Then in the height of COVID in 2022, we were all the way up at $4.57. And we've come down to $3.80 last year. And right now, we're expecting to be around $3.50. And through that time, our east volume that we serve went up by about 120,000 more cases that we served in the 2020, '21 and '22 time period. Kind of associated with that, some incremental cemetery preneed lead activity helped to drive preneed cemetery growth. And then specifically for SCI, some of our capital that's been deployed to investments in technology, helping to drive the preneed selling tools that our counselors are using with Beacon, using our marketing tools to drive more and better leads, as well as pushing that through our sales force, CRM system and utilizing that more effectively, that has helped us kind of create a stronger base within our cemetery segment. And so there's been a lot of movement going on with all of those metrics. I would say 2 or 3 metrics that have been kind of moving more than others. As you think about our business, one, of course, volume, as I said. When we kind of came into 2023 and put forth our volume expectations, I would say that when you think of the blender that has to be put forth and kind of pulled together associated with the volume expectation. I knew as soon as we kind of click save on our model that we were going to be wrong. But I've been surprised as we've kind of progressed throughout this year that we've been pretty close on those expectations, from kind of starting with our 2019 base volume that we had, taking into account acquisitions and dispositions that we did, taking into account continued impact from COVID. '23, we're still seeing some mortality from COVID. We're still seeing an impact as well from these excess death phenomenon that I know that most of you all are familiar with, as it relates to people who just deferred getting health care, just the mental anguish kind of that everyone's gone through the last 2 or 3 years, and the increase in alcoholism and drug abuse, kind of -- and the impact on mortality. So as we kind of began the year, we looked at that, pulled it all together, as well as taking into account a volume pull forward expectation. Because, again, the 120,000 incremental deaths that we serviced 2020 through 2022 those had to have come from future years that we would have expected them pre-COVID to come from. And so we've built this model, pulled it all together. '23 has kind of trended as we expect. And as we look forward to 2024, as Tom mentioned on the call, we're currently expecting flat to low single-digit declines in volume as we see that pull forward moderating some, which is actually a tailwind, and we see offsetting that declines or we're expecting declines in COVID as well as these other excess deaths. So from a volume perspective, that's a big component. Cemetery preneed has been another factor that's been kind of volatile over the last several years. I would say these investments in technology that we -- that I talked about a little bit earlier, has helped to create us kind of a stronger base in our cemetery preneed sales perspective. And kind of coming into 2023, just talking about factors that have impacted that, I'd say that the consumer softening that we've witnessed during the year has probably been an impact a little bit more than we would have expected coming into 2023. As we look forward to 2024, our expectation right now for that consumer is no necessarily softening, but no kind of foundation really being established in that consumer. And so that's really what's kind of driving a low single-digit increase in cemetery preneed sales, when kind of in a normal year, we may have expected 3% to 6%. And so as we talked about on our earnings call, right now, we're expecting 2024 to have an earnings per share of $3.65 at the midpoint of our range that we've got. So that's increasing $0.15 on our currently expected 2023 EPS. And so that's 3% to 4%. That's not in our 8% to 12% secured framework, but as we kind of look forward, we're kind of expecting 2024 to kind of be the foundational year that finally, as we look forward beyond '24, the volume is going to get back to that low single-digit growth, average is going to hang in there on the funeral side to be the low single-digit growth. And then cemetery preneed, we're hoping in 2025, we'll finally be back in that 3% to 6% type growth basis. Now I think where -- Larry, you may have been coming from is back in May of 2022, we put forth an expectation as we looked forward to '23, '24, and we expected back in May of 2022 that we would hit $3.85 in 2024.

That was kind of a 5% to 7% organic kind of growth message, right? That's [ 12% ] EPS. That always -- so you're saying that you think that becomes a reference benchmark as we get out into '24, '25 now.

That's right. I mean, when you look pre-COVID from like 2005 to 2019, we were growing on a compounded annual growth basis of about 14%. When you look at those years. There are going to be some years that you're going to be below that 8% to 12%, and some years that you're going to be above that 8% to 12%. But I think that, that range is a good range for us to kind of target. And as we look forward to 2025 and beyond, we're expecting to be there.

Is -- I think your funeral volumes in the quarter were down kind of mid-single digits. But Tom, he said a reference, kind of low -- down low single digits next year. So I presume he's expecting kind of the normalization to kind of kick in next year? Is that kind of -- is that what kind of underscores the mentality of that message?

Well, I think it gets closer to the normalization because again, you've got this pull forward impact. And when I think about 2023, just at a high level, we expected 21,000 cases as a headwind in 2023. As we look forward to 2024, we're expecting, let's say, around 18,000 cases as a headwind. And so that's going to be a 3,000 case tailwind for us looking forward into 2024. As we look forward to 2025 and beyond, we're expecting that to continue to moderate. We're expecting continued moderation in the excess deaths and the COVID, but we believe will finally be at that new base and able to grow from there. But again, it's anyone's guess. That's currently our crystal ball and what we're expecting from a volume perspective.

And getting to that 3% to 6% on the cemetery side, the preneed, is that kind of embedded in that message, if you will, as that kind of part of that?

It's part of the 8% to 12%. Yes. So to your point, 5% to 7% organic growth, on the funeral side, that's coming from a normal 1% growth in volume, low single-digit growth in average. And then on the preneed cemetery side, 3% to 6% growth on preneed cemetery, they hit that 8% to 12%.

Those [ other ] components.

Correct.

Okay. And on the average side, the pricing side, I know that Eric, in the past, has talked a great deal about the adoption of technology as part of the kind of the sales point. Can you just speak to that, to what you're doing investing in kind of technology to drive that consumer endpoint, if you will?

Sure. So we've got what we've termed Beacon as our preneed selling technology. And then on the atneed side, we've got HMIS+. And what this is essentially on a tablet or a big screen TV, we're able to have the counselors walk through the family, every single product and service that we have to offer. And so that helps us then go through and just make sure that every single piece and product is able to be touched by the counselor. And then on top of that, we've got a team centrally who's going out to every single market and touching every single one of our 1,500 locations, at least once per year. And we've got the flexibility with that Beacon software to be able to adjust those pricing pretty much immediately, to allow the most effective driving of kind of the average using that, yes.

Margins, I know in the cemetery side, you've seen kind of margins improve. I'm really looking back kind of over the last 5 years and [ end ]. But is that something we could see continue, the margin improve in opportunity going forward? Is that at your fingertips, is that visible in any way?

Yes. No, I definitely think that it is. Pre-COVID, we used to talk about funeral volume or margins being in the 19% type range. And with those dynamics around volume and average, it will drive revenue growth. But the margin percentages are kind of going to hang in there because we do have a large, fixed cost structure. On the cemetery side, those pre-COVID had been somewhere around 27%, 28%. And during COVID, those rose to 36%, 37%. And those have moderated down to the low 30%-type range. As we look forward, that 3% to 6% production growth that we've talked about being embedded as part of the 8% to 12% earnings growth framework, that is on the cemetery side, going to be driving that margin growth. We expect those dynamics would help drive it 50 to 80 basis points, assuming that amount of preneed growth. On the funeral side, as we look further out, right now in our near-term expectations, we don't have this. But as we look further out, when the baby boomers start impacting us, when we start seeing the impact of -- it's going to be -- it's not a hockey stick, but maybe a 1% to 2% incremental volume growth on top of that low single-digit growth that we currently are expecting in the near term, that's when we expect to see some more margin growth on the funeral side.

Okay. Great. Deployment, you generate a wealth of cash flow. Deployment of capital and your CapEx has been running 300, 300 plus. Can you talk about, I guess, starting with that line item in particular? The allocation, CapEx, what is -- if you were to break that into buckets, what is -- what is that spend dedicated towards?

Sure. So about $130 million of that relates to cemetery development spend, where we're going out into our markets for our 450 cemeteries, taking undeveloped land and either developing out lawn spaces, clearing trees, creating mausoleums, going out and building essentially the inventory that our counselors would then be able to sell to drive our cemetery preneed sales. Another $120 million of that would be related to either funeral or cemetery facility maintenance spend. So that's going to be the roofs, that's going to be the roads, the sidewalks, so on and so forth. So just to make sure that we're able to continue operating and selling as we would want to and be up to the expectations of the consumer. And then finally, the remaining $50 million really relates to this corporate and digital investment spend that we were talking about, associated with Beacon, associated with our sales force, our marketing initiatives and efforts as well as customer making it more contemporary of a process for our customers to go through.

Okay. Great. Great. If you [ still do ] a bucket, there is some component of that $300 million that is kind of dedicated towards growth, if you will. More of the technology than the sales side.

That's right. That, as well as on the cemetery inventory development. That's helping to drive that top line for the cemetery.

Okay. Great. Any questions in the audience, kind of going along here? So one in the back left.

I'd be very surprised if there was, but just around what the leverage target in capital allocation, with all the volatility. And you guys have had a very stable algorithm. It's been a target, I think you've had for as long as I can remember. Could you just discuss like how you got to that level? Is that like the level that you think equity will bear? I just would be interested in -- I mean, it's been around for so long, just sort of how you got there?

Sure. No, I appreciate that.

I just want to say that we're in a leveraged finance conference. We really like that level.

So I've kind of been terming our 3.5 to 4x leverage target as kind of our Goldilocks zone, if you will. We don't see much benefit of going above that, because of the indentures that we're currently issuing under, there are actually some investment-grade covenants within that. And so as we think about going above that 4x, we don't want to put that at risk. We enjoy that flexibility that those covenants allow us to have. Conversely, as we think about the benefit of dropping below that 3.5x, as we look at the pricing that we're able to achieve in the market currently and then what it would take to actually allow us to achieve an investment-grade target, we believe that's going to be somewhere around $1.5 billion to $2 billion of capital that would need to be deployed to reducing the debt. And as we think about that trade-off, to your point, from an equity perspective as well as a creditor perspective, we just don't see the benefit really exists for us to want to push down that path. And so to your point, we've had this 3.5 to 4x target since we acquired Stewart back in December of 2013. So almost 10 years now that we've had this in place. And it seemed to work well. And it's a manageable target. We've got the stability of the cash flow and the after deployment of capital to maintenance acquisitions, dividends and so on and so forth. We then have some excess cash available that historically, where there's an opportunity, we have done share buybacks, but that's our lever to make sure that we are able to stay within the bounds of that 3.5 to 4x leverage range.

So I have this feeling pretty generally about a lot of my credits, but I feel like the rating agencies aren't super kind to you. Just looking at spread, you guys trade quite a bit tighter than I think your BB- rating. I mean, so like what are they missing? And obviously, this is -- you engage with them. I'll just sort of ask for a view on that, if you don't mind.

I think the death care industry is just -- it's kind of an anomaly that's out there. It's hard to truly say what makes the most sense and how do you place us? The rating agencies do have methodologies in place that they've put forth. They've tried to be as clear as they can with the metrics that they're using, in qualitative and qualitative -- quantitative metrics that they're employing. And we're trying to -- I think they're trying to put a round peg in a square hole and tried to match that. And I would tend to agree when you look at the credit default spreads and you look at other metrics associated with SCI, we trend to be -- we tend to trade a little higher than where our rating actually is, to your point. And that being said, we've been pretty comfortable. Again, in this 3.5 to 4x range, it seems we're able to keep creditors happy. We've been able to keep our equity holders happy. We're obviously in dialogue with as many investors on both sides that we can to make sure that we're kind of steering the ship as early as we can, but I totally get your point.

This is just more of a general industry question, but you see a lot of these GLP-1 drugs, they affect hospitals, they affect snacking companies. Has there been any talk at the C-suite level in terms of how that affects volumes, backlog in the death care industry in general? Or is it -- or is it just everything that's guaranteed is death and taxes in life so far?

I think it's still a little early for us to kind of make an assessment around the impacts of GLP-1. We've had that question pop up on a couple of our one-on-ones earlier. And the commentary kind of goes back to about 10, 15 years ago, we were working with a gentleman from Harvard, a statistician to kind of look at the death rates and so on and so forth. And his perspective was people are smoking less, which is helping mortality, but Americans are eating more, which is negatively impacting it. So we're kind of back to where we are. So as you think about these GLP-1s and the proliferation of these weight loss drugs, it definitely could have an impact and it could have a positive impact on mortality, which I definitely think we all appreciate. But I think it's still too early to say kind of what the impact will be. Medicare, I don't think covers it yet. So it's still pretty expensive to be widely distributed. I think that there's still some reviews that the FDA is wanting to do on a longer-term basis. So any impact, I would say, may begin manifesting itself in 3, 4, 5 years. And that's around the time frame that we're kind of thinking that the baby boomers are going to start impacting us. And that's when we'll start seeing this 1% to 2%-type growth higher than what we normally would expect to occur, and we expect that to kind of be occurring for about 10 years straight until we kind of hit that plateau of the baby boomer generation. But right now, it's not really been a huge kind of point of conversation.

Aaron, to the point of the guys' 2 questions, how much -- the cremation trend, is that just an organic headwind? Is that just embedded in the market now? That's not really -- the dynamics not really moving one direction or another.

You're exactly right. I mean the dynamic is definitely moving one direction and that's up. And it's consistently been moving up 100 to 150 basis points, and it's been doing so for the last 20, 30 years, and so when you think about -- when you look at other countries, is cremation rates have kind of stabilized? It's been around 75%. And so we're already the world's or America's largest cremation provider that's out there. We've got 19% more to get to that 75% area. So I'd expect, as you look forward over the next 5 to 10 years, that 100 to 150 basis point shift is going to start moderating that slope. And at some point, we're going to just kind of bounce up and down around that 75%. But between now and then holding all else constant, if you take that 1% shift in burial to cremation, it's about a $12 million EBITDA headwind that we've got. But you have to keep in mind that's on a $1.2 billion, $1.3 billion EBITDA company. So it's definitely a headwind, but it's something that we've been able to manage for the last several decades.

Yes, I just wanted to follow up on that. And I was curious from -- because you're spending the 130 or so on cemetery land and then the mausoleums. Just geographically, what you are touching on with the cremations, where are you seeing the demand more or faster accelerated or shift? I'm just curious where the properties are, if you're seeing more of a broad trend around those?

I would say that you see the cremation trends higher on the West Coast, in the Northwest, up in Colorado. You're going to see them upwards of 70%, 80%, like I mentioned. So you definitely see that occurring. And we saw it accelerate a little bit during COVID, and that was something before we kind of understood what was happening, we got a little bit worried about that, but that was more associated with just people not having access to cemeteries. There were many local cemeteries that just weren't open. And so they weren't able to do a burial. And so 2020 occurred and then 2021 came forth and kind of reverted back to normal. But one thing I would like to add to that note on the cemetery side, we are seeing more of an opportunity coming from the cremation side. I'd say about 17% to 18% of our sales do go to cremation consumers, whether it be through glass-front niches or through columbariums, cemetery or cremation benches. So we're trying to make sure we are addressing the consumers in any way that we can.

Aaron. Again, it's an extension of, I think, a prior question and your leverage profile, but acquisitions [ said ], Alderwoods, Stewart, in the many years past. And I think after Stewart, leverage peaked at maybe mid-4s, somewhere in that context and then dove right back down. And now you kind of do some tuck -- I would characterize as kind of tuck-ins, about $100 million a year in terms of spend. What is there -- in your core competency, is there anything there that is large enough that could really kind of rattle the dial anymore of leverage?

I would say that in the current environment, like we were discussing earlier, the FTC environment, it's hard to imagine any type of transaction of scale that would be able to kind of achieve the return hurdles that we would expect. Potentially under different FTC administrations, there may be an opportunity. But right now, I think it would be difficult for us to want to think about testing that. That being said, there is a firm up in Canada of scale, Arbor Memorial, they did go private. They had been public, went private back in 2012. Their footprint is pretty complementary to ours up there. And we don't -- just at a high level, expect to see many barriers to doing that. But that being said, it went private there, it's a family-run business, it's a great business. And what we see even with our tuck-in acquisitions is the families have to be ready to sell. We're not -- we don't want to be in a position that we're just throwing money at them just to get them to sell. And so they damn sure know that when they're ready for a liquidity event, we're going to be there to do that. So I think in the near term, you'll probably see us in that $75 million to $125 million.

Stay in that range. And to just offshoot to that, one, would you go outside of your core competency?

I wouldn't want to say we just stick our head in the sand and never think about it. We've thought about it. We've looked at different options and opportunities out there. We've -- in our historic -- history, have been in the insurance industry. We've kind of managed our own preneed insurance business, but we sold that off. There were complexities, regulatory as well as capital complexities associated with that, that made it difficult. We, at one point, owned our own casket manufacturer. But what you find is we weren't consuming enough caskets to kind of make it make sense, and when competitors find out that they're buying caskets from their competitor, they don't really care to do that. And so it's just -- that kind of didn't make sense. But we've looked at different opportunities in the past. We've evaluated a REIT structure pretty heavily. And so if there is an opportunity that seems to make sense, we'll definitely put the work in to evaluate it and think through it, but it would really have to make sense and honestly, past the 60 minutes [ red face stuff ], we don't want to put ourselves in any compromising type position given the industry that we're in.

If I could ask as an extension of your comment there, why wouldn't a REIT transaction fit? Because I know it's come up many times over the years, just the concept.

Well, right now, it's because the tax laws have changed and before you can take advantage of the tax benefit, you have to make the change to the REIT and then wait 10 years before you're able to benefit from that. But at the time, as we looked at the business -- splitting the business in 2 and then kind of looking at the valuation of our strategy that we've been employing going forward, the associated execution risk for employing that REIT strategy versus employing the strategy that we had been, it just really didn't make sense, and we've luckily been able to kind of play forth and it's worked out okay.

Okay. One last. Any other questions in the audience before I go to run my -- my last question being international markets. I know, going back years ago, that different footprint at that time kind of exited the national front. But absent Canada, I presume that the international markets would not come into play? Or is that...

No, you're right. I think at one point, we were in 23 different countries across the world. And I think right now, again, as we look at our opportunities here in the U.S. and Canada, we still see a lot of tuck-in opportunities. We see some opportunities on the equity side. We think employing this going forward, at least in the near and medium term makes sense. When you think about international, it's really difficult because you really have to keep that management team in place for whatever acquisition you do, because even though they're similar cultures, they're still not the same. And so you have to make sure you maintain that. And so the synergy opportunities just really aren't as prolific as they are here in the U.S.

Okay. Well, great. Thank you, Aaron.

My pleasure.

Thank you. Thank you, guys for joining us. Thanks, everyone.