Service Corporation International (SCI) Earnings Call Transcript & Summary

Good morning, everyone. I'm Scott Schneeberger, the senior business services analyst at Oppenheimer. Thank you all for joining us today. It's our pleasure to have from Service Corp. Senior Vice President and Treasurer, Aaron Foley, to speak on the company's investment story. We're drawn to Service Corp.'s leading position in the funeral services and cemetery offering industry, its opportunity to capitalize on the favorable demographics of 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'll be using a fireside chat format. I'll ask Mr. Foley some high-level questions upfront to get an overview of the business. And then later in the session, I'll facilitate audience questions. So please feel free, audience, to send in anything to me, and I will ask on behalf to Mr. Foley.

So getting started, could you please discuss the overall business model and strategy?

Yes. Thanks for having me, Scott. Good to see you. So SCI is the largest operator in the U.S. and Canada of funeral homes and cemeteries. We've got about 17% by revenue market share. The other consolidators make up an estimated 9% of market share. So that leaves about 75% of the market that truly is mom-and-pop and smaller operations. As you think about our business, we separate it between funeral segment and cemetery segment. And as you would expect, the funeral segment's going to reflect our funeral services, the products and services that come along with that, whether it be the casket, the flowers, the catering, the actual pickup and removal, embalming and so on and so forth. On the cemetery side, it's going to be that -- from a property perspective, we've got property that we're selling, but also other products and services such as an opening and closing of that cemetery lot, the graveside service if the family so chooses and then outer burial containers and markers from a merchandise perspective. When you think about kind of the strategy that SCI has followed with those businesses over the last, really, 20-plus years is we've kind of had the same algorithm, if you will. We've targeted an 8% to 12% earnings growth framework over time. That's split about 5% to 7% is from our base business. And then you've got another 3% to 5% coming from capital deployment, whether that's from acquisitions, from growth capital or from, ultimately, share repurchases. During that time, we've reduced our outstanding shares from about 340 million outstanding to just under 145 million as we speak today. And so it's been a relatively stable business to be in outside of the recent COVID experience that we've had that's obviously thrown a wrench into things from that perspective, but it's relatively stable.

Looking closer at the atneed funeral and cemetery businesses. Growth was elevated during the pandemic, you just mentioned. That was followed by a settle-down period thereafter, normalization. If you could please share recent funeral volume trends as well as perspective on the broader timing of demographic tailwinds just to get a sense of the forward trend there.

Sure. In 2020 and 2021, we saw volumes increase 13% in '20, another 4% in 2021. And then as we started seeing the COVID event tail off starting in 2022 on, 2022 volumes were down by about 4% to 5%; 2023, down another 5% to 6%; coming into 2024, down another 2.5%. So we're seeing moderation in that volume decline expectation. And as we parse apart the data as well as we can, there's obviously no perfect way to specifically identify each and every death and the drivers and how a potential pull-forward impact from those excess deaths that happened above and beyond what normal was back in 2020 through 2023 really. We've kind of settled into what we believe now is a more normalized period of volume activity. As you've heard in our guide, we're expecting flat to slightly down volumes in 2025. And that's really a function of what we believe the COVID impact, any excess deaths and any negative impact from the pull-forward kind of now being embedded in the base. There's going to be a long tail, particularly to that pull-forward impact that as the years go on, that pull-forward impact is going to start -- continue moderating is what I'd say, being a natural tailwind to us. But we do think that we're getting further away from volatility that we've seen. And as we spoke about, we did see in May -- really May and June of last year and then November as well, there were these blips is what I'll call them, in funeral volume when we saw volume come in lower than expectations. And of course, initially, our concern was, are we losing market share, is there a competitive force that's driving that decline in volume. And what we ultimately found is that it truly was a death rate dynamic that was impacting not only us but the broader industry as well. And as I sit here today, I can't tell you that we're not going to see a similar month like that occur, potentially sometime in 2025, but I think it's going to become less of an issue as we get through this year and further away from that COVID experience. And as you mentioned, there is, of course, an impact on cemetery with atneed. It's very similar to the dynamics that you're seeing on the funeral side. But I do think it's important to keep in mind that there is, on the cemetery side, our core cemetery business, which makes up 85% to 90% of our cemetery preneed sales. There is a correlation between funeral volumes as well as cemetery velocity. So during this period that we saw the volumes declining, we were also seeing cemetery velocity declining, and that linkage comes from if a family loses a mother or father, the remaining spouse will want to preneed to be in geographic proximity to the lost spouse. But then also certain family members, even younger, may decide they also want to drive a preneed sale. And so I just mentioned that to say as this volume decline has occurred, we've also seen some headwinds on the cemetery side that have been managed through as well.

Excellent. Great overview again. I want to talk about funeral revenue per service. That's been steadily growing in the low single digits, essentially since the pandemic. Please discuss the drivers and provide a long-term perspective on what you see there. And also, what's behind it? What are some of the offerings?

Sure. I would say that generally, even post COVID, honestly, during COVID and pre-COVID, the funeral business really has been driven by an inflationary-type pricing power, if you will, that we've got. It's not -- there are 22,000 funeral homes across the U.S. and Canada. So it's a highly competitive environment. And so driving price outside of inflationary-type pricing is somewhat difficult without putting broader business at risk. So I would say that, that is and continues to be the main driver. As we saw 2022-2023, when inflation was higher, closer to that 4%, 5%, 6%-type range, we did see mid-single-digit-type growth in our funeral average sales during that period. Now there are other dynamics that can have an impact on that. One is the cremation mix. As we see that mix shift from burial to cremation, you're going to see some headwind on that inflationary-type average growth. And so historically, that trend, really over the last 25 years or so, has been somewhere in that 100 to 150 basis points type range. In 2024, we actually saw that closer to 60 to 80 basis points of an increase. And what we -- and actually, in the first quarter, we saw a 40 basis point increase. So it seems that, that rate of increase is moderating some. Today, as we stand, we're at about 60% cremation mix currently. As we look at other countries where Western-type death care civilizations and cultures, we see that, that cremation mix seems to have stabilized somewhere around 75 to 80 basis -- or 80 percentage points. And so as we get closer to that point, you would expect that, that slope of increase, so that 100 to 150 basis points, would start moderating. And so there's a good likelihood that we're probably going to be closer to maybe 75 to 125 basis points of shift maybe over the next 5 to 10 years and start seeing it moderate even more until it kind of stabilizes there. But that's a dynamic that creates a headwind to us on the average side. And then a final component and it's a smaller piece of our business, but we've got this nonfuneral home channel in our funeral business. And one of the dynamics impacting the business there is a business shift that we've been doing over the last 2 to 3 years, which has created some volatility, but it's, we believe, setting us up for some strong foundational growth going forward. And the dynamic that I'm referring to is we used to deliver and recognize urn kits at the time of sale. We're stopping doing that. And so we've got that headwind currently. But what we're starting to see is those urn kits that have been deferred and put on preneed contracts, we're starting to see those now come out of the backlog, and they're impacting that nonfuneral home business. And in the first and really the fourth quarter, we saw a nice 10%-plus growth in that sales average. So that's going to be something that will help drive us going forward. But keep in mind, out of our $4.3 billion of revenue, that makes up $250 million to $300 million of that revenue. So as I sit here today and try to explain what I think is going to happen with our averages over the next several years, I think we're still going to be in that low single-digit, inflationary-type growth period. If we do start seeing some inflationary impacts outsized as a result of some tariff implications, we will react accordingly and -- because us as well as the other 20,000 funeral homes out there are going to be feeling similar-type pressures. And I think we'll be able to see that pricing impact there.

Appreciate it. Makes sense. Let's discuss funeral preneed sales, how they have the potential to impact revenue and market share in future periods. Additionally, please address any recent developments impacting this category as well as provide long-term perspective on its potential growth profile at Service Corp.

Yes. So as I just mentioned, at SCI Direct, we've been having a shift there, where from delivering urns to deferring them. And that obviously created some volatility from a counselor perspective, but a bigger -- impact preneed production, preneed sales. A bigger impact, though, is we have shifted that as SCI Director, the nonfuneral home business, from selling 100% trust instruments to now with a new general agency agreement with Global Atlantic. We're now having them sell insurance contracts. And so what that does is it helps us generate general agency commissions that go to help offset some of that decline from the nondelivered urns that we're losing in the current period. So again, once we see that stabilize, we're going to have a strong foundation of general agency revenue there. But then ideally, once we have this foundation under us, we'll see strength in that funeral preneed production going up as well. But stepping back just a little bit, that shift from trust to insurance on the SCI Direct or nonfuneral home side really did have an impact to our counselors and impact to how they were selling to consumers. One, to sell an insurance product, you have to have an insurance license. So we had to go through a process to get each of those counselors tested and licensed as an insurance salesman. And then on top of that, because you're now selling a life insurance product, you have to be able to be competent in understanding the structures of those contracts but then be able to convey to the consumer the benefits of having that life insurance component associated with that preneed contract. Therefore, if you sell a contract that's to be paid over 5 years, if the individual passes in year 2, the insurance will kick in and the family doesn't need to pay for the remaining years of payments under that contract. Under a trust agreement, you don't have that benefit. You don't have that insurance benefit. So those dynamics have created a headwind as we've made this shift in SCI Direct. And as we look at really -- as we saw in the first quarter, we saw a headwind in nonfuneral home preneed sales revenue. If you look at our press release and look at that line item, we expect a similar headwind in the second quarter, maybe somewhat of a headwind in the third quarter until we kind of stabilize in the fourth quarter. As we stand here today, about 80% of our production has been already switched in SCI Direct to this new sales model. And as we get to the end of the year, 100% will have switched. And so as we look to 2026 and beyond, we expect not only these contracts that have the deferred urn kits coming out of the backlog to give strength, but also the stability in the preneed sales production and the growth in that general agency revenue as that production growth should also provide strength going forward. On the core business for funeral production, in July of last year, we switched from TruStage, which was our previous insurance provider, to Global Atlantic. And that, as you've seen over the last 3 quarters now, has generated some strong core general agency revenue growth on a year-over-year business. And we implemented that in July of last year. So we expect the second quarter will also have some strong growth coming through on the general agency commission side of things until we lap it and then see some stability on that funeral production base. But that change as well created some headaches, if you will, maybe not as much as on the SCI Direct side, but it also has created headaches on the core funeral preneed production side that our counselors have been working through. And they've honestly been doing a better job as they've progressed through since July of last year. And we're starting to see some stabilization of that funeral preneed. But I'd expect we're still going to see a little bit of a headwind here in the second quarter until we get really into the third quarter, when we start seeing some year-over-year growth in that preneed production. But that being said, for 2025, as Tom mentioned on the call last week, we are expecting low single-digit declines in our funeral preneed production for 2025 as a result of all that volatility. But as we look forward to 2026, expecting stability there and growth, which to -- really back to your question, our hope is that growth in that backlog, which today, in total, for funeral and cemetery sits right at $16 billion, that growth is going to help not only lock in future market share, but hopefully grow some preneed -- or funeral market share going forward as well. I think that -- we recognize that we're cannibalizing some amount of future atneed sales by putting these preneeds in place. But with the structure and how we've set it up with general agency commissions and such that go to -- more than offset selling compensation for our counselors in total for the program, we still feel like it's a good structure for us to follow the strategy.

Had trouble with the Mute button there. We're going to move over now to cemetery preneed, historically, a P&L growth driver for Service Corp. Please discuss the drivers of the growth you've experienced in this category as well as how it's trending here at the start of 2025 and your outlook for it over the balance of the year as well as longer term like you did just on funeral, the details.

Sure. So you really have to separate the cemetery preneed business between core and large sales. So the core business or core preneed sales make up about 85% to 90% of the preneed, and then the large sales make up the balance or 10% to 15%. And when you look at that core business through 2024 and really the first quarter of 2025, we've seen growth in that aspect of our business. That core preneed sales has been growing. It's not been growing -- it's been growing more in that low single-digit-type range as a result of some of these volume dynamics that I've mentioned and how that conveys or correlates into the cemetery velocity. But that core business has stayed in pretty strong. Where we've seen some volatility, and I wouldn't even say necessarily it's weakness, it's more of a timing perspective, is in the large sale dynamic. These large sales are definitionally internally any sale greater than $80,000. And in many cases -- or not many, but several cases, you're going to have individual contracts where people are spending $2 million, $3 million, $4 million on a private mausoleum to be built on an area of our cemetery that's highly customized and built to their specifications. And those types of transactions can take weeks, months, and in some cases, we've even seen years where conversations with the families to get them ultimately comfortable with what they ultimately would like as their final resting place. And what we saw in 2024 was the first and the fourth quarter were strong cemetery preneed quarters. The second and the third quarter were somewhat weak. And it's ranged anywhere from $30 million to close to $60 million per quarter. But on average, it's been about $45 million per quarter. The first quarter of this year came in closer to that $30 million range. We knew that it was going to be a tougher comp again because the first quarter last year was strong, but it was a little bit lighter than our expectations. I would say that right now, our perspective is, is that is likely timing. January, was the weakest month for us. It started moderating in February and March. We actually saw slight positive. And then as Tom mentioned on the call, April came in pretty strong as well, even higher than March. And so the trajectory seems strong and gives us confidence in that. That being said, as we step back and kind of look at the macroeconomic environment, and everyone's looking at MSNBC, CNBC, Bloomberg and -- just seeing all this data coming in and flying around, whether it be about tariffs, whether it be about inflation, jobs reports and such, there seems to be a lot of angst currently in the environment. And I think that we're looking at that and saying, "Look, we're not seeing it now. And the trajectories haven't given rise that, that is transpiring into our business because we're seeing continued strength. But I think that we took the approach to moderate our cemetery preneed expectations because of all this volatility. And we took that 2025 perspective from a low to mid-single-digit-type growth in cemetery preneed to closer to a low single-digit-type growth in cemetery preneed. Now at the end of the day, ideally, our perspective would be, and everyone's I would think as an investor, that we're wrong, that it's going to trend more to the upper end. But I think that we just wanted to take a little bit more cautious perspective and moderate those expectations for ourselves. But that's kind of the broad dynamic for 2025. I would say that cemetery, unlike the funeral business, we've got a lot more pricing power. Of course, you've got some inflationary dynamics, but these 450, 500 cemeteries that we own are these green bastions generally in the middle of these urban jungles. And they're just very difficult, if not impossible, to replicate. And as a result of that scarcity factor, you've got pricing power that's built in there from a real estate perspective. But then on top of that, we've got this strategy that we've talked about a lot about how we go in and tier our cemetery properties. So 15, 20 years ago, you would go into one of our -- potentially some of our cemeteries and see it's just homogenous lots being sold. We're now going in and we still have those homogenous lots for the consumer who wants those as an entry-level-type inventory items. But we've built everything from private estates, bench estates, we've dug holes and created lakes, so lakefront-type property, all the way up to the private mausoleums that I was mentioning before that can go for several million dollars. And I think that, that tiering strategy followed and worked on with our counselors has really helped to provide some strong average support for those sales and those cemeteries that we operate in. And so I think that there continues to be strength on the cemetery side. I think we've got some dynamics this year and over the past few years with volume coming down and this year more so now with the macroeconomic environment that we're watching. But I think that that's going to continue to be a nice component of our earnings growth going forward.

Great. That sets up a nice segue. We're fortunate enough to be conducting a field trip with Service Corp. to Rose Hills in Los Angeles, which is not only the largest memorial park in the company's portfolio. It's actually the largest in all of North America, possibly the world. Could you please discuss some interesting attributes of that property? You were just touching on some, in my view. But if you could kind of draw the parallel and then -- parallels to your entire portfolio as well as Rose Hills represents it?

Yes. Sure, Scott. And we're really excited about that. So on June 5, I think there are still spots available. So if interested, definitely reach out to Scott or Daniel. We're very happy to kind of showcase this property, again, not because it's the largest, but I think as -- from an investor point of view, it really helps to crystallize SCI's strategy and how we serve just multiple cultural backgrounds here in America, but also showcases the tiering of the property that we've talked about. And so I think it's a good opportunity to kind of see that. As you mentioned, Rose Hills is significant for SCI. It makes up 8%, 9% of our EBITDA. Over $100 million of that is EBITDA coming through. And it at one point used to be its own public company before being bought by the Loewen Group back in the '90s and ultimately acquired by us in 2006. And as Scott mentioned, it's one of our star properties. We're very proud of it. And we're happy to see you all come in and visit.

Just making sure I'm off. All right. And just as I'm going to the next question, we're coming up on time, a little bit more over 5 minutes. And I do have -- I can see a question or 2 in queue. So audience, I'm wrapping this part up. If you have any questions, now would be a good time to get them in. So yes, just a couple more in my segment. This one essentially on margins, particularly in the cemetery segment, can have a meaningful impact on your reported EPS. Can you please discuss some of the primary drivers? Which items, in particular, investors should be watching as you progress over 2025 and beyond that could move the margins up or down? And again, I mentioned cemetery segment. It can be across the whole portfolio.

Yes. So what I'd say is every dollar, incrementally or decrementally, that comes through the top line generally has about a 70 to 80 percentage impact on the bottom line. And so in periods of revenue growth, we're going to have a differential growth in earnings. And so specifically on cemetery, if you go back 20 years -- 15, 20 years or so, we were closer to 20%-type margins on cemetery. As we've been executing on our strategy to drive cemetery preneed production, you've seen that, that has transpired into margin growth. And you've seen it go now, we're at the lower 30s from a margin perspective. At some point during COVID, we even approached 40% from a margin perspective, just highlighting the leverage strength from that top line coming through. As we stand here for 2025 with the expectation of low single-digit growth in cemetery preneed, that's going to drive low single-digit growth to cemetery top line with the fixed cost structure that we have in place, which is relatively large as well and something that we focus on constantly. That being said, there is inflationary pressure that goes to compress margins to some degree. So in total, for 2025, we're generally thinking somewhere around flat margin-type dynamics for 2025 for cemetery. As we look forward to '26 and beyond, as we get back into the more normalized mid-single-digit growth in -- or expect to in cemetery preneed, that's where we're going to start seeing that low to mid-single-digit growth on the cemetery revenue side dropping down at 70% to 80% to the bottom line and then back to kind of that 80, 100 basis points type growth, 50, 100 basis points type growth on the cemetery margin side. On the funeral, it's very similar. But with flat volume and low single-digit growth in average, that's going to drive basically flat margins in that 21% range that we're expecting for 2025 until that baby boomer dynamic starts to impact the business where we start seeing an incremental 1%, 1.5%-type volume coming through, then that's where we expect to see some margin growth, 50 basis points or so, coming through on the funeral side as well.

I'm asking one more. I'm going to cop on my section back a little bit because we have 2 questions waiting and only about 4 minutes. So a quick one for you right here and then I'll get to the other 2, and that's just free cash flow. The company has historically generated strong free cash flow. Please share your expectations for what you're going to deliver in 2025 and beyond, and then also address how you allocate capital.

Sure. Thanks. So this year, at the midpoint, we're expecting to generate $860 million of operating cash flow. That's lower than prior year because keep in mind, we did have a headwind of $150 million of cash taxes that we're expecting to pay in 2025 because we've benefited the last 1.5 years or so. So out of that $860 million, taking out about $315 million of CapEx, we're expecting free cash flow of around $550 million. We pay $180 million dividend. We are expecting to buy back about -- or buy about $100 million of acquisitions at the midpoint of our $75 million to $125 million guidance range. We're expecting to spend another $70 million to $80 million for growth capital for real estate, new funeral homes, new cemeteries. So you're left with around $150 million or so out of that free cash flow. That's absent other opportunities. And assuming our intrinsic value, there's a discount to it enough, which, as you would expect with the current volatility that we're seeing, we believe that it does, we're going to continue to be buying back shares. And so that's really the algorithm, honestly, that we've been following for the last 20 years, just growing over time.

I'm going to ask the last 2 just because we only have a couple of minutes left. I'm going to ask you these 2 questions at the same time and basically paraphrase. The first one is, do you have enough cemetery land? How do you manage cemetery land? And the second one is essentially on the funeral rule. And there's some elements to it, but you can guess what that is. So just -- those are the 2 main themes. If you could address them both, please.

So I'd start with the funeral rule. There's no incremental guidance that I can give there. Really, the last update I had was in October 2023, when there was the symposium that took place that industry participants as well as organizations took place in -- to discuss questions that the FTC had. But as of right now, I have no further developments on that front, unfortunately. I think a big push of that funeral rule is ultimately, as you know, to get pricing put online. And we've got pricing online at 75% of our locations already. So at the end of the day, we're ready to comply with whatever the FTC will come out with. We're just waiting to see, obviously, the volatility in the -- in D.C. right now kind of -- it remains to be seen where things head. On cemetery land, I've got the easy answer and then kind of the more complex. The easy is when you take our portfolio as a whole, on average, when you look at the velocity of sales that we're currently doing, we've got over 100 years of available inventory out there with our 36,000 acres of land that we have. But the more complex question is -- or the complex answer is there is a handful. There are a few cemeteries that we are getting a little bit closer to that end of life on those cemeteries. And there are multiple strategies that we employ to kind of manage that end of life. One is to raise prices. Again, because of the scarcity factor, we can raise prices, slow down that velocity and try to find that balance where the sales are supported and growing, albeit maybe at a lower velocity coming through. We can go in and reconfigure cemetery roads, sidewalks and structures to be able to provide more inventory as well. We've had instances where we will go in and build multistory mausoleums. So if we don't have space to build wide, we can build up. And so we've done that as well. And then more recently, over the 5 -- last 5, 7 years, we have been looking at our footprints that we understand well, where we see that there might be some land constraints occurring. And we, ideally, will buy land adjacent to existing properties that we have to more easily develop out that cemetery land and increase the inventory in that situation. But outside of that, watching the population of that cemetery and where they're moving, we historically haven't really built any greenfield cemeteries. But we found opportunities really in the last 5 to 7 years where we've bought land. We've developed that -- a portion of that land. If you buy 80 acres, you're only going to develop 10 acres and then kind of see how that goes and grow as needed. But we did that recently far West Houston. And a cemetery opened in -- a new cemetery was opened in 2022. We had this 15-year pro forma model and projections. And by year 2, we were at year 7 of those projections because the velocity was so great. So we're identifying other areas like that across our footprint. And you've seen our real estate spend increase some as we've dipped -- started to dip our toe into that arena to help alleviate some of those instances of land constraint.

Excellent. Thanks. You covered both questions comprehensively and what would they entail just with the little keywords. So thank you. Great job. Audience, thank you. Thanks for those questions. Thanks for being attentive. And a really good overview. We appreciate it. Thanks, all.

Likewise. Thank you, Scott. Thank you, Daniel. You all take care.