Service Corporation International (NYSE:SCI), the largest funeral company in America, announced May 29 that it was buying Stewart Enterprises (Nasdaq:STEI), the number two company in the funeral business for $1.4 billion including the assumption of debt. Does this make Service Corporation's stock a buy? I'll have a look.
SEE: What It Costs To Die
What It's Buying?
Stewart Enterprises is the second largest provider of funeral and cemetery products and services in the U.S. Approximately 42% of its locations are located in Florida, Texas and California, which represent three of the largest states for people over the age of 65. With 217 funeral homes and 141 cemeteries in 24 states in the U.S. and Puerto Rico, it generated $516.1 million in fiscal 2012 with operating earnings of $79.4 million.
In 2012, 43% of the funeral services performed by Stewart Enterprises were cremations. By 2025 cremations nationwide are expected to rise to 57% of all funeral services performed in the country. Although only 19% of its cemetery events in 2012 were cremations, sales of those cremations increased 15% year-over-year providing a large opportunity in the future.
On the downside, Stewart Enterprises' revenue in 2003 was $522 million, $6 million higher than its revenue this past year. The same holds true for its profitability. Clearly consolidation is necessary in order for death care companies to grow.
Highlights Of Transaction
The combined businesses will have pro forma revenue of $3 billion and adjusted EBITDA of $820 million with Stewart Enterprises contributing about 15% of the total. Service Corp. estimates that it will generate $60 million in annual cost savings within 24 months of the deal closing thanks to reduced back-office costs, elimination of duplicative public company costs, and improved purchasing power. With no reason to doubt their estimates, the merged businesses will have an adjusted EBITDA margin of 27%, comparing very favorably with peers Carriage Services (NYSE:CSV), Hillenbrand (NYSE:HI) and Matthews International (Nasdaq:MATW).
SEE: Analyzing An Acquisition Announcement
Should You Own Its Stock?
Service Corp. after the merger will have adjusted EBITDA of $820 million. Prior to the combination the two companies had $2.18 billion in total debt and cash of $266.6 million. Assuming Service Corp. used all of the cash available, it would require an additional $903.4 million in debt to complete the acquisition. Prior to the synergy savings of this deal, Stewart Enterprises had an enterprise value 12.1 times EBITDA while Service Corp.'s multiple was 8.6 times EBITDA. Therefore, I'll assume the combined company is somewhere in between.
Given a multiple of 10 times EBITDA, Service Corp. will have an enterprise value of $8.2 billion. With zero cash (for simplicity I'm assuming the combined $266.6 million in cash would be used for the acquisition although that's not what usually happens) and debt of $3.08 billion, it would have a market cap of $5.12 billion or $23.79 per share.
SEE: A Clear Look At EBITDA
If Service Corp. hits my multiple estimate of 10 times EBITDA, investors can expect to hit $24 or thereabouts within 12-24 months. If Service Corp. can achieve its $60 million in synergies by the middle of 2014 than it's probably not a bad investment. However, if it takes two years to achieve these savings or not at all, I believe there are better investment opportunities available over the next two years.
Should you buy SCI stock?
It all depends on how good management is at integrating Stewart Enterprises into the fold. Service Corp. must perform flawlessly in order to achieve a 29% return over the next 12 months. If there are any unforeseen difficulties or it takes the full 24 months to integrate STEI, the industry's limited growth provides very little margin of safety.
While I don't see enough upside necessary to view SCI as an attractive investment and probably wouldn't buy its stock, it doesn't mean you shouldn't. At the end of the day, the death care industry is generally low growth, low risk, investing.
At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.