Can You Rest In Peace With Funeral Stocks?

By Matt Cavallaro | October 28, 2011 AAA

Families with tight budgets are cutting back on everything, including funeral arrangements for loved ones. Still, there's a guaranteed market for death care companies. Even though it might seem heartless to profit from death, there are some interesting opportunities calling out from beyond the grave. (To help you plan your future and the future of your family, read Getting Started On Your Estate Plan.)

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Nothing Is Certain Except Death and Taxes and Competition
Analysts that doubt this industry because of statistics showing longer life expectancy thanks to preventative health care and medical innovation are missing the point. The fact is that total death volumes must inexorably increase. Over the next 50 years in the U.S., the number of deaths annually is expected to climb 50%. People are rarely happy to employ funeral service firms, but this is one industry where market sentiment has no influence. Inevitably, the industry will soon enjoy substantial and stable revenues from an aging and unhealthy U.S. population.

In reality, the true threat to pure play funeral stocks is burial trends and competition. Cremation, in particular, is pressuring both sales and margins. Families and government bodies are increasingly opting for lower cost cremation services rather than burials. Cremations are not only cheaper, they squeeze margins by eliminating potential upsale of caskets and other funeral products. The Cremation Association of North America reports 34% of all deaths resulted in cremation in 2007, and by 2015 that number is expected to jump to 44%.

Additionally, big box retailers like Wal-Mart Stores, Inc. (NYSE:WMT) and Costco Wholesale Corporation (Nasdaq:COST) are waging a price war against funeral service companies. Traditionally, caskets are not inexpensive. Now, you can get a casket at one of these retailers at a competitive price. (For more on Wal-Mart and Costco, check out Analyzing Retail Stocks.)

Don't Bury Funeral Stocks
Despite these competitive threats, there are some interesting stocks in the funeral segment. StoneMor Partners L.P. (Nasdaq:STON) jumps out because of a phenomenal 8.69% annual dividend yield. StoneMor's yield and steady cash flow are attractive, but earnings have been unreliable.

Service Corporation International (NYSE:SCI) is North America's largest funeral home and cemetery operator. Services pays a healthy 2.01% annual dividend yield, and is also the best performing stock in the space year to date, up 21%. This outperformance has pushed Service's price-to-earnings multiple past 20, the most expensive in the group.

Over the past month, Stewart Enterprises, Inc. (Nasdaq:STEI) is the top performer, having risen 14.6% from a year ago despite a disappointing third quarter earnings report. Stewart Enterprises pays a solid 2.25% yield.

Then there is Batesville, Indiana-based Hillenbrand, Inc. (NYSE:HI) which is really worth taking a close look at. Hillenbrand trades at a very cheap multiple of 12.1 times earnings, and pays an excellent 3.77% yield. On the downside, Hillenbrand's casket business and margins are vulnerable to a price war with Wal-Mart and Costco.

The Bottom Line
There will always be a market for these companies' services, and the market is only going to get bigger. If StoneMor can demonstrate more stable earnings power, that yield will become even more attractive, resulting in very tangible price support. While some of these names are interesting and valuations are good across the board, significant risks to the funeral business remain. In addition to changing dynamics in consumer burial behavior and competitive pressures from mega-retailers, investors must worry about a downdraft in preneed sales if the economy deteriorates further. End-of-life services companies highly leveraged to preneed sales may expose investors to volatility risk. It might be better to wait for this group to stabilize before resting comfortably with some of the big dividends. (For more on dividends, check out Why Dividends Matter.)

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At the time of writing, Matt Cavallaro did not own shares in any of the companies mentioned in this article.

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