InvoCare (ASX:IVC) is a leading operator of funeral homes, cemeteries and crematoria across Australia, with smaller operations in NZ and Singapore. In the Australian market, IVC is the only player with national brands. These include White Lady Funerals, Simplicity Funerals, and Value Cremations.
After a challenging 2020, we recently revisited the Company’s fundamentals to assess the prospects for a re-rating in the shares back to pre-COVID levels. This was given the improvement in macro conditions. In particular, how well is the Company positioned to improve market share in funerals now that COVID-19 restrictions have been eased? Our main focus on this report is the Funerals business, which is likely to be the main driver of sentiment in the near term. In context, the Company’s Memorial Parks business across Australia and NZ accounts for ~25% of group revenue and ~40% of group EBITDA and is a higher-margin, and more resilient, business than IVC’s Funerals business.
Key Fundamental Considerations
More Challenges Than Opportunities for the Funerals Business
For the six months to 30 June 2020 (1H20), IVC’s overall funeral case volumes in Australia (which accounts for ~80% of overall Funerals revenue) declined by -3.4%. This decline was greater than the -2.4% for the market, implying a market share loss of up to 100 basis points for IVC. Funeral case averages* for 1H20 declined by 6.6%, given COVID-19 restrictions on the number of attendees at funerals due to social distancing.
With social distancing measures now largely lifted, case averages are expected to eventually revert back to pre-COVID-19 levels. However, we consider that there are challenges in IVC achieving a material improvement in case averages and recovering market share loss. We outline 3 factors supporting this view:
1. IVC’s Volumes Are Still Correlated to Death Rates – But the Company is Losing Market Share
At the 1H20 result, IVC estimated that the number of deaths was down -2% to -4% in 1H20. In four of the last six years, IVC’s industry volume have been typically well below the number of deaths that have occurred in Australia. Assuming IVC’s regions broadly track Australian death volumes over time, this implies a loss of market share greater that what has been disclosed by IVC.
2. COVID-19 Likely to have Accentuated Trend Towards Low-Cost Service
Industry sources indicate that following COVID-19, funeral clients are becoming more price sensitive. The implication from this is that IVC could lose additional volumes to smaller/less corporatised operators who are better able to cater for clients on a budget whilst maintaining (and in some cases offering a better) service levels.
In context, price sensitivity in funerals existed pre-COVID-19 and is one reason why IVC’s case volumes were struggling to grow Pre COVID-19. Given the rising cost of burial plots and crematorium services over the last 5-10 years, more clients are choosing more affordable funerals, by electing to have a direct burial or cremation (i.e. without requiring a traditional funeral service), or to have a single, rather than a dual, service.
3. Further CAPEX Required to Support ‘Protect & Grow’ Program
In late 2017, the Company commenced a capital expenditure (CAPEX) program, with plans to spend $200m over four years on refreshing operating sites and advancing IT systems and processes. The program, called ‘Protect & Grow’, was implemented in order to reverse market share decline and increase revenue by providing an improved product offering.
When the CAPEX plan was first initiated in 2017, the Company was expecting the un-renovated locations to keep their market share flat, however the reality is that market share has been in constant decline. Further, while the performance of renovated sites has been better that non-renovated sites (i.e. in terms of metrics such as case volumes, net sales and earnings), the base against which these improvements are being measured is declining. The implication here is that not only is additional CAPEX required; but the return on CAPEX is unlikely to be as high as expected.
Is the Expansion into Pet Cremation a Sound Strategy?
In November 2020, IVC announced the acquisition of two pet cremation businesses with a combined presence across five states. The acquisitions were funded by debt. However, balance sheet gearing following completion of the acquisitions is still comfortable given strong operating cash conversion and a tapering CAPEX profile in FY21.
Whilst the acquisitions are EPS accretive and the historical organic growth rate is impressive, we struggle to see the strategic appeal of the acquisitions. Firstly, the acquisitions do not significantly lift the EBITDA base (~$110m in FY20 on a group basis). From this perspective, the ~$50m spent on the acquisitions could have been: i) Redirected into the Protect & Grow program, which is running behind schedule and to date, not generating the cost savings expected, or ii) Used to acquire funerals businesses, in order to help protect market share in the core funerals market. Secondly, there are not expected to be any material synergies post integration of the two acquisitions.
Fundamental View of InvoCare
In November 2020, the Company announced the appointment of Olivier Chretien as the new MD & CEO from 1 January 2021. Mr Chretien (an external appointment with no direct industry experience) replaces Martin Earp, who has held the MD & CEO role since March 2015.
A key focus for investors going forward is the extent to which the incoming MD & CEO can improve market share in the funerals business as well as the return on invested capital (ROIC) from the Protect & Grow program. Successful execution of these strategies would result in an acceleration in EPS and thus, a re-rating in the shares.
To this end, with the shares currently trading on a FY21 P/E multiple of 30x, the market is factoring in EPS improvement of +30% in FY21, with FY20 results due to be released in February 2021. At current levels, we would prefer to see signs of improvement in both ROIC and market share before we take a more favourable view on the shares, with a more favourable view requiring confidence in the new MD & CEO executing on the above-mentioned strategies.
The charting pattern for IVC looks very interesting here where it seems to be making a “cup and handle” formation. This means that it looks like it has found a good low and is getting ready to move higher again. With the share price spending the last several weeks congesting under $12 resistance, it appears to be only a matter of time until it makes a break. A break of $12 is therefore a buying opportunity as that should lead to a rally back up towards $15.
* Funeral case average refers to the amount paid by clients for funeral services only and does not include the burial/cremation costs which are typically paid upfront by clients.
Michael Gable is managing director of Fairmont Equities.
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