StoneMor Partners from The Kelly Letter
StoneMor Partners (STON) is the second-largest owner and operator of cemeteries in the United States, with 278 cemeteries and 90 funeral homes in 28 states and Puerto Rico. It’s steadily acquiring new properties to create a stronger moat around its business.
Revenue is derived from products and services related to its cemeteries and funeral homes, sold both pre-need (prior to a person passing away) and at-need (when a person has passed away); and income from its two trust funds, the Perpetual Trust and the Merchandise Trust, worth $318M and $450M respectively. The Perpetual Trust provides funding for the upkeep of cemeteries and receives additional capital as a percentage of interment right sales. The Merchandising Trust is funded with cash from a percentage of sales the company has collected for services or merchandise not yet provided to the customer. An outside investment company manages the trust funds with a goal of providing low-risk income.
Forty-three percent of the trust funds are allocated to real assets (MLPs, infrastructure, and real-estate equities) for stable, growing cash flow and protection against inflation. Eleven percent is allocated to global dividend-paying stocks. Primary exposure to bonds is to agency and non-agency mortgages and emerging market debt. The portfolio has reduced its exposure to traditional fixed income and interest-rate sensitive issues because the investment company expects rates to begin to normalize over the next several years. We expect the same thing.
In its cemetery business, most of StoneMor’s competition consists of independent owners and operators with fewer resources than StoneMor controls, in different geographic markets, and therefore present little competition. The scarcity and high cost of real estate, plus strict zoning regulations near cities, present a high barrier of entry to would-be new competitors. StoneMor’s strong financial position enables it to market its pre-need products more effectively than its smaller competitors can, and to acquire competitors steadily over time, reducing competition even further. In the past 10 years, it’s doubled the number of cemeteries it owns, and added the 90 funeral homes.
The opportunity to continue acquiring its way to higher profitability and a stronger business moat is substantial. There are 22,000 funeral homes and 9,600 cemeteries in the United States. Of these, 80% are independently owned and operated.
StoneMor’s financials are frequently misunderstood because it’s structured as an MLP. Most MLPs are energy outfits, and pay high dividends. StoneMor has the dividend part right, but is in a decidedly different industry.
As a publicly-traded company, StoneMor must report its results under GAAP regulations. In the case of StoneMor with its heavily future-oriented business model, this can lead to distortions in the way its financial performance is perceived. GAAP requires that the company defer recognition of the value of income received until products and services are provided. This means that all of its pre-need revenue is not counted until customers receive what they paid for. This can defer recognition for a long time—indeed, customers hope so! Currently, StoneMor is holding back $600M in net deferred revenue, about two years of future business.
Because of this, the difference between non-GAAP accounting and GAAP accounting at StoneMor is significant. Last year, its non-GAAP operating profit was $67M while its GAAP equivalent was just $6M. Percentage-wise, non-GAAP showed a 20% operating profit while GAAP showed a 2.6%. Most analysts look only at GAAP. This leads to StoneMor looking unable to support its dividend and, therefore, failing to earn a recommendation. Using another way of looking at the business results, simplified “owner’s earnings” reveals StoneMor’s compound annual growth rate to be almost 15%. This is good.
Since February 2005, StoneMor has paid out 40 consecutive quarterly distributions. Throughout most of this history, the company has looked unable to continue funding the generous payouts when judged by GAAP reports. The non-GAAP reports have told a different story. Fear that the dividend will be cut or eliminated altogether crops up regularly around StoneMor, and sends its stock price lower. Yet, the dividend has been maintained and the stock price has eventually recovered.
If this behavior can continue—as I believe it can—then the stock will work well with our signal system.
For the past three years, the stock has fluctuated between about $17 and $25. It’s gone sideways for the past year in a tighter range between $23 and $24.25 or so. This is not ideal, but more volatility may show up in the future. For now, I’ve added StoneMor to the extended Watch List with an initial buy-price target of $23.
Jason Kelly, The Kelly Letter, www.jasonkelly.com, August 8, 2014
