Dignity PLC going six feet under?

On Friday, January 19, DTY crashed almost 50% to 962p per share, having closed at 1,916p the previous day. This was due to a trading update where the company said they would be cutting their simple funeral service price by 25% and freezing the price of their traditional funeral service to protect their market share, due to increased competition in the industry and market share erosion.

During the trading update call, one analyst was predicting a 50% drop in EBITDA (earnings before interest,  taxes, depreciation and amortization) due to these actions, which would lead to only a 2x debt service ratio. Total annual debt service is about £33m (interest and capital) and their debt covenants state that EBITDA must be at least 1.5x this (about £50m). They also have an undrawn debt facility of £50m.

After the above update its share price drifted down to 750p before recovering to about 1,000p, and yesterday it closed at 932.50p. I looked into the company very superficially after it crashed since Dignity PLC is the only listed funeral services company in the UK (usually a very solid and regular industry), but decided to move on because I saw that it had a great deal of debt. My interest has not diminished, however, and since the 2017 results will be published this Friday, April 20, I decided to analyse this company first, after a request I received from a friend when I published this article.

Profile

As per its FT profile, DTY provides funeral services through three segments: funeral services, crematoria, and pre-arranged funeral plans. The company operates about 720 funeral locations trading under established local names all over the UK, 40 crematoria in England and Scotland, and has about 374,000 active funeral plans.

DTY has a market cap of £463.87 million, a dividend yield of 2.62% and a PE ratio of 8.03. When I check out its financials on FT’s website, I can see that:

  • revenue has increased every year since 2013;
  • net income remained flat for the last three years at around £57 million, and was negative in 2014;
  • net profit margin for 2017 was 17.84%;
  • return on equity for 2017 was 269.46% (this can’t be right, can it?);
  • cashflow has been decreasing every year since 2013, and was negative in 2016 and 2017;
  • the PCF ratio is 6.09;
  • long term debt rose in 2014 but decreased a little every year since, and it is 92.36% of capital, which means that the company is leveraged 12x! (this is a bit scary… juuuuuust a little bit…);
  • dividends were increased every year since 2013.

Now I know why Dignity PLC has such a high ROE! If not for the huge debt level, and the flat net income, and the ever decreasing cashflow, this would be a dream company (yeah, right). Let’s go deeper and check the latest releases…

2017 preliminary results

On March 14 Dignity PLC published the preliminary results for the 52 week period ended 29 December 2017. Let’s check out the Pros and Cons:

Pros

  1. Revenue and operating profit rose 3% to £324m and £104.6m, respectively (page 1);
  2. 2017 financial performance was in line with market expectations (page 2);
  3. Deaths in the UK in 2017 were flat at 590,000 (page 2);
  4. 98% of clients say they would recommend the company (page 2);
  5. Good year of pre-arranged funeral plan sales, with active pre-arranged funeral plans increasing to 450,000 from 404,000 in 2016 (so the FT profile is a bit outdated) (page 2);
  6. Engagement of L. E. K. Consulting to help develop their plan for the funeral business, with the results of the operating review to be released in August, and early indications to be detailed in the first quarter update on May 14. Whatever changes are made, this will imply a restructuring cost which does not have a value yet (page 2);
  7. 2017 financial performance was strong enough to justify an award to the Executive Directors of 95% of their maximum bonus, but following the trading update in January they decided to waive this in full (kind of decent of them) (page 5);
  8. At year end 2017, the group operated a network of 826 funeral locations throughout the UK (another thing the FT is wrong about) (page 11);
  9. The group operates 45 crematoria in the UK, has another three in construction, and performed 63,400 cremations compared to 59,500 in 2016 (page 12);
  10. 69,000 pre-arranged funeral plans were sold compared to 49,000 in 2016. Of these, 35,000 were plans linked to life assurance plans with third parties and the others were trust based plans. At the end of 2017, the Trusts held £940m of assets related to 306,000 trust based plans and had a surplus of £27.3m (pages 12 and 13);
  11. The company has a £50m revolving credit facility with the Royal Bank of Scotland, for which it pays £0.3m every year (page 17);
  12. In their investor presentation, Dignity also states that the 2017 funeral mix was: 60% full service at £3,800; 7% simple service at £2,700; 27% pre-arranged at £1,650; 6% other at £500; and ancillary revenues of about £280 per funeral. It was anticipated that the cut in prices would increase the proportion of simple funerals to 20%;
  13. Since the price of the simple funeral was reduced these increased to 15% of the funeral mix, a bit below the 20% forecast in the January trading update.

Cons

  1. Cash generated by operations decreased 5% to £115.4m (page 1);
  2. Basic earnings per share were flat at 115.8p (page 1);
  3. Acquisition of 24 funeral locations and one small crematorium, with total acquisition investment of £28.3m (I’m putting this down as a con because they appear to want to spend money instead of paying down debt or strengthening the balance sheet) (page 2);
  4. Due to the focus on protecting market share, the business model for the funeral business is changing. These actions will lead to substantially lower profits in 2018 but “should create a new platform to allow stable growth in the future” (page 3);
  5. The Board is proposing to maintain the final dividend of 15.74p to be paid in June (really?) (page 5);
  6. The average reduction in the number of funerals per location between 2004-2014 was 3.6% per year, which increased to 6.8% between 2015-2017 (hence the reduction in prices and hiring of consultants) (page 7);
  7. DTY expects to spend an additional £2m per year on digital and other promotional activities starting this year (page 7);
  8. There are 30% fewer deaths per funeral director in the UK compared to 25 years ago (page 8);
  9. DTY conducted 68,800 funerals compared to 70,700 in 2016 (page 11);
  10. 2017 maintenance capex was £12.7m (page 11);
  11. The group pension plan has a deficit of £24m, but at least they closed the plan in February 2017, and instead started a defined contribution scheme (page 16);
  12. £565.7m in bonds outstanding due to be repaid by 2049 with no refinancing or rollover or facilities. The market value of these bonds at year end was £686.5m. If the company repayed all amounts due under these Secure Notes, it would cost them £764m (page 17);
  13. Net profit attributable to equity shareholders was flat at £57.8m (page 21);
  14. Of the £647.8m the company has in fixed assets, £226.1m is goodwill and £159.4m is intangible assets (page 22);
  15. Total equity is merely £46.4m, and was negative in 2016 (-£3.5m). If I remove goodwill and intangible assets, this leaves me with tangible equity of -£339.1m (page 22);
  16. Total cashflow was -£17.8m in 2017 and -£15.1m in 2016 (page 24).

Since Dignity PLC has a lot of debt outstanding as bonds, they also publish a bondholders report. The main highlights were:

  • Unaudited EBITDA was £110.1m compared to £114.2m in 2016;
  • Free cashflow was £88.2m, down 6% from £93.8m in 2016;
  • The company has £225.5m in creditor amounts falling due within one year, and less than £50m in cash and cash equivalents!!! Or am I reading this wrong? Why is this number not mentioned in the shareholders report?;
  • Total financial indebtedness rose £10.3m to £731.6m;
  • The financial covenant is 1.5x EBITDA (meaning if EBITDA falls below 1.5x their debt service, the company is in breach to their bondholders). This stood at 3.24x at the end of 2017;
  • The restricted payment conditions are 1.4x free cashflow and 1.85x EBITDA (meaning if they fall below these ratios, there will be no dividend payments). Free cash flow cover stood at 2.59x at the end of 2017;
  • 2017 operating margins were: group 37%, funeral services 41%, crematoria 58%, and pre-arranged funeral plans 28%;
  • Debt service for 2017 was £34m.

Conclusion

The £225.5m in creditor amounts due within one year is extremely concerning. There are no notes about this number in the bondholders report and it isn’t even mentioned in the shareholders report. This alone would be more than enough for me to pass, or run away from this company.

Even if the number above didn’t exist, I have many other concerns. The decrease in profits for 2018 is hard to quantify exactly since we won’t know the new funeral mix until the end of the year, and the cost of the restructuring plan that L. E. K. Consulting is going to suggest is anyone’s guess. I do think it’s very possible (and even probable) that Dignity will break their debt covenants and will have to cut their dividends and stop buying up funeral homes and crematoria to shore up capital to handle these challenges (or maybe just borrow more money, since they seem to like that instead of being conservative; raising capital would be a better option but…). Even if they don’t break their covenants, it’s going to be too close for comfort (actually, it already is!).

I really dislike this company and its management. They have been more concerned with buying up more funeral homes and crematoria, and paying dividends to shareholders, instead of managing their money conservatively to pay down debt and strengthen their balance sheet. I don’t know exactly why they decided to borrow so much money in the past (I didn’t go through the last annual reports, and at this point I don’t really want to anyway), but considering that liabilities have been increasing almost every year for the last five years while the company never had more than £50m in shareholders’ equity (and was even negative for a few years) makes me wonder about their financial management skills.

I don’t know what their share price will do in the future (I’m guessing down), but I don’t want to be associated with these guys, so Dignity goes straight to the ‘No’ tray.

There’s more pain ahead…

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