Carriage Services, Inc. (NYSE: CSV) (“Carriage Services” or the
“Company”). Mel Payne, Chairman and CEO, issued the following
statement: I have been waiting almost thirty years to write a press
release like this one. Everything from this point on should be
considered my personal yet educated opinion about various aspects
of Carriage and “Mr. Market,” the famous allegory created by
investor Benjamin Graham to describe what he believed were the
irrational or contradictory traits of the stock market and the risk
of following groupthink. Mr. Market was first introduced in
his 1949 book,
The Intelligent Investor, and its
most famous practitioner is Warren Buffett. My favorite book on
investing and human nature remains, “
Seeking Wisdom: From
Darwin to Munger,” written by the Swedish investor Peter
Bevelin in 2005, who observed and studied the philosophy of Charlie
Munger and concluded that his “simplicity and clarity of thought”
was unequal to anything Bevelin had seen before.
This press release should be considered the
second extension to my recent 50 Page Shareholder Letter titled,
“A TALE OF HIGH PERFORMANCE TRANSFORMATION,”
following the first extension which was our record first quarter
earnings release on April 21, 2021. The story of Carriage’s
transformation since September 12, 2018 is now complete, and this
press release will lay out the last chapter of our transformation
related to capital allocation priorities and current intrinsic
value of our shares with selective data and hopefully entertaining
and colorful narrative, in the following sections:
|
SECTION |
|
PAGE |
I. |
The
current Nature of Carriage; |
|
1 |
II. |
Service Corporation
International: THANK YOU; |
|
4 |
III. |
The Story of Carriage’s $400
million Bond Refinancing; |
|
5 |
IV. |
Service Corporation International
versus Carriage Tom Brady Bond Valuation Comparisons; |
|
6 |
V. |
Service Corporation International
versus Carriage Rodney Dangerfield Equity Valuation
Comparisons; |
|
8 |
VI. |
The Future: The Best of Times
With Everything Before Us; |
|
10 |
VII. |
What It All Means and Why It
Matters. |
|
12 |
I. The Current Nature of
Carriage
As my wife and I were returning to Houston from
Brooklyn (Williamsburg) this past Sunday from three days of
celebrating our son Preston’s 35th Birthday with his sister and
many friends at a rooftop party on Saturday night, I was catching
up on my reading and came across an article in Barron’s on Page 24
that featured an interview with Larry Puglia, the retiring Manager
after 28 years of T. Rowe Price Blue Chip Growth Fund. As a
self-taught professional equity investor and Chief Investment
Officer of our preneed trust funds since October 14, 2008
(see Sections II, Pages 20-22, and IX, Pages 36-40 in my 2020
Shareholder Letter), I was immediately struck by the headline, “How
to Top The S&P for 28 Years.”
The headline reminded me of a similar but even
higher performance beating The S&P 500 Index from 1991 to 2005
by Bill Miller when he was Portfolio Manager of the Legg Mason
Capital Management Value Trust. Unfortunately, Bill subsequently
got clobbered with huge losses when he doubled down on various
financial stocks in the 2008/2009 financial sector crisis and
crash. The headline also brought to mind Foster Friess of Friess
Associates, who had an incredible run of over 20% annual returns
during the decade of the 80’s and into the 90’s as Manager of the
Brandywine Fund, who in 1999 was called by CNBC as one of the
century’s greatest investors. There have been many other master
investors that I have studied over the last thirty years, but
Larry’s interview with Barron’s was custom made for this
release.
During Larry Puglia’s 28 years at the helm of
one of the flagship funds at T. Rowe Price, the $102 billion T.
Rowe Price Blue Chip Growth Fund at April 30th had returned an
annualized 12.2% versus 10.5% for the S&P 500. The
first question to Larry from Barron’s was: “What led to your
outperformance?” Larry’s answer below serves as a summary version
of my view of the “Current Nature of Carriage:”
“A few things. First,
a focus on quality franchises with durable compounding of earnings
and, especially, free cash flow. Second, one of the frameworks we
use to examine companies is [Harvard Business School Professor
Michael] Porter’s concept of sustainable competitive advantage. The
framework – looking for an industry or company with high barriers
to entry, low threat of substitute products, and power vis-à-vis
its suppliers and customers – really appealed to me and was
utilized extensively.
Third, we had a focus
on [corporate] management and how well they were allocating
capital. Capital allocation is extraordinarily important, because
if you’re investing in companies that have superior free cash flow,
but management doesn’t know how to reinvest it wisely, it’s like a
fast ship without a rudder; it will soon run aground.”
Barron’s: “Free cash
flow is at the core of your strategy. Why?” Larry: “It’s the
discretionary cash that a company has available to fund its growth.
Return on equity is a book measure. Book earnings and accounting
results in general are more subject to manipulation. Free cash flow
is much more difficult to manipulate. If you have early-stage or
rapidly growing companies that are throwing off a lot of free cash
flow, that means they have tremendous flexibility to fund their
growth. Many of our companies have free cash flow equal to or
greater than their net income.”
Larry’s answers to these two questions are 100%
on target as to the current nature of Carriage, which was explained
in Section XI of my 2020 Shareholder Letter titled
Observations about 2020 and the Evolution of our Standards
Operating Model (p. 42–44). And a significant part of our
Recurring Free Cash Flow over the next five years is a result of
our superior track record in managing our preneed trust funds since
October 14, 2008, whose twelve plus years of annualized
returns were 14.4% through March 31st (220 basis points higher
than Larry’s), made even more remarkable because of our heavy asset
allocation of 60% plus or minus most of the time to fixed income
securities (98% High Yield but NO JUNK)!
I am formally commenting for the first time in
this release on our recent highly successful $400 million bond
refinancing, inasmuch as the transaction closing was today. Our new
eight year 4.25% senior unsecured notes will save $9.5 million in
annual cash interest costs equal to about 36 cents per share
or 3 cents each month, plus about $400,000 of annual cash
interest cost savings from lower pricing on the approximately $55
million outstanding borrowings on our new Five Year Bank Revolving
Credit Facility led by Bank of America. So on a Proforma basis
assuming our refinancing was effective December 31, 2020, our
Adjusted Proforma Net Income for first quarter 2021 would have been
approximately $16.4 million, our Adjusted Proforma EPS
approximately $0.90 per share and Free Cash Flow approximately
$27.2 million, or 60% higher than our accounting “book”
earnings.
From this point forward, Free Cash Flow Equity
Yield will be a valuation metric we publish and use for purposes of
determining Carriage’s intrinsic value by using a normalized
Recurring Free Cash Flow (FCF) Equity Yield compared to our new
lower cost of capital of about 6.4%, down about 1.0% from 7.4%
before our refinancing.
I will take this announcement opportunity to
also express to outsiders who might be interested in Carriage for
any one of a variety of reasons what our new low cost balance sheet
means for the future of Carriage, especially timely and relevant as
we approach the 30th Anniversary of the founding of Carriage
Services on June 1, 1991. We will host a conference call tomorrow
morning at 9:30 AM Central to take questions about any content in
this release, especially related to our current equity valuation
compared to my view of our intrinsic value, as well as our future
value creation capital allocation strategies and priorities over
the next eight year term of our new senior notes.
I will communicate in this press release using
the same language and (hopefully) witty style that I do internally,
more along the lines of a combination of the blunt, politically
incorrect Charlie Munger (97 years) and his wonderfully wise and
insightful younger partner Warren Buffett (90 years), with a loving
touch of Alan Abelson here and there (I miss his amazingly witty
and clever financial journalism as writer for Barron’s Up
and Down Wall Street column). In fact, I’m reminded of
“Snowball,” the authorized autobiography of Warren
Buffett’s life, and one page in the chapter “Warren, What’s Wrong,”
where he talks about the concept of a person living their life with
either an “Inner or Outer Scorecard” (and person by person varying
degrees of each).
Warren says on this page that, “The big question
about how people behave is whether they’ve got an Inner Scorecard
or an Outer Scorecard. It helps if you can be satisfied with an
Inner Scorecard . . . Now my dad: he was a hundred percent Inner
Scorecard guy. He was really a maverick. But he wasn’t a maverick
for the sake of being a maverick. He just didn’t care what other
people thought. My dad taught me how life should be lived.”
I have used this page often to mentor and teach
Carriage Leaders as well as my two grown children, always coaching
them to be mindful of doing the right thing in every situation
regardless of what others might tell you to do or think of you for
not doing it. I always say that following your own often very
lonely path can be a scary journey with no guarantee of happy
outcomes, but can also lead to unimaginable achievements and a life
full of joy and meaning. I then show whoever I’m mentoring my
editorialized version of this page on living life with an Inner
Scorecard rather than an Outer Scorecard, dated
October 1, 2014 with this handwritten note:
“I finally arrived
here (don’t care what other people think) rather late in life and
am a better person and leader because of this confidence in my
self-identity!”
I am extraordinarily proud to announce that,
only 18 days from today on June 1, 2021, Carriage will celebrate
its 30th year anniversary from its founding on June 1, 1991 by me
and three other co-founders. But it was my idea from the beginning,
as the three co-founders dropped off the journey in the 2000/2001
timeframe when the going got tough and I had to jump in my foxhole
and fight for my and Carriage’s financial survival after our shares
collapsed in early 1999 from $29.25 to $1.00 in August 2000. My
thinking then and now was that at $29.25 it didn’t seem real and
therefore wouldn’t last (read my 2016 Shareholder Letter: IT
WASN’T! AND DIDN’T!), whereas at $1.00 I said I was excited rather
than depressed because our share price could only fall another
dollar! But the first $28.25 plunge was painful (margin calls,
etc.), humiliating and indeed way beyond humbling!
I remember well the first small equity deathcare
conference held in New York toward the end of 2003 when the sector
was showing early signs of recovery after five years of
restructuring and deleveraging after the bank loan leveraged
acquisition mania of the 1990’s (consolidation of ANY BUSINESS at
ANY PRICE!). I showed a slide of Carriage’s revenue growth and Free
Cash Flow during the peak acquisition mania period by year from
1996 to 2003, which reflected that our Free Cash Flow was a “peak
negative” $10 million in 1998 as our share price was peaking at its
high of $29 per share. The host sell side equity analyst for this
small regional firm was shocked and said, “I didn’t know that! I
was focused on Proforma Acquisitions EPS!” That’s because the 10-12
sell side analysts for the 5 domestic public companies in our
sector and their GARP (Growth At A Ridiculous Price) equity money
managers were valuing each company based on Proforma EPS related to
the next year’s “Budget for Acquisition Spending!” CRAZY? YOU BET!
Bubbles always look crazy in hindsight.
Over the last twenty years Carriage has been
gradually rebuilt into what I now refer to as a “High Performance
Culture Company” that just happens to be in the funeral and
cemetery industry. My original idea was not to be the biggest
(Service Corporation International pioneered consolidation in our
industry starting in the early 60’s, and long ago achieved that
pinnacle of success) but to become the best. So I will now declare
proudly that we have achieved my definition of Being The
Best, which is the “Highest Recurring Free Cash
Flow per dollar of revenue and per common share” in the
sixty year history of deathcare
consolidation. THAT WASN’T EASY!
Carriage has evolved into a highly sophisticated
framework of three core models with many correlating linkages since
2003, and transformed itself over the last two and one half years
into a superior Free Cash Flow Value Creation Platform for
operating and consolidating the highly fragmented funeral and
cemetery industries, “A Tale of High Performance
Transformation” that was comprehensively covered in my
recent 50 page 2020 Shareholder Letter.
Carriage has emerged from this
TRANSFORMATION, which was accelerated by the
COVID-19 Pandemic, as a “GROWN UP HIGH PERFORMANCE
RECURRING FREE CASH FLOW MACHINE!” And we believe our
common shares are DEEP CHEAP! My
opinion is that the current range of intrinsic value is as
follows:
CSV Intrinsic Value Roughly Right Range:
$50 to $60 Per Share
The balance of this press release will be
dedicated to why I view our intrinsic value so much higher than the
historical price of our shares including the current price of
$36.58, as well as the specific valuation methodology and reasoning
behind this choice for determining intrinsic value compared to
other valuation methodologies.
II. Service Corporation
International – Thank
You.
I will try to explain just how cheap our shares
are relative to the only comparable benchmark in our sector,
Service Corporation International (SCI), whose Founder and
Visionary Pioneer is Bob Waltrip, a dear friend of mine, and whose
management team led by Tom Ryan since 2005 has done a magnificent
job of restoring credibility to both our debt and equity securities
as great investments. Shown below is a section (not the best one or
the funniest, but very true and relevant) of a congratulatory email
I sent to Tom, Bob and the SCI Management Team after their recent
“blowout first quarter performance.”
“Tom, you and your
team have done a wonderful job restoring credibility to our
industry as an equity investment opportunity based on large and
increasing cash earnings with minimal downside and large upside
over five to ten year timeframes. Your capital deployment
history since you acquired Alderwoods in November 2006 tells an
amazing story of shrinking the supply of common equity shares
available publicly in our sector by a huge percentage as you
acquired Alderwoods, Keystone and then Stewart Enterprises, all
while simultaneously shrinking your outstanding shares by another
huge percentage from repeated share repurchase programs. WOW
what an amazing industry, and great long term execution by (you and
your team). Now you have set a great valuation tone and level for
our “shrunken” equity sector and a standard for me and my team to
attempt to achieve over the next several years.”
III. The story of Carriage’s
$400 million Bond Refinancing.
Bank of America’s High Yield Sales Organization
made a compelling case with a specific game plan that they could
lead our refinancing of $400 million 6.625% Senior Notes maturing
2026 and deliver the best execution. In my previously issued 50
Page Shareholder Letter titled, “A TALE OF HIGH PERFORMANCE
TRANSFORMATION,” I comprehensively explained with both
high performance data and interpretive narratives in eleven
different sections how our credit profile had amazingly transformed
in only 15 months from a Proforma Total Debt to EBITDA Ratio of
6.0 times at the beginning of 2020 to only 3.8 times at March
31, 2021.
My charge to the Bank of America team was
simple: With my five years of private placement experience with The
Prudential from 1971-1976, who were the masters of the universe in
that era in “High Yield” lending to growing private companies (NO
JUNK NOWHERE AT NO TIME!) before Michael Milken
pioneered the concept for public companies in the 1980’s; followed
by five years of large, complex international and domestic
credit lending as head of the Chemical Division of Texas Commerce
Bank, which was one of two Triple A Banks in the U.S. when I left
to pursue an entrepreneurial career at the end of 1980: “Just get
me and Ben in front of the sharpest bond minds managing the largest
pools of bond money in the world, and we will do the rest!”
We launched our new bond issue offering on
Monday morning, April 26th, first at 9:00 AM with a conference call
presentation to the Bank of America Sales Teams followed by a
global call with interested money managers, where more than 100
people from some of the largest pools of bond capital globally
participated, many of which then scheduled one on one virtual
meetings of one hour each with Ben and me over the next three
days.
In my previously issued Shareholder Letter, I
had addressed the sustainability of our Recurring Free Cash Flow
after COVID normalization of death rates at some point as well as
the maintenance of a strong credit profile with a more consistent
and lower Total Debt to EBITDA Leverage Ratio of 4 times or less in
the future versus much of the past thirty years, and I had
anticipated questions from investors about whether I might lever up
the balance sheet again to make a large acquisition or series of
acquisitions like we did in the last quarter of 2019.
From a big picture perspective, I believe there
was a prior perception by some bond investors, but especially
credit rating agencies, that there was an inevitable conflict
between equity investors and debt investors related to leverage
policy and capital allocation. They believed that higher leverage
ratios of 4 times to 6 times to facilitate a more aggressive
acquisition pace was “equity friendly,” while a more conservative
debt ratio policy of 4 times or less together with a flexible and
balanced capital allocation policy was “debt friendly.” My answers
to this angle of questioning was clear and compelling to
EVERY BOND PROFESSIONAL: NO
MORE HIGH LEVERAGE!
At the end of the second day of one-on-one calls
on Tuesday, April 27th, Bank of America indicated that there was
strong demand for our bonds, yet we still had calls with some of
the largest bond firms on Wednesday. That was when I knew that we
could likely achieve my pre-offering goal of demand orders in the
range of $2.0 billion to $2.4 billion for our issue of $400
million, a demand to supply multiple of 5 to 6 times. That was my
definition of success and acknowledgement that our
TRANSFORMATION was complete, just as I had
publicly explained to both equity and debt investors all through
2020 in our earnings releases dated February 19, 2020,
May 19, 2020, July 28, 2020,
October 27, 2020 and February 21, 2021, and
particularly in my Shareholder Letter and First Quarter 2021
Earnings Release dated April 21, 2021.
The strong order momentum and demand for the
senior notes resulted in a coupon of 4.25% or 276 basis points over
eight year treasuries, which were yielding 1.49% on Thursday, April
29th. The order book consisted of a number of long term holders of
our existing notes and I would like to thank them for their
continued support of Carriage. I will explain how this pricing on
our new senior notes offering relates to my opinion on the
intrinsic value of our common shares in Section V of this
release.
I would like to thank the entire syndicate of
underwriters for our success with this bond offering, but
especially the two High Performance Bank of America Superstars of
Jae Lee and Tom Kruse, who did everything I asked of them and more
(never easy, always hard), along with the many Carriage leaders and
our supporting legal and accounting partners at Porter and Hedges
and Grant Thornton.
IV. SCI versus CSV Carriage
“Tom Brady” Bond Valuation Comparison
Before getting to a comparison of SCI versus CSV
equity valuations using 3 different methodologies, it is very
instructive to first look at relative bond valuations and risk
premiums on SCI debt compared to our new bond deal over so called
“risk free treasuries.” Warren, Charlie and I all agree that “risk
free” is a STUPID Way of thinking about Treasury
Debt, but financial journalism is not what it used to be with Alan
Abelson!
With my twenty year background in credit
analysis, debt investing and restructuring and turning around
troubled companies before co-founding Carriage, I have always found
high yield investors committing unsecured eight to ten year money
with light restrictive covenants to be much more analytical and
astute as to determining the cash earning power of a company with
less emphasis on accounting metrics such as EPS, as well as Free
Cash Flow sustainability and resilience through adverse economic
and financial environments and cycles. This long press release is
certainly aimed at equity investors and not at bond investors in an
attempt at closing the Recurring Free Cash Flow Savvy Gap, a
“precedent learning” required to understand our admittedly biased
view of intrinsic value of our company.
Shown below are the current yields on the two
most recent SCI ten year bond issues, including the most recent
$800 million 4.0% Ten Year Senior Notes Offering that priced
this past Monday, May 10, 2021, at 240 basis points over
ten year treasuries of 1.60%.
Issuer |
CSV |
SCI |
SCI |
SCI |
Issue Date |
29-Apr-21 |
10-May-21 |
3-Aug-20 |
7-May-19 |
Maturity |
15-May-29 |
15-May-31 |
15-Aug-30 |
1-Jun-29 |
Amount Issued ($
millions) |
$400 |
$800 |
$850 |
$750 |
Sr. Unsecured Bond Ratings
(S&P / MDY) |
B+ / B2 |
BB / Ba3 |
BB / Ba3 |
BB / Ba3 |
Issue Spread vs Treasury |
T+276 |
T+240 |
T+281 |
T+267 |
Coupon |
4.25% |
4.00% |
3.375% |
5.125% |
Price ($) as of
5/12/2021* |
$100.0 |
$99.8 |
$97.3 |
$107.5 |
Yield to Maturity as of
5/12/2021* |
4.3% |
4.0% |
3.7% |
4.0% |
*Source: Bloomberg - Based on
last trade above $250k posed on 5/12/2021
Without exception on our virtual one-on-one
calls with bond investors over the three full days of our
presentations, each wanted to better understand the “Normalized and
Sustainable Free Cash Flow and Consolidated EBITDA Profile” of
Carriage after whatever COVID performance lift has dissipated or
disappeared altogether. In other words, they asked about the same
skeptical ideas and concepts that we get asked by equity investors
but which are most assuredly not part of the High Performance
Culture Language at Carriage, such as the predictive performance
impact of pull forward higher funeral volumes from the future now,
push forward funeral volumes lower later and for longer, together
with company performance, etc.
My answer was apparently compelling: Virtually
all the COVID-19 lift has been in our Same Store Funeral Segment in
the 12 months ending March 31, 2021, as Same Store Revenue was up
approximately $10.0 million and Field EBITDA approximately
$7.8 million, plus a much smaller lift in the At-need Cemetery
subsection of our Same Store Cemetery Section of approximately $1.2
million revenue and $1.0 million Field EBITDA. Every other Section
(Acquisition Funeral, Same Store and Acquisition Preneed Cemetery,
Financial) was negatively correlated to COVID-19 (Preneed Cemetery
Property Sales a lot), yet have been trending up materially since
mid-2020 with total performance momentum continuing into our first
quarter and April.
Our funeral volumes have been quickly
normalizing in our Eastern and Central Regions (not yet in
California), yet both burial and cremation averages have been
rapidly increasing, more than offsetting revenue lost to volume
declines. We will show a very transparent set of Five Quarter Trend
Data when we report our second quarter performance, along with
monthly Same Store Funeral volume and revenue average trends
together with revenue variances caused by each, just as we did in
our first quarter release. In fact, I don’t know another public
company that reports its performance data with such transparency as
we do, which should have been a confidence and reputation builder
throughout such an extremely uncertain health and economic period
that we have experienced since the beginning of the Coronavirus
Pandemic began in March 2020.
So even if you subtracted an assumed $8.8
million of Field EBITDA and pretax Free Cash Flow related to
COVID-19 lift from our TRANSFORMATIVE HIGH
PERFORMANCE over the last twelve months ending March 31st,
we would still have achieved Adjusted Consolidated EBITDA of
$108.7 million and estimated Free Cash Flow of
$75.7 million. We remain highly confident that we will achieve
our updated Two Year Scenario ending 2022 and Rolling Four Quarter
Outlook ending March 31, 2022, which reflects Total
Revenue of $340-$350 million, Adjusted Consolidated EBITDA of
$112 million to $118 million, Adjusted Diluted EPS of
$2.45 - $2.55 and Adjusted Free Cash Flow of $70 million to
$74 million, none of which reflects any performance
contribution from how we allocate our Free Cash Flow over the next
year or indeed over the full eight year maturity of our new
4.25% senior notes.
V. SCI versus CSV “Rodney
Dangerfield” Equity Valuation Comparison
Shown below are selective public data profiles
of both SCI and CSV, as of May 12, 2021.
(in millions, except Share Price, Margins and
Yield) |
SCI |
|
CSV |
Shares Outstanding |
|
170.0 |
|
|
18.2 |
Current Share Price |
$ |
53.85 |
|
$ |
36.58 |
Equity Market Value |
$ |
9,155 |
|
$ |
666 |
Total Debt |
$ |
3,656 |
|
$ |
469 |
Enterprise Value |
$ |
12,811 |
|
$ |
1,135 |
Estimated |
2021 |
2022 |
AVG 21/22 |
|
2021 |
2022 |
AVG 21/22 |
Adjusted Diluted EPS |
$ |
2.89 |
$ |
2.62 |
$ |
2.76 |
|
$ |
2.50 |
$ |
2.70 |
$ |
2.60 |
Price to EPS |
|
18.6x |
|
20.6x |
|
19.5x |
|
|
14.6x |
|
13.5x |
|
14.1x |
Adjusted Consolidated
EBITDA |
$ |
1,086 |
$ |
1,013 |
$ |
1,050 |
|
$ |
115 |
$ |
119 |
$ |
117 |
Adjusted Consolidated EBITDA
Margin |
|
30.9% |
|
30.1% |
|
30.5% |
|
|
32.5% |
|
33.0% |
|
32.75% |
Enterprise Value/Adjusted
Consolidated EBITDA |
|
11.8x |
|
12.6x |
|
12.2x |
|
|
9.9x |
|
9.5x |
|
9.7x |
Adjusted Free Cash Flow |
$ |
530 |
$ |
505 |
$ |
518 |
|
$ |
72 |
$ |
76 |
$ |
74 |
Adjusted Free Cash Flow
Margin |
|
15.1% |
|
15.0% |
|
15.1% |
|
|
20.3% |
|
21.1% |
|
20.7% |
Adjusted Free Cash Flow Equity
Yield |
|
5.8% |
|
5.5% |
|
5.7% |
|
|
10.8% |
|
11.4% |
|
11.1% |
The table above references Non-GAAP measures which are defined
later in this press release under the section titled Non-GAAP
Financial Measures.
The above table reflects a very strong view by
Mr. Equity Market of the benefit of being a long term shareholder
of SCI, a view we wholeheartedly agree with as I stated earlier in
this release. If anything in the future might change Mr. Market’s
view of SCI’s equity value, it would be to a materially higher
level based on an expansion of its performance valuation multiples
as the large and generally increasingly unhealthy population of
baby boomers begins to die and pushes up death rates for the next
20 to 30 years (note the 40% to 50% of COVID-19 deaths either
directly or indirectly traceable to nursing homes and assisted
living facilities).
It is also not yet clear scientifically whether
or not COVID will become an endemic virus that constantly adapts to
various vaccine booster shots on an annual basis much like the flu,
which would regrettably add incremental annual deaths to normalized
future death rate trends whatever they would have been without the
element of Coronavirus.
On the other hand, the 3 different valuation
methodologies reflect a very weak view of the benefits of being a
shareholder of Carriage relative to SCI, even though we show a
slight increase in 2022 in all of our performance metrics over 2021
with its COVID performance lift, while SCI shows a slight decrease
year over year. All our valuation multiples are materially lower
but vary significantly depending on the valuation methodology.
Shown below are the degrees to which CSV shares are undervalued
relative to SCI using the average performance metric multiple for
2021 and 2022 of SCI applied to Carriage’s average performance
metric for 2021 and 2022.
- CSV Average EPS
of $2.60 times SCI Average EPS Multiple of 19.5 equals CSV price of
$50.70 per share;
- CSV Average
EBITDA of $117 million times SCI Average EV/EBITDA Multiple of 12.2
equals CSV EV of $1,427 million, less $465 million CSV debt, equals
$962 million CSV Equity Market Value divided by 18.2 million shares
equals CSV price of $52.86 per share;
- CSV Average
Adjusted Free Cash Flow of $74 million divided by SCI’s Average
Free Cash Flow Equity Yield of 5.7% equals CSV price of
$71.33.
CSV’s current price of $36.58 is therefore
trading at a 27.8% discount to the Proforma CSV price using SCI’s
P/E Multiple applied to CSV accounting earnings of EPS, by 30.8%
using a blended accounting/cash earnings (EBITDA before capital
structure cash costs) of EV/EBITDA, and by 48.3% using our
preferred methodology of Free Cash Flow Equity Yield.
With our senior notes refinancing now completed,
we have lowered our cost of capital by about a full percentage
point to 6.4%, the lowest by far in our 30 year history. We most
assuredly do not yet deserve to have as low a cost of capital as
SCI, nor do we need to for superior long term compounded
shareholder returns, so using a “Roughly Right Range” of Free Cash
Flow discount rates of 6.4% to 7.4% applied to our 2021/2022
Average Free Cash Flow of $74 million yields a current price range
for intrinsic value per share over the next twelve months of $54.95
to $63.53. We round down to determine our current “Roughly Right
Range” of Intrinsic Value of $50 to $60 per share. That was
easy!
Looked at another way, our new bondholders were
sent a pre-offering notice by our Bank of America team on a “no
company name basis” that Carriage was coming to market with an
offering code-named (my idea) “The Brady Project.” Yep, that Tom
Brady, the GOAT Quarterback of the Super Bowl winning Tampa Bay
Buccaneers. Our bonds got priced at the GOAT Brady Price, only 276
basis points (risk premium) over eight year treasuries and 50 basis
points (CSV risk premium adjusted for ten years) over the ten year
risk premium of 240 basis points on SCI’s $800 million 4.0% senior
notes offering priced on Monday of this week. So if the smartest
bond investors price so little risk premium into our eight year
senior notes compared to the ten year notes of SCI, why do equity
investors currently price into our common shares a risk premium of
over 500 basis points in the form of a Free Cash Flow Equity Yield
of 10.9% for CSV compared to SCI’s current Free Cash Flow Equity
Yield of 5.8%.
Referring back to Benjamin Graham’s wonderful
allegory of Mr. Market, we learned that Mr. Market is often
identified as having human behavioral manic-depressive
characteristics. So we will put our own witty spin on the Mr.
Market allegory in explaining the difference in our extremely High
Free Cash Flow Equity Yield compared to SCI’s rightfully earned
extremely Low Free Cash Flow Equity Yield.
Our current Free Cash Flow Equity Yield of 10.9%
“rejects” a Tom Brady pricing view of our common shares and more
accurately reflects a Rodney Dangerfield pricing view of our common
shares. But we have finally arrived after almost 30 years at a
point in the evolution and maturation of Carriage where “We don’t
care what Rodney Dangerfield thinks” about the intrinsic value of
our shares. Because we know Mr. Rodney Dangerfield Equity Market is
“emotional, often irrational, offers transactions that are strictly
at our option, is there to serve us and not to guide us, and by
being patient will offer us the chance from time to time to buy our
shares from him at prices well below what they’re actually worth
(intrinsic value).”
Like now, which is why our Board has already
authorized $25.6 million in repurchase authority in connection with
our Stock Repurchase Program and why we will be in the market to
see if Mr. Rodney Dangerfield Equity Market will sell us some of
his shares on the cheap. If so, he will undoubtedly reflect on his
dealings with us in a few years and conclude, “No Wonder I don’t
get NO RESPECT!”
VI. The Future: The Best of
Times With Everything Before Us
I left the other major question from every major
credit investor unanswered as to “meat on the bone” until the end
of this release, i.e. will I at any point suddenly re-leverage up
our balance sheet to do a large amount of Mergers &
Acquisitions activity like at the end of 2019? The answer is
NO – BECAUSE WE DON’T NEED TO for the creation of
superior compounded shareholder returns over the next eight
years.
It was, however, necessary to do so at the end
of 2019 to create a Carriage HIGH
PERFORMANCE TRANSFORMATION, as I explained on Pages 29 to
33 in Section VI of my Shareholder Letter. But that’s now complete,
so doing so again would fall into Charlie Munger’s and my
definition of doing “Stupid Stuff!” The very question itself from
anyone at this point means they have likely not read my recent
Shareholder Letter, or worse don’t believe the high and sustainable
performance reality of our transformation since September 12, 2018
that I covered in comprehensive detail with both High Performance
Data and interpretive narrative. Otherwise it wouldn’t have taken
50 Pages!
What my Executive Team and I will do is focus on
optimizing the Free Cash Flow Value Creation Platform of Carriage
with flexible and savvy capital allocation to achieve high relative
returns on capital over the next eight years while operating at
leverage ratios of 4 times or below.
We have proven beyond a shadow of a doubt that
we can handle much more leverage than 4 times, as well as the
ability to rapidly deleverage (from 6 times Proforma to
3.8 times in fifteen months), a High Performance Free Cash
Flow characteristic that should now lead to an expansion of our
valuation multiples. How many companies do you know that can
de-lever 2.2 turns in fifteen months out of Free Cash
Flow? Let us know because we want to buy their shares
for our preneed trust funds!
On Page 10 of my Shareholder Letter under the
table of our updated and increased Two Year Scenario ending 2022
(also increased again in our first quarter release dated April 21st
on Page 6), I wrote the following paragraph.
“After the planned refinancing of our senior
notes on or before June 1, 2021, we will have completely
transformed all parts of our company into a sustainable and
predictable shareholder value creation platform for the future by
savvy, flexible and wise capital allocation to optimize the
intrinsic value of each CSV share over time. When we report our
full year 2021 performance results in February 2022, hopefully
after the tragedy of COVID-19 is behind our country and the world,
we will produce another Three Year Roughly Right Scenario for the
2022-2024 timeframe. This time we will also include multiple
scenarios relating to various capital allocation assumptions and
the application of benchmark valuation methodologies to our
increasing performance metrics which will reflect a range of CSV
share price levels over the three year period that closely align
with the higher 30% to 40% five year compounded CSV share price
return categories in our Good To Great II Shareholder Value
Creation Incentive Plan.”
I have been surprised and quite disappointed
that more equity investors have not been more tuned into the
Five Year Good To Great II Shareholder Value Creation
Incentive Plan that I created in the midst of the
Coronavirus market crash for fifty leaders (10 Standards Council
Members) who will get rewarded with appreciated CSV shares based on
five year compounded share price levels of 20%, 25%, 30%, 35% and
40% achieved by the end of 2024. I covered this program repeatedly
in our quarterly earnings releases starting on
May 19, 2020 and my Shareholder Letter, and it was
comprehensively explained in our recent proxy statement as
well.
Moreover, I recently signed a new seven year
employment agreement and told our Board that I only wanted an
upfront incentive of 150,000 additional options with an exercise
price of $34.79 on the day of Board approval, but which would vest
only on price, i.e. 50,000 at $53.39 and 100,000 at $77.34 after
the stock has closed at or above that price for three consecutive
trading days. So why would I do that? Let me explain.
A. Capital Allocation Extremes.Even through our
Capital Allocation Program for the next eight years will be
flexible, savvy and opportunistic, let’s think together about two
different extremes, the first where all Free Cash Flow is allocated
to high quality acquisitions, and the second where all Free Cash
Flow is allocated to CSV share repurchases
B. “Back of the Envelope” Eight Year Free Cash
Flow from Existing Portfolio.
Our Rolling Four
Quarter Outlook ending March 31, 2022 on Page 6 of
our first quarter earnings release reflects an Adjusted Free Cash
Flow Range of $70 million to $74 million, increasing
slightly in the Two Year Scenario table to $72 million to
$76 million in 2022 (assumes no change in tax rates under
Biden Administration). So it would seem on the conservative side to
assume we would average $75 million of Free Cash Flow over the
next eight year term of our senior notes, i.e. a total of
$600 million of Free Cash Flow which can be allocated by me
and our Executive Team and Board to optimize the intrinsic value of
Carriage per share.
C. 100% Capital Allocation to Acquisitions.
One extreme, which I
explained to every one-on-one bond candidate, would be to only
selectively and steadily by year buy top quality acquisitions,
assuming a rule of thumb price multiple of three times revenue. In
reality, I’m not sure that after 60 years of consolidation history,
we could find quality acquisitions of that amount, especially on a
pace that would keep our leverage consistently below 4 times. But
theoretically, at the end of eight years we would have acquired
$200 million of additional acquisition revenue and grown our
current revenue of $350 million to $400 million (less than 2%
compound revenue growth rate – NOT A FORECAST – just for glass half
empty predictions of the future!). Moreover, there is no credit in
this simple back of the envelope view of Carriage for incremental
Free Cash Flow that would begin to accrue from any new acquisitions
as they were closed and integrated over the eight year
timeframe.
Assuming a 35%
Consolidated EBITDA Margin on $600 million of revenue at the end of
2029, our Consolidated EBITDA would be $210 million and our
Total Debt would still be-HALLELUJAH-stuck at $450 million!
Our formerly high Total Debt to EBITDA Ratio (some weak thinkers
somewhere said I was not only aggressive but RECKLESS!) would have
shrunk from 6 times Proforma at the beginning of 2020 to a measly
2.14 times at the end of 2029! There would likely be a shareholder
revolt to kick me out for not using more leverage to optimize our
intrinsic value and market price per share! I would vote YES!
Here’s the best part.
Without leveraging up our balance sheet, our equity valuation
multiples would hopefully begin to expand toward those of SCI
today, and hopefully sooner rather than later. Applying a 12 to 13
times EBITDA multiple to $210 million EBITDA at the end of 2029
produces a Total Enterprise Value Range of $2,520 million to
$2,730 million, less $455 million of total debt, produces an
equity market capitalization range of $2,055 million to $2,265
million. Assuming our outstanding shares rise to approximately 20
million from approximately 18.2 million currently, mostly from
“price vested” equity programs for our leadership teams
(Good To Great II Shareholder Value Creation Incentive
Plan, etc.), the market price per share of Carriage would
be in the range of $102.75 to $113.25 per share. In other words,
Mr. Rodney Dangerfield Equity Market by then would have sold all
his shares to Mr. Tom Brady, the Greatest Of All Time
Investors!
D. 100% Capital Allocation to Share
Repurchases.
The other extreme
option for capital allocation would be share repurchases. Assuming
the current Mr. Market Rodney Dangerfield Equity Price of $36.58
remains the price over the next eight years (a good reason he will
continue to get NO RIP RESPECT), then we could repurchase 16.4
million shares for $600 million equal to 90% of the current
18.2 million shares outstanding, of which about 12% to 13% are held
by insiders, including about 10% by me, my wife and two adult
children!
Now seriously, savvy
equity investors out there in the real world, wouldn’t you want to
own a (large) piece of a company that could theoretically go
private in eight years at current prices?!?
P.S. Confidential
message to private equity firms: NO WAY because you would make us
repeat all the “stupid stuff” we did in the 90’s!
VII. What it all Means and
Why It Matters.
This has already been a long press release about
A TALE OF HIGH PERFORMANCE TRANSFORMATION, so I
will end with a wonderful email about the Carriage Good To
Great Flywheel (Page 41 to 42 of my Shareholder Letter)
that I recently received from Doug Reinke. Doug became Managing
Partner of Dakan Funeral Home in Caldwell, Idaho in the Boise area
when we acquired the business twenty-five years ago in June 1996,
two months before our IPO in August 1996.
Dear Mel,
When I was a boy
growing up on the family farm in the pheasant capital of the world,
Gooding, Idaho, one of my memories is of my father bailing hay with
an international Harvester baler. Aside from a very loud engine,
the energy needed to slam the plunger into the bale chamber to make
the hay bales came from the inertia of a flywheel mounted on the
side of the machine. The flywheel weighed several hundred pounds,
so much so that when it needed to be removed for service, it was
certainly a multiple person job.
As I read your
shareholder letter and listened to the earnings call yesterday, I
had a vivid image come to mind of one of those infrequent times
when a shear pin broke on the shaft connecting the flywheel to the
plunger. My dad would climb off the tractor, and disengage the
drive belt from the engine to the flywheel. Now, unfettered by the
belt from the engine, the flywheel seemed to increase momentum for
a time. The flywheel, so perfectly balanced, would spin at an
incredible rate of speed and the only thing to do was watch and
wait for it to stop on its own.
Over the past 25
years, I have participated in the ESPP and have NEVER sold a share.
I have not given the accounts much attention, just check in on them
from time to time so to speak. So yesterday after listening to the
call and reading your letter, I opened the account for the first
time in a while to check on how things were going. I knew what the
share price had been doing but I can’t even tell you how many
shares I have. You have always said don’t sell, so I haven’t. So I
opened the account(s) and I’m looking at the balances in the
hundreds of thousands of dollars.
Mel, congratulations
to you and the executive team on building a perfectly balanced
flywheel and . . .
Thank you.
Sincerely
Doug
Doug, thank you for your inspiring message to me
and the Carriage Leadership Team. I am proud to let the whole world
know that you are the only leader of Carriage to ever climb a
mountain and plant a Carriage Flag on the peak.
Just know that the leadership team and I are
working for you in your well-deserved retirement, so NEVER
SELL YOUR SHARES!!!
Mel
NON-GAAP FINANCIAL MEASURES
This press release uses Non-GAAP financial
measures to present the financial performance of the Company. Our
non-GAAP reporting provides a transparent framework of our
operating and financial performance that reflects the earning power
of the Company as an operating and consolidation platform.
Non-GAAP financial measures should be viewed in
addition to, and not as an alternative for, the Company’s reported
operating results or cash flow from operations or any other measure
of performance as determined in accordance with GAAP. We believe
the Non-GAAP results are useful to investors to compare our results
to previous periods, to provide insight into the underlying
long-term performance trends in our business and to provide the
opportunity to differentiate ourselves as the best consolidation
platform in the industry against the performance of other funeral
and cemetery companies.
Reconciliations of the Non-GAAP financial
measures to GAAP measures are also provided in this press
release.
The Non-GAAP financial measures used in this
press release and the definitions of them used by the Company for
our internal management purposes in this press release are
described below.
- Special items are
defined as charges or credits included in our GAAP financial
statements that can vary from period to period and are not
reflective of costs incurred in the ordinary course of our
operations. Special Items are typically taxed at the federal
statutory rate or the net operating tax rate in effect during the
period.
- Adjusted
Consolidated EBITDA is defined as Consolidated EBITDA after
adjustments for special items that we believe do not directly
reflect our core operations and may not be indicative of our normal
business operations. Consolidated EBITDA is defined as net income
before income taxes, interest expenses, non-cash stock
compensation, depreciation and amortization, and interest income
and other, net.
- Adjusted
Consolidated EBITDA Margin is defined as Adjusted Consolidated
EBITDA as a percentage of total revenue.
- Adjusted Free Cash
Flow is defined as cash flow provided by operating activities,
adjusted by special items as deemed necessary, less cash for
maintenance capital expenditures.
- Adjusted Free Cash
Flow Margin is defined as Adjusted Free Cash Flow as a percentage
of total revenue.
- Adjusted Free Cash
Flow Equity Yield is defined as Adjusted Free Cash Flow divided by
Equity Market Value. Equity Market Value or Market Capitalization
is our shares outstanding multiplied by our closing share price on
May 12, 2021.
- Adjusted Diluted
Earnings Per Share (EPS) is defined as GAAP diluted earnings per
share, adjusted for special items.
- Total Debt is
defined as indebtedness under our bank credit facility, Senior
Notes due 2029, acquisition debt and finance leases.
Reconciliation of Non-GAAP Financial
Measures:
Reconciliation of Performance Scenarios
(estimated years ended December 31, 2021 and 2022).
Earlier in this press release, we present
Performance Scenarios which reflects management’s opinion on the
performance of the portfolio of existing businesses, including
performance of existing trusts, and excludes size and timing of
acquisitions unless we have a signed Letter of Intent with a high
likelihood of a closing within 90 days. These are not intended to
be management estimates or forecasts of our future performance, as
we believe precise estimates will be precisely wrong all the
time.
Reconciliation of Net Income to Adjusted
Consolidated EBITDA (in thousands) and Adjusted Consolidated EBITDA
Margin:
|
CSV |
|
2021E |
|
2022E |
Net Income |
$ |
43,700 |
|
|
$ |
49,200 |
|
Total Tax Expense |
19,500 |
|
|
22,000 |
|
Pretax Income |
$ |
63,200 |
|
|
$ |
71,200 |
|
Net Interest Expense,
including Accretion of Discount on Convertible Subordinated
Notes |
24,500 |
|
|
21,000 |
|
Depreciation &
Amortization, including Non-cash Stock Compensation and Other |
24,800 |
|
|
26,800 |
|
Net Loss on Divestitures and
Impairment Charges |
— |
|
|
— |
|
Consolidated EBITDA |
$ |
112,500 |
|
|
$ |
119,000 |
|
Special Items |
2,500 |
|
|
— |
|
Adjusted Consolidated
EBITDA |
$ |
115,000 |
|
|
$ |
119,000 |
|
|
|
|
|
Revenue |
$ |
354,000 |
|
|
$ |
361,000 |
|
|
|
|
|
Adjusted Consolidated EBITDA
Margin |
32.5 |
% |
|
33.0 |
% |
Reconciliation of Net Income to Adjusted
Net Income (in thousands):
|
CSV |
|
2021E |
|
2022E |
Net Income |
$ |
43,700 |
|
|
$ |
49,200 |
|
Special Items |
1,800 |
|
|
— |
|
Adjusted Net Income |
$ |
45,500 |
|
|
$ |
49,200 |
|
|
|
|
|
Reconciliation of GAAP Diluted Earnings
Per Share to Adjusted Diluted Earnings Per Share:
|
CSV |
|
2021E |
|
2022E |
GAAP Diluted Earnings Per Share |
$ |
2.40 |
|
|
$ |
2.70 |
|
Special Items |
0.10 |
|
|
— |
|
Adjusted Diluted Earnings Per
Share |
$ |
2.50 |
|
|
$ |
2.70 |
|
Reconciliation of Cash Flow Provided by
Operating Activities to Adjusted Free Cash Flow (in thousands),
Adjusted Free Cash Flow Margin and Adjusted Free Cash Flow Equity
Yield:
|
CSV |
|
2021E |
|
2022E |
Cash Flow Provided by Operating Activities |
$ |
79,500 |
|
|
|
$ |
87,000 |
|
|
Cash used for Maintenance
Capital Expenditures |
(10,000 |
) |
|
|
(11,000 |
) |
|
Special Items |
2,500 |
|
|
|
— |
|
|
Adjusted Free Cash Flow |
$ |
72,000 |
|
|
|
$ |
76,000 |
|
|
|
|
|
|
Revenue |
$ |
354,000 |
|
|
$ |
361,000 |
|
|
|
|
|
Adjusted Free Cash Flow
Margin |
20.3 |
% |
|
21.1 |
% |
|
|
|
|
Equity Market Value (in
millions) |
$ |
666 |
|
|
|
$ |
666 |
|
|
|
|
|
|
Adjusted Free Cash Flow Equity
Yield |
10.8 |
% |
|
11.4 |
% |
CAUTIONARY STATEMENT ON FORWARD-LOOKING
STATEMENTS
Certain statements made herein or elsewhere by,
or on behalf of, the Company that are not historical facts are
intended to be forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. In addition
to historical information, this Press Release contains certain
statements and information that may constitute forward-looking
statements within the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. All statements, other
than statements of historical information, should be deemed to be
forward-looking statements. These statements include, but are not
limited to, statements regarding any projections of earnings,
volume, revenue, cash flow, capital allocation, debt levels,
interest costs, equity prices, corporate incentive compensation or
other financial items; any statements of the plans, timing and
objectives of management for acquisition activities; any statements
of the plans, strategies and objectives of management for future
operations or financing activities; any statements regarding future
economic conditions or performance; any statements regarding
hypothetical future strategic alternatives for the company; any
statements of belief; and any statements of assumptions underlying
any of the foregoing and are based on our current expectations and
beliefs concerning future developments and their potential effect
on us. The words “may”, “will”, “estimate”, “intend”, “believe”,
“expect”, “seek”, “project”, “forecast”, “foresee”, “should”,
“would”, “could”, “plan”, “anticipate” and other similar words or
expressions are intended to identify forward-looking statements,
which are generally not historical in nature. While management
believes that these forward-looking statements are reasonable as
and when made, there can be no assurance that future developments
affecting us will be those that we anticipate. All comments
concerning our expectations for future revenue and operating
results are based on our forecasts for our existing operations and
do not include the potential impact of any future acquisitions. Our
forward-looking statements involve significant risks and
uncertainties (some of which are beyond our control) and
assumptions that could cause actual results to differ materially
from our historical experience and our present expectations or
projections. Factors that could cause actual results to differ
materially from those made or suggested by the forward-looking
statements contained herein include those identified in the
Company’s Annual Report on Form 10-K for the year ended December
31, 2020, our Quarterly Reports on Form 10-Q for the quarter ended
March 31, 2021, and other public filings and press releases,
available at www.carriageservices.com. Investors are cautioned not
to place undue reliance on forward-looking statements, which speak
only as of the date hereof. We undertake no obligation to publicly
update or revise any forward-looking statements after the date they
are made, whether as a result of new information, future events or
otherwise, except to the extent required by law.
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