InvoCare's US venture laid to rest

InvoCare is calling time on its US expansion, but the Australian business is going strong.

Say what you will about the company’s US expansion – and as a shareholder I wasn’t keen – but you must love a management team as disciplined as InvoCare’s. In 2015 the company announced it would spend up to US$8m launching a funeral business in Southern California, with sales ‘not expected to exceed US$10m until the third year’.

Showing admirable discipline, with US$6m invested, management admitted in February this year that the operation was a dud. With sales of just $US1.4m in 2016, InvoCare will close the business. Management deserves praise for sticking to its original targets and knowing when to shut up shop. Closure costs won’t be significant, with management expecting around $0.7m.

Indeed, why head off overseas when your Australian business is a goldmine? In the 2016 results delivered in February, the company’s largest division produced a 6% lift in operating earnings before interest, tax, depreciation and amortisation (EBITDA) to $98m. That represents an impressive margin of 25%, showing the economies of scale inherent in the company’s 30%-plus market share in most metropolitan markets.

Key Points

  • Shutting down US venture

  • Australian business strong

  • New strategy to meet demand

What made the result even more impressive was that many Australian metrics headed in the wrong direction. The number of deaths grew at a below-trend 0.8% (compared with a forecast of 1.4%), while the company lost market share in New South Wales, Queensland and Western Australia. However, InvoCare managed to make up the difference with price increases, cost control, market share gains in Victoria and strong sales of memorials.

Island time

The 2016 results from New Zealand and Singapore were less impressive, with both divisions reporting earnings growth of just 2% in local currency. In New Zealand, the number of deaths fell by around 3% and aggressive pricing from competitors saw market share decline. Despite the number of deaths increasing 2% in Singapore it was a similar story in the Lion City – volumes fell as cut-price operators took share.

In the end, it’s likely that Australia will continue to be the main driver of InvoCare’s business. And, while the death rate swings about from period to period, the long-term demographics for the company are favourable. With increasing numbers of old people, death rates are expected to increase, particularly as we enter the 2020s. These demographics, along with annual price increases and bolt-on acquisitions, make InvoCare’s long-term growth almost assured.

Table 1: InvoCare result 2016
Year to Dec 2016 2015 /(–)
(%)
Revenue ($m) 450.7 436.4 3
EBITDA ($m) 112.3 105.4 7
NPAT ($m) 55.2 49.4 12
EPS (c) 50.4 45.1 12
DPS (c) 42.5* 38.0 12
Franking (%) 100 100 N/a
* Final dividend 25.5 cents, ex date 6 Mar
Note: Figures are underlying results

With that in mind, managing director Martin Earp delivered his ‘Protect and Grow’ strategic plan with the 2016 results. The aim is to optimise the company’s assets and meet increased demand over the next decade.

The plan will involve InvoCare refurbishing existing sites and establishing new sites where it has identified gaps in its network. It will also move to managing its areas by geography rather than brand, as well as rolling out ‘shared service’ facilities. It all makes sense.

Higher debt

As with most strategic plans, there will be a cost. Management expects to spend $200m on network improvements and efficiency gains. It will be funded by increasing debt facilities as well as cash flow, which again makes sense – InvoCare’s balance sheet can handle a little more debt.

What got the market excited – and has driven InvoCare’s share price towards its all-time high – is that management forecasts the plan to deliver long-term double-digit earnings per share growth. While this goal is reflected in management’s incentive targets, it might be a bit of a stretch. InvoCare’s target of 3–4% annual price rises seems high given low inflation, evidence of low-cost competition already hitting the company, and the apparent trend towards less expensive funerals.

This year management expects mid-single digit earnings per share growth, which would take the figure to about 53 cents. That puts the stock on a price-earnings ratio of 26. While that seems high, InvoCare deserves a premium rating thanks to its stable business and built-in growth.

We don’t want to let a stock like this go too easily, so we’re lifting the Sell price from $16 to $18. We’ll also increase our Buy price to $12, reflecting slightly higher growth expectations. While InvoCare has barely put a foot wrong since listing in 2004, setbacks aren’t impossible.

We’ve now lifted our price guide twice in a year – the last time was at the time of InvoCare: Interim result 2016. It’s an indication we’ve been too conservative but the current price is too high to jump in now. HOLD.

Disclosure: The author owns shares in InvoCare.

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