Carriage Services Announces Closing of Senior Notes Offering and New Intrinsic Value Roughly Right Range
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
|I.||The current Nature of Carriage;||1|
|II.||Service Corporation International: THANK YOU;||4|
|III.||The Story of Carriage’s
|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
The headline reminded me of a similar but even higher performance beating The S&P 500 Index from 1991 to 2005 by
During Larry Puglia’s 28 years at the helm of one of the flagship funds at T. Rowe Price, the
“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
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
I am formally commenting for the first time in this release on our recent highly successful
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
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
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
“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
I remember well the first small equity deathcare conference held in
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
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
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
“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
III. The story of Carriage’s
Bank of America’s
My charge to the
We launched our new bond issue offering on Monday morning,
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
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
I would like to thank the entire syndicate of underwriters for our success with this bond offering, but especially the two
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
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 $800 million 4.0% Ten Year Senior Notes Offering that priced this past
|Amount Issued ($ millions)|
|Sr. Unsecured Bond Ratings (S&P / MDY)||B+ / B2||BB / Ba3||BB / Ba3||BB / Ba3|
|Issue Spread vs
|Price ($) as of 5/12/2021*|
|Yield to Maturity as of 5/12/2021*||4.3%||4.0%||3.7%||4.0%|
*Source: Bloomberg - Based on last trade above
Without exception on our virtual one-on-one calls with bond investors over the three full days of our presentations, each wanted to better understand the “Normalized and Sustainable Free Cash Flow and Consolidated EBITDA Profile” of Carriage after whatever COVID performance lift has dissipated or disappeared altogether. In other words, they asked about the same skeptical ideas and concepts that we get asked by equity investors but which are most assuredly not part of the High Performance Culture Language at Carriage, such as the predictive performance impact of pull forward higher funeral volumes from the future now, push forward funeral volumes lower later and for longer, together with company performance, etc.
My answer was apparently compelling: Virtually all the COVID-19 lift has been in our Same Store Funeral Segment in the 12 months ending
Our funeral volumes have been quickly normalizing in our Eastern and Central Regions (not yet in
So even if you subtracted an assumed
V. SCI versus CSV “Rodney Dangerfield” Equity Valuation Comparison
Shown below are selective public data profiles of both SCI and CSV, as of
|(in millions, except Share Price, Margins and Yield)||SCI||CSV|
|Current Share Price||$||53.85||$||36.58|
|Equity Market Value||$||9,155||$||666|
|Estimated||2021||2022||AVG 21/22||2021||2022||AVG 21/22|
|Adjusted Diluted EPS||$||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
$2.60times SCI Average EPS Multiple of 19.5 equals CSV price of $50.70per share;
- CSV Average EBITDA of
$117 milliontimes SCI Average EV/EBITDA Multiple of 12.2 equals CSV EV of $1,427 million, less $465 millionCSV debt, equals $962 millionCSV Equity Market Value divided by 18.2 million shares equals CSV price of $52.86per share;
- CSV Average Adjusted Free Cash Flow of
$74 milliondivided by SCI’s Average Free Cash Flow Equity Yield of 5.7% equals CSV price of $71.33.
CSV’s current price of
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
Looked at another way, our new bondholders were sent a pre-offering notice by our
Referring back to Benjamin Graham’s wonderful allegory of
Our current Free Cash Flow Equity Yield of 10.9% “rejects” a
Like now, which is why our Board has already authorized
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
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
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
“After the planned refinancing of our senior notes on or before
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
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
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
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
Assuming a 35% Consolidated EBITDA Margin on
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
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
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
When I was a boy growing up on the family farm in the pheasant capital of the world,
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 . . .
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!!!
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
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:
|Total Tax Expense||19,500||22,000|
|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||—||—|
|Adjusted Consolidated EBITDA||$||115,000||$||119,000|
|Adjusted Consolidated EBITDA Margin||32.5||%||33.0||%|
Reconciliation of Net Income to Adjusted Net Income (in thousands):
|Adjusted Net Income||$||45,500||$||49,200|
Reconciliation of GAAP Diluted Earnings Per Share to Adjusted Diluted Earnings Per Share:
|GAAP Diluted Earnings Per Share||$||2.40||$||2.70|
|Adjusted Diluted Earnings Per Share||$||2.50||$||2.70|
Reconciliation of Cash Flow Provided by Operating Activities to Adjusted Free Cash Flow (in thousands), Adjusted Free Cash Flow Margin and Adjusted Free Cash Flow Equity Yield:
|Cash Flow Provided by Operating Activities||$||79,500||$||87,000|
|Cash used for Maintenance Capital Expenditures||(10,000||)||(11,000||)|
|Adjusted Free Cash Flow||$||72,000||$||76,000|
|Adjusted Free Cash Flow Margin||20.3||%||21.1||%|
|Equity Market Value (in millions)||$||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
Source: Carriage Services, Inc.