InvoCare’s wide moat going cheap

Australian funeral home operator InvoCare (ASX: IVC) is trading at a 24 per cent discount and is tipped to retain its long-term competitive dominance in the Australian death care industry.

Morningstar analyst Angus Hewitt, who has taken over coverage of the wide moat stock, expects the effects from covid-19 will fade and he forecasts earnings to recover from calendar 2021 as restrictions ease.

"We expect InvoCare to continue to dominate the Australian death care industry," Hewitt says.

"We estimate it already enjoys a revenue share of over a third in Australia as the largest provider of funeral, cemetery, and crematorium services.

"The company boasts well-known, highly respected brands and cost advantages over the long tail of smaller players in the highly fragmented death care industry, underpinning a wide economic moat rating."

InvoCare closed on Tuesday at about $11.64, which is a 24 per cent discount to Hewitt’s fair value estimate of $15.30.

Despite a virtually non-existent flu season and significantly lower mortality rates in calendar 2020 death rates are very consistent over the long run, Hewitt says.

Australia's aging population supports demand and Hewitt expects the number of deaths to grow at an average compound annual growth rate of about 2 per cent a year for the next decade accelerating beyond 2030.

Flexible pricing

InvoCare is the largest funeral, cemetery, and crematorium operator in Australia, New Zealand, and Singapore.

It owns a portfolio of 60 brands, including three national Australian providers: from its flagship brand White Lady, to its less expensive funeral homes Simplicity Funerals, and Value Cremations.

2020 was a tough year for funeral home operators. In the case of InvoCare, government limits on attendance at funerals curbed its ability to offer the full range of services, and demand for higher margin, premium services fell in favour of cheaper services with streaming capabilities.

While mourners are disinclined to worry about the price of a funeral, Hewitt does not expect InvoCare to seek excessive price rises because of the potential risk to the company's reputation and its market share.

Instead he anticipates the company will increase revenue per case by broadening the range of professional services to meet changing customer needs.

InvoCare’s scale also allows it flexibility on pricing. White Lady for instance offers services that can cost about 50 per cent more than a traditional invocare funeral, while at the other end of the spectrum, Simplicity Funerals cost about 10 per cent more than the average independent players.

InvoCare (IVC), Propel Funeral Partners (PFP) - 5YR

Source: Morningstar Premium

This brand strength and price flexibility have allowed the company to consistently increase prices ahead of inflation while it's underlying business is broadly maintaining market share.

Prepaid funerals also allow InvoCare to secure future sales, which in turn provides a low-cost source of funding.

Hewitt’s fair value estimate of $15.30 a share implies a fiscal 2021 price-to-earnings ratio of 36.

“We estimate sales will continue to grow at a mid-single-digit pace over the next five years,” Hewitt says.

“This growth is underpinned by the company continuing to raise prices by about 3 per cent per year, low single-digit growth in the number of deaths per year, and incremental market share games.

“Over the longer term, we expect the ageing and growing population to boost case volumes; according to projections from the Australian Bureau of Statistics, this is likely to accelerate beyond fiscal 2024 commer peaking at close to 3 per cent by 2032.”

Healthy balance sheet

Hewitt says InvoCare is well positioned to capitalise on this growth, given its dominance in the local market.

The company has a solid balance sheet following the $274 million dollar equity raising in calendar 2020. Shareholder distributions are mixed, however.

InvoCare typically pays out about 80 per cent of earnings as dividends, which Hewitt deems fair given the strong cash generation and cash conversion. In 2020, the company paid a fully franked dividend of 29 cents.

There are some lingering risks, however, Hewitt says.

InvoCare’s main rival is Propel Funeral Partners (ASX: PFP), which listed in late 2017, and has a market cap of $285 million versus $1.67 billion for InvoCare. Propel has a 7 per cent market share in Australia and 5 per cent market share in New Zealand.

While much smaller, Propel is aggressively building this through acquisitions, which Hewitt warns may lead to InvoCare overpaying for its own acquisitions.

Another risk is demographic in nature. When the death rate dips below trend, as it did during the benign flu seasons of 2018 and 2020, InvoCare’s profitability can tighten.