Australia | May 27 2013
-Deaths flat in 4 months to April
-Stock appears expensive
-Digital business key to future
-Longer-term view required
By Eva Brocklehurst
Funeral director, InvoCare ((IVC)), has had a strong run recently as investors seek out quality stocks with good growth potential. It surprised brokers at the AGM by offering a year-to-date assessment of earnings growth. At the operating earnings level it was 7.7% for the four months to April, somewhat softer than many had anticipated. The reasons cited were additional costs, digital business initiatives and lower-than-expected case volumes. Case volumes were up 4% in the four months, including acquisitions, while comparative volumes were up just 1%, as the number of deaths was relatively stable. Average funeral case prices were up 3-4%. The broker reaction to more muted earnings growth was far from severe as, while the stock is viewed as expensive, most take a long-term view.
Macquarie is the most upbeat, retaining the only Outperform rating on the FNArena database. The broker notes the attraction in a company that is able to lift prices to, at least, meet inflation levels. Cemetery and crematorium memorial sales are up, with the deferred revenue pool increasing. It's the investment in digital initiatives that should underpin the company's market position longer term. HeavenAddress, Mymemorial and Funeralorganiser.com.au are expected to enhance service, increase consumer engagement and loyalty. The first mover advantage that InvoCare has in digital is likely to be what sets it apart in future years, in Macquarie's opinion.
Given the stronger market, the investment returns on pre-paid funds under management are exceeding the impact of price rises and should boost reported profit. Moreover, the company has improved market share and the Singapore division case averages continue to benefit from package pricing and accessory sales. The concern for some brokers is, as JP Morgan noted, that the earnings multiple expanded with the recent outperformance of the stock, despite the fact that the earnings outlook was relatively stable. InvoCare is trading at around a 90% premium to the Small Industrials Index, at a level not seen since the GFC. The broker has adjusted earnings forecasts downward slightly for FY13 and FY14 and remains Neutral on the stock.
Deutsche Bank believes the AGM commentary about margin pressure should not have been a surprise, as the company flagged that earlier in the month in a presentation. The magnitude of the impact was the negative. In the context of the market sector in which InvoCare is located, Deutsche Bank finds the earnings growth over the four months was solid. The broker likes the relatively defensive earnings, medium-to-long term structural tail winds, annual price increases, operating cash flow conversion and return on capital. It's just that this is largely captured by the current valuation, hence a Hold rating.
One of two Sell ratings on the database, Citi has judged the stock expensive, despite the quality of the franchise. The broker has made modest reductions to earnings forecasts, around 2%, primarily to reflect higher interest costs. The broker finds the stock is still expensive on an absolute and relative return basis. The stock is trading on Citi's 12-month forward price/earnings multiple of 22 time versus earnings growth forecasts of 9% in FY13, 7% in FY14 and 7% in FY15.
InvoCare is not without earnings volatility. There is the death rate, which is beyond the company's control, but also the high fixed nature of the costs. Should investment return on funds fall below inflation, the margin would be impacted, and in turn the stock would have difficulty achieving targets. The converse is equally true, Citi acknowledges. The business may be well managed and have a favourable industry structure but, trading on 26.8 times the revised FY13 earnings estimate, means, for UBS, a downgrade to Sell from Neutral.
To cap, on the FNArena database there are one Buy, three Hold ratings and two Sell. The consensus target price is $10.49, indicating 0.6% downside to the last share price. The targets range from $9.19 to $11.60. The dividend yield on consensus FY13 earnings is 3.5% and for FY14, 3.7%.
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