Benign Winter Bodes Poorly For InvoCare

This story features INVOCARE LIMITED. For more info SHARE ANALYSIS: IVC

Conditions for funeral director InvoCare continued to deteriorate through September and 2018 guidance has been softened.

-Market share increased over 2018 despite disruptions
-Good trading opportunities exist during seasonal variations
-Benefits from refurbishments not clear until 2020
 

By Eva Brocklehurst

InvoCare ((IVC)) has softened its guidance for 2018 after a benign flu season and mild winter reduced the number of deaths and subsequent funerals. The number of deaths in Australasia continues to be below trend, down -5.9% for the period June to August.

The company estimates conditions have further deteriorated through September. Market softness has resulted in a -3% decline in revenue so far in 2018. This has pressured prices, reducing the company's ability to achieve increases. InvoCare is managing its cost base to mitigate the impact.

UBS is not overly concerned, as long as the volume decline is not exaggerated by losses of market share and discounting is not required in order to maintain that share. The company has noted its market share increased over 2018 despite the disruptions.

Macquarie, too, would be concerned if the decline in case averages over 2018 does not revert when volumes rebound. The broker considers the stock fairly valued in the context of cyclical weakness, amid expected benefits from refurbishment.

Revenue Pressures

The decline in deaths was most pronounced in the company's highest yielding states, NSW and Victoria, which Bell Potter believes centres particularly on metropolitan Sydney and Melbourne.

The broker expects revenue to remain under pressure because of an unfavourable sales mix and continued competitive pricing in a soft market. The shift in mix towards lower-value cremations and strong competition is also the basis of Deutsche Bank's negative thesis. Costs are increasing as is capital expenditure and the broker maintains a Sell rating.

Citi expects investors to remain cautious regarding price competition, returns on capital expenditure and the emergence of a well-capitalised second operator that is actively acquiring smaller businesses.

Historically there have been good trading opportunities in the business when meaningful seasonal variations have occurred, Ord Minnett points out. Nevertheless, given a substantial capital expenditure strategy and the structural issues at its UK-listed counterpart, the broker assumes the market is cautious about whether the near-term headwinds are indeed structural.

While acknowledging some challenges, Ord Minnett believes these are offset by potential tailwinds for funeral insurance emanating from the Hayne Royal Commission and ageing demographics.

Over the next six months InvoCare will go through the largest segment of its 'Protect & Grow' strategy and the operating risk is significant. Still, a de-rating of the share price signals to Ord Minnett the risk/reward is more balanced and the rating is upgraded to Hold from Lighten.

While disappointed with the slowdown, Morgans is encouraged by management's execution. The broker highlights market share in Australia has increased despite ongoing disruptions and that puts InvoCare in a solid position for when conditions improve. Market conditions are expected to bounce back and InvoCare will benefit from its investment in the business. In the short term, the broker considers the stock fully valued.

Outlook

Previous guidance was relatively ambitious, Ord Minnett believes, as it assumed flat earnings in the second half despite a drop in first half earnings. Citi expects a 2018 decline in earnings per share of around -16.5%, net of the 11 acquisitions made so far in 2018.

The broker acknowledges a fair amount of uncertainty regarding the earnings profile over the next couple of years. The company will have completed around 40% of its planned capital expenditure by the end of 2018 with plenty to still occur next year. This will cause disruptions and the benefits will not be clear until 2020, in the broker's opinion.

The company's gearing may appear high relative to other industries but cash generation remains significant and Ord Minnett observes gearing is not out of step with offshore peers. Based on reduced earnings forecasts, the broker now believes InvoCare will be getting close to its gearing covenant, which requires a debt to earnings ratio of less than 3.5x, or 4.0x including acquisitions.

The company has calculated that for every -1% decline in the number of deaths annual funeral revenue is reduced by around -$3m. Morgans downgrades 2018 underlying operating earnings (EBITDA) estimates by -7% and underlying net profit by -10%.  UBS assumes the weakness continues into the December quarter and allows for no price increases in the second half, reducing forecasts for earnings per share by -17% in 2018 and -3% in 2019.

Bell Potter reduces 2018 and 2019 earnings forecasts by -15% and -12% respectively. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Hold rating and lowers the target to $11.60, highlighting InvoCare is in the midst of a challenging transformation which increases the risks in the business.

FNArena's database has six Hold ratings and one Sell (Deutsche Bank). The consensus target is $11.82, signalling 2.8% upside to the last share price.

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