StoneMor is an interesting business. Here is the company description:
"StoneMor Partners L.P. owns and operates cemeteries and funeral homes. The Company operates through two segments: Cemetery Operations and Funeral Homes. Its Cemetery Operations segment sells interment rights, caskets, burial vaults, cremation niches, markers and other cemetery related merchandise. Its Funeral Homes segment offers a range of services, including family consultation, final expense insurance products, the removal and preparation of remains, provision of caskets and related funeral merchandise, the use of funeral home facilities for visitation, worship and performance of funeral services, and transportation services. It sells cemetery products and services both at the time of death, which it refers to as at-need, and prior to the time of death, which it refers to as pre-need. It operates approximately 310 cemeteries in over 30 states and Puerto Rico, and approximately 100 funeral homes in over 20 states and Puerto Rico."
When you first read this description, there's a lot about the industry you should like. In fact, running cemeteries could be quite profitable. Deathcare isn't exactly an exciting business, it is hugely fragmented, people will always die, you can develop local monopolies, regulations mean barriers to entry. All of this is true, yet somehow, StonMor is a high yield bond issuer, highly levered, with severely opaque accounts. Recently the stock has collapsed.
There are three segments here: At-need, pre-need and investment trusts. At-need and investment trusts are easy to understand. At-need services basically cover the cost of the burial and funeral and average aroun $1,700 per burial. The investment trusts throw off investment income (from dividends and coupons) to shareholders.
The segment that is messy is pre-need. This is where the company sells merchandise and services to a person or family before they die. The average contract for this is $3,200 (vs. $1,700 for at-need). That's almost twice the price.
Here is where it gets complicated. First, 70% of the proceeds from a pre-need contract must be placed in the merchandise trust and only released on the service has been provided. This is a reserve of sorts for when the funds will be needed. What StoneMor has developed a practice of doing is building the vaults for the burial, so they can release the funds from the Merchandise Trust and recognize them as revenue and margins. There are more than a few people who believe this is not right. But StoneMor has been doing this and paying out a fat fat dividend of $2.64 per unit per year. They had this open ended opportunity of acquiring cemeteries across the U.S. and selling tons of pre-need cemetery and funeral services. Growing via equity issuance, the growth opportunity is somewhat open ended since the industry is incredibly fragmented. The financial statements are impossible to figure out, since the IS, BS and CF statement are all non-sensical on a GAAP basis. The company provides non-GAAP operating numbers, which make sense to me.
However, the big issue here is that results have tanked recently due to a very specific problem associated with the sales force. An attempt to improve productivity back fired, and the sales force shrunk dramatically. The result was a sharp drop in pre-need sales volumes. This makes sense because at-need sales hardly need a sales person. Fewer sales people resulted in a drop in the highest margin product, which led to a sharp decline in profitability and since a lot of cash flow came from front loading revenue recognition from pre-need sales, cash flow plummeted. We got a massive dividend cut. The market still doesn't believe the current dividend level is sustainable (current yields are 16%) and management has proposed rehiring the old sales force will work. That remains to be seen. One analyst thinks the problem is market saturation and that all the pre-need sales have been done and now we're seeing a big drop due to that effect. That could be true.
"StoneMor Partners L.P. owns and operates cemeteries and funeral homes. The Company operates through two segments: Cemetery Operations and Funeral Homes. Its Cemetery Operations segment sells interment rights, caskets, burial vaults, cremation niches, markers and other cemetery related merchandise. Its Funeral Homes segment offers a range of services, including family consultation, final expense insurance products, the removal and preparation of remains, provision of caskets and related funeral merchandise, the use of funeral home facilities for visitation, worship and performance of funeral services, and transportation services. It sells cemetery products and services both at the time of death, which it refers to as at-need, and prior to the time of death, which it refers to as pre-need. It operates approximately 310 cemeteries in over 30 states and Puerto Rico, and approximately 100 funeral homes in over 20 states and Puerto Rico."
When you first read this description, there's a lot about the industry you should like. In fact, running cemeteries could be quite profitable. Deathcare isn't exactly an exciting business, it is hugely fragmented, people will always die, you can develop local monopolies, regulations mean barriers to entry. All of this is true, yet somehow, StonMor is a high yield bond issuer, highly levered, with severely opaque accounts. Recently the stock has collapsed.
There are three segments here: At-need, pre-need and investment trusts. At-need and investment trusts are easy to understand. At-need services basically cover the cost of the burial and funeral and average aroun $1,700 per burial. The investment trusts throw off investment income (from dividends and coupons) to shareholders.
The segment that is messy is pre-need. This is where the company sells merchandise and services to a person or family before they die. The average contract for this is $3,200 (vs. $1,700 for at-need). That's almost twice the price.
Here is where it gets complicated. First, 70% of the proceeds from a pre-need contract must be placed in the merchandise trust and only released on the service has been provided. This is a reserve of sorts for when the funds will be needed. What StoneMor has developed a practice of doing is building the vaults for the burial, so they can release the funds from the Merchandise Trust and recognize them as revenue and margins. There are more than a few people who believe this is not right. But StoneMor has been doing this and paying out a fat fat dividend of $2.64 per unit per year. They had this open ended opportunity of acquiring cemeteries across the U.S. and selling tons of pre-need cemetery and funeral services. Growing via equity issuance, the growth opportunity is somewhat open ended since the industry is incredibly fragmented. The financial statements are impossible to figure out, since the IS, BS and CF statement are all non-sensical on a GAAP basis. The company provides non-GAAP operating numbers, which make sense to me.
However, the big issue here is that results have tanked recently due to a very specific problem associated with the sales force. An attempt to improve productivity back fired, and the sales force shrunk dramatically. The result was a sharp drop in pre-need sales volumes. This makes sense because at-need sales hardly need a sales person. Fewer sales people resulted in a drop in the highest margin product, which led to a sharp decline in profitability and since a lot of cash flow came from front loading revenue recognition from pre-need sales, cash flow plummeted. We got a massive dividend cut. The market still doesn't believe the current dividend level is sustainable (current yields are 16%) and management has proposed rehiring the old sales force will work. That remains to be seen. One analyst thinks the problem is market saturation and that all the pre-need sales have been done and now we're seeing a big drop due to that effect. That could be true.
If you set aside their business model and huge amount of complexity around revenue recognition / deferment, they are not lying about the fall in pre-need contract sales being the cause of the drop in revenues.
In their Q3 results, they sold 27.4K cemetery contracts of which 14.6K were at-need and 12.8K were pre-need. The at-need contracts sell for an average of $1.7K while the pre-need sell for $3.2K (according to their reported billing number). The pre-need contract number fell by 1K YoY. So basically, from a revenue perspective, that's $1.7MM of revenues (1.7K times 1K).
Their explanation of why revenues fell makes sense. One analyst on the investor day seemed to claim that they have saturated the market for pre-need contracts. That could be happening, although we need more analysis on that front. The management team is claiming that they need to re-hire the sales force that left due to changes in their compensation structure and sales will shoot back up on pre-need contracts. But they are also saying that getting those sales back will take time since only a small number of sales people stay on longer term after sales trainings.
The risk here is that the debt (which is high yield) and the lack of cash flow due to the deferment of revenues leads to a liquidity crisis. That's why the stock has collapsed. I have reservations about this business of installing vaults from pre-need sales to release revenues since it could lead to income being front-loaded, but it does lead to a release of cash, which can be used to fund the dividend. The trick here is that if they do restore pre-need contract sales, they might be able to raise the dividend again, so the stock could shoot up. On the flip side, the pre-need sales are a big of a boiler room operation, since they involve cold calling, door knocking, installation payments with high interest rates and upfront recognition of revenues for services that haven't been delivered yet.
One question I do have is on the maintenance CAPEX side. Are they able to use principal from the Perpetual Care trust to fund maintenance CAPEX on their cemeteries? I did read that they can use interest and dividends, in which case, it seems like they are responsible for maintenance CAPEX with no benefit from the Perpetual Care Trust.
As far as the business model is concerned, this is very difficult to model. The MLP model works, but it will always be subject to criticisms due to the huge revenue recognition issues and complicated balance sheet.
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