As of this writing, more than 250,000 Americans have died from the COVID-19 pandemic. Forecasts call for this figure to grow to well beyond 300,000 by the end of 2020. The US is special in this respect, as our government failed to contain the contagion. For most firms, this has been a disaster, but one company that continues to benefit from this is Service Corporation International (SCI). The owner of funeral homes and cemeteries has seen a ramping up of business this year and it’s largely due to the increase in deaths seen throughout the US. Though this is likely temporary for the firm, the excess cash generated should be a permanent part of the company’s value proposition and should fuel investors returns for the long haul.
A look at recent performance
Since I last wrote about Service Corp, a lot has happened. Most important is the fact that the company released financial results for the third quarter of its 2020 fiscal year. In that release, the firm had plenty of positive surprises for investors. Revenue, for instance, came in at $918.2 million. This represents an increase of 19.4% over the $769.2 million seen the same quarter last year. Management cited pre-need and at-need cemetery and funeral services as contributors to this increase.
As the third quarter’s revenue rose, so too did other metrics. Net income surged from $70.8 million to $127.4 million. Operating cash flow, unfortunately, did drop some, but only modestly from $209.3 million to $195.1 million. This also resulted in free cash flow declining from $154.7 million to $154.4 million. Though this decline may seem discouraging, it’s important to recall that cash flow can sometimes fluctuate between quarters.
The third quarter wasn’t just a one-off for the business. 2020 as a whole appears to be a really good year for the firm. Revenue so far in 2020 has totaled $2.54 billion. This is 6.8% higher than the $2.38 billion seen the first three quarters of its 2019 fiscal year. Net income has surged 41.6% over the same timeframe, rising from $222.4 million to $314.9 million, and operating cash flow is up 18.5% at $559.4 million compared to $472.2 million last year. Free cash flow, meanwhile, stands at $430.2 million. This is 31% above the $328.4 million seen in 2019.
But don’t take my word for it that this move higher has been attributable to COVID-19. Take management’s: “Today we are reporting adjusted earnings per share of $0.79, a $0.42 increase over the prior year quarter as the impact of COVID-19 has increased the number of funeral services performed as well as the number of burials in our cemeteries. As community restrictions lifted over the last few months, we have experienced unprecedented growth in our preneed cemetery sales as well as a significant improvement in the number of families who are desiring memorial services.”
Shares look attractive
As sad as this is for those affected, it’s undeniably a net benefit for the business and its shareholders. It could also represent a good buying opportunity for long-term investors who don’t mind some volatility. Sure, this trend will likely be temporary for the business, with COVID-19 dying down once a vaccine becomes both widely available and widely administered. Once that happens, growth should slow some, but the cash the company generates from this boost now will permanently affect (in a positive way) the company’s fundamental condition.
To see just how much of an impact we should expect this year, consider the company’s latest financial guidance for 2020. At present, the firm expects earnings per share of between $2.50 and $2.75. At the mid-point, this works out to $2.625 per share. The guidance management provided in the second quarter of this year was for earnings of between $1.78 and $2 per share, and original guidance expected for 2020 was between $1.96 and $2.16. At these mid-points, this works out to extra earnings for the year of between $97.41 million and $126.71 million.
Another way to look at this is through the lens of operating cash flow. Operating cash flow for 2020 is now projected to be between $740 million and $790 million. At the mid-point, this works out to $765 million. In the second quarter, management had only been forecasting between $600 million and $660 million for a mid-point of $630 million, and earlier this year the expectation was for operating cash flow of between $590 million and $640 million for a mid-point of $615 million. This implies a beat over prior mid-point forecasts of between $135 million and $150 million.
The last way we should look at this is through the lens of free cash flow. Based on management’s figures and my calculations, this metric should be about $585 million at the mid-point for 2020. This compares to $450 million previously anticipated in the second quarter this year and $375 million expected when management first put out guidance for 2020 earlier this year. In all, this works out to between $135 million and $210 million for the year above what was anticipated.
Using the company’s projected earnings and its current price of $48.52 per unit, we find that shares are trading at a loft multiple of 18.5. This is lower, though, when we use free cash flow and operating cash flow. With free cash flow, the multiple is about 14.3, while with operating cash flow it is just under 11. Bears would argue that we could even see a dip in profits and cash flow next year, especially if the vaccine becomes available soon, but given the timing of the recent surge higher in COVID-19 cases and the (once again) rising death toll, I would wager that the first quarter next year might be surprisingly strong for the business. This could give it not one, but perhaps two robust years to benefit from.
Based on the data provided, it seems clear that Service Corp is an excellent business fundamentally. Shares look a bit pricey, but for a stable cash cow like it, I would make the case that they could see even more upside from here. This is especially true if we don’t see a vaccine widely-administered fairly soon, and even if that is the case, the long-term path for a company like Service Corp, with a history of strong cash flow and decent cash flow growth, is clearly bullish.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.