Carriage Services: Cheap After The Failed Buyout

Carriage Services (NYSE:CSV) operates funeral homes and cemeteries in the United States. The company has a strategy of acquiring small independent operators in the country to consistently grow the company's earnings. Although the company has a very significant amount of long-term debt, I believe that the stock is relatively low in risk. I believe the current valuation is quite cheap considering the company's financials; for the time being, I have a buy rating for the stock.

The Company & Stock

Carriage Services operates funeral homes and cemeteries in the United States. As of March, the company had a nationwide footprint with 173 funeral homes and 32 cemeteries across almost 30 states. I believe that the company's business is highly resistant to macroeconomic turbulence, as the company's earnings stayed near stable in the 2008-2009 financial crisis - the industry's demand is constant in nature.

The company's strategy revolves around the consolidation of the deathcare industry. For example, in March of 2023, the Carriage Services acquired Greenlawn Funeral Homes, Cemeteries and Cremations, adding three funeral homes, two cemeteries, and a crematorium into the company's portfolio. The industry as a whole is very fragmented as Carriage Services estimates independent revenues to account for 80% of the industry. Carriage Services' acquisitions have historically been constant - from 2002 to 2022, the company's cash acquisitions add up to a total of $525 million:

Carriage Services' stock saw a significant rise in 2021 as a result of the Covid pandemic - in 2020 and 2021 combined, the stock rose by around 150%. Since the peak in late 2021, Carriage Services' stock has been on a long-lasting decline. After Park Lawn submitted an all-cash proposal for the acquisition of Carriage Services in June, the stock rose significantly temporarily. Since, the stock has come down significantly and on the third of October, Park Lawn communicated that the company withdrew its offer for the acquisition. After the withdrawal, Carriage Services' stock has continued its downfall:

Financials

Carriage Services' revenue history is quite consistent. The company has achieved a compounded annual growth rate of 4.2% in a mostly stable manner:

The revenues saw a fast increase in 2020 and 2021 as a result of the Covid pandemic. After the pandemic started to subside in 2022, the company's revenues decreased by -1.5% in 2022. Since, the company has gone back on track into slight growth with a H1/2023 revenue growth of 2.3%. On a more long-term basis, I don't believe Carriage Services' organic performance is very good - the company's long-term 4.2% growth is a result of constant acquisitions.

The company has a good EBIT margin level, that has mostly stayed stable in Carriage Services' long-term history. From 2002 to 2022, the company's average EBIT margin has been 19.1%, with the current trailing margin being slightly above at 21.1%.

Carriage Services holds a significant amount of debt on the company's balance sheet. The long-term debt balance of $602 million significantly exceeds Carriage Services' market capitalization of $322 million at the time of writing. With trailing figures, the company's interest expenses are around 41% of the operating income. As Carriage Services' cash flows are very stable, I believe that the debt level can be sustained, and doesn't pose too much of a risk for shareholders.

Valuation

Carriage Services currently trades at a forward P/E of 8.4. The ratio is widely below the company's ten-year average forward P/E of 14.1, as well as a new low in the period:

The low P/E ratio doesn't seem to price in the company's stable operations. To estimate a rough fair value for the stock, I created a discounted cash flow model in my usual manner. In the model, I estimate the company to grow its revenues by 3.5% in 2023, along the company's guidance. After the year, I estimate a growth of 3.0% for 2024 as a result of recent acquisitions. After the year, I estimate Carriage Services' growth to slow down in steps into a low perpetual growth of 1.5%, as the company's organic growth has historically been quite poor.

I don't see significant catalysts for Carriage Services' margin to move into either direction. For the current year, I estimate an EBIT margin of 21.6%, half a percentage point below the achieved 2022 level as the first half of 2023 showed a margin below the previous year's level. After 2023, I estimate the EBIT margin to bounce back into the 2022 level of 22.1%, where the margin stays into perpetuity. The mentioned estimates along with a cost of capital of 7.63% craft the following DCF model with a fair value estimate of $29.80, around 38% above the price at the time of writing. The estimated fair value corresponds to a fair forward P/E of 11.6, which seems to be more in line with the company's history than the current ratio.

The used weighed average cost of capital is derived from a capital asset pricing model:

In Q2, Carriage Services had $9.4 million in interest expenses. With the company's current amount of interest-bearing debt, the company's interest rate comes up to an annualized figure of 6.25%. The company uses a significant amount of debt - I estimate the company's long-term debt-to-equity ratio to be 50%.

On the cost of equity side, I use the United States' 10-year bond yield of 4.88% as the risk-free rate. The equity risk premium of 5.91% is Professor Aswath Damodaran's latest estimate made in July. Despite the high debt balance that leverages risks for shareholders, Yahoo Finance estimates Carriage Services' beta quite low at 0.88. Finally, I add a small liquidity premium of 0.5% into the cost of equity, crafting the figure at 10.58% and the WACC at 7.63%.

Takeaway

As the rumored buyout of Carriage Services failed, investors should look at the value of the company's underlying operations. The company has stable operations and continues to expand its nationwide footprint through constant small acquisitions in the very fragmented industry. Although the failed sale of the company has reasonably caused a selloff, I believe that the current stock price already represents a favorable risk-to-reward. My DCF model estimates the stock to be quite significantly underpriced, which is why I have a buy-rating for the time being.