Service Corporation International

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Service Corporation International provides end-of-life care products and services, with a wide network of funeral service locations and cemeteries, operating in a relatively stable, but also highly competitive industry.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

SCI is the largest provider of funeral services in the US, with a significant portion of its business being pre-need arrangements, meaning that people purchase or reserve their services ahead of time.

Business Explanation

Service Corporation International (SCI) operates primarily in the death care industry, providing funeral services, cremations, and cemetery products and services across the United States, Canada, and certain European countries. The company operates through two main segments:

  • Funeral segment: This includes providing funeral services, cremation services, and related merchandise, such as caskets and urns. Services include planning, embalming, viewing, and transportation of remains.
  • Cemetery segment: This involves providing burial rights, interment services, and related merchandise, such as burial containers and memorials.

SCI is not simply a collection of funeral homes. Its strategy is to offer a full suite of funeral and cemetery options and be known for its service quality, which is a key differentiator in the industry.

Revenue Distribution

SCI’s revenue stream is diversified by geography and business segment, but the majority of revenue originates in the US:

  • Funeral Operations: The company’s funeral segment generates revenue through professional fees for services rendered, sales of merchandise like caskets and urns, and pre-need sales of funeral arrangements.
  • Cemetery Operations: Cemetery revenue is generated through sales of burial spaces, interment services, and sale of burial merchandise like monuments and markers.
  • Geographically, the majority of their revenue comes from the USA, with Canada and Europe generating far less.

Pre-need sales are a substantial portion of SCI’s revenue. Consumers who purchase a pre-need contract are not locked in and can easily cancel the contract. Therefore, while pre-need sales provide deferred revenue, they also represent a risk for the company.

The death care industry is stable and predictable, given the inevitability of mortality. However, it is also facing some key trends:

  • Increasing Cremation Rates: Cremation rates have continued to rise, posing a threat to more traditional burial methods.
  • Consolidation: The industry is undergoing consolidation, with larger companies acquiring smaller ones to expand their reach and scale.
  • Price Competition: While the death care industry is stable, competition among different providers can make pricing more difficult
  • Changing Consumer Preferences: There is a growing trend toward personalized and environmentally conscious memorial services.

SCI operates in a relatively fragmented and competitive market landscape. The biggest competitor for SCI is StoneMor, with smaller competitors being other regional and local funeral service companies.

Though it is a large, public company, SCI must compete against local players who often enjoy community support, long-standing relationships, and personal connections that are key for clients in a deeply personal industry.

Financials Analysis

Here’s a detailed look at SCI’s financials:

  • Historical performance: While revenues had slight year-over-year growth from 2020-2022, profits were severely impacted by the COVID-19 pandemic, with net income being close to zero in 2020, which then slowly rebounded throughout 2021 and 2022. From 2023 revenues and income are slowly rebounding to where they were pre-pandemic.
  • ROIC and margins: Return on Invested Capital (ROIC) is an important metric that determines how well the company creates value and while ROIC has been declining in recent years, the company is trying to focus on operational and cost improvements to bring it up. Historically, SCI has high gross margins but a comparatively low operating margin. High revenues do not translate directly to higher profitability because selling funeral services requires high personnel, marketing, and overhead costs.
  • Cash flow: SCI’s operating cash flow is highly variable, influenced by large swings in their working capital position. The business is working on expanding their cash flows for long-term sustainability. * Debt Profile: SCI has very large long-term debts on its balance sheet; it has been using debt to make acquisitions. A recent ratings downgrade is evidence that the company’s debt and leverage is a cause for concern and that they are struggling to create value.
  • Recent acquisitions: The company has recently been using acquisition, primarily to consolidate a fragmented industry. While acquisitions can allow a company to expand, the success of acquisitions is not guaranteed. The acquired companies have to be integrated successfully and must improve operating performance within the new structure.
  • Preneed contracts: The company’s preneed sales are a crucial component of its financials, though it carries the uncertainty of future income. The recognition of revenue in the future for contracts that are booked in the present is not guaranteed, as clients can back out of them.

Moat Analysis

SCI possesses a narrow economic moat, primarily based on:

  • Brand and Reputation: SCI has established a recognized brand name in the death care industry, having been around for many years.
  • Economies of Scale: SCI’s extensive network of locations allows them to achieve economies of scale in purchasing and distribution.
  • Barriers to Entry: The industry has high barriers to entry, as the need for capital to buy facilities and develop relationships with customers is significant.

Despite their leading position, SCI’s moat is relatively narrow because smaller companies can still compete by providing lower pricing, better personal relationships, and different or more tailored services.

Risks to the Moat and Business Resilience

Here are the key risks that could affect the business’s ability to generate long-term value:

  1. Changes in Consumer Preferences: Shifting consumer preferences toward less traditional funeral and burial options could reduce demand for SCI’s core services.
  2. Competition: The death care market has numerous competitors that can offer lower prices or services or personalized and more culturally relevant experiences. If new and upcoming competitors are able to fulfill those needs better than SCI, then SCI would have a challenge competing.
  3. Regulatory Changes: Changes in regulations, such as those pertaining to pre-need contracts and licensing, could increase expenses or limit opportunities.
  4. Debt Burden: The high debt load that the company has taken on to finance acquisitions could become burdensome, limiting future capital deployment and profitability.
  5. Technology Disruption: Any new innovative technology that significantly alters the way the funeral and cemetery business is done could quickly make SCI uncompetitive, especially as the company is struggling to increase its use of technology.
  6. Economic Downturn: The economic state of the market has a direct effect on SCI’s business. The company has already been struggling with inflation and increased gas prices and so another economic downturn might further affect its profitability.

The company also faces risk of legal action. The company is constantly engaged in litigation, primarily because of the deeply personal nature of its business. Any negative lawsuit that is in favor of the counterparty can lead to increased costs, and also damage the company’s brand image, leading to the loss of business.

However, SCI has some key aspects that demonstrate its resilience:

  • Stable demand: The business is somewhat recession proof. During periods of economic downturn the company can maintain a steady flow of cash, and can also generate additional revenues if the death rates increase.
  • Established infrastructure: The company’s vast network of facilities provides a base for generating recurring revenues.
  • Preneed arrangements: These generate predictable long-term cash flows.

Understandability Rating: 2 / 5

I’m giving SCI a rating of 2 out of 5 for understandability because:

  • The basic business model is easy to understand—providing funeral and cemetery services.
  • However, the company’s financial statements are somewhat difficult to navigate, and its debt-heavy acquisitions can be opaque to outside investors. The complexities of the business and the nature of deferred revenue from preneed contracts makes it a slightly difficult to understand business and to estimate its future value.
  • To properly understand the financial data and the competitive forces at play, a person needs to spend a lot of time studying the reports.

Balance Sheet Health Rating: 4 / 5

I am giving Service Corporation International a balance sheet health rating of 4 out of 5 because:

  • The company has significant long term debts, and its financial obligations might be limiting it in the long-term
  • It has a high debt-to-capital ratio, however, it is attempting to reduce that in the near future.
  • The current ratio is a bit low, as the current liabilities are almost double its current assets, implying that it is reliant on non-current assets and revenue to pay its short term debts.
  • However, the company has been generating positive revenue, and operating activities are producing cash for the company, though the majority of which is being spent on long term investments.
  • The company has an adequate amount of shareholder equity, and cash and cash equivalents in hand.