Everyone knows that next week’s figures from funeral parlour and crematoria owner Dignity will not be pretty, but the longer-term outlook is not good, either. A low rating is not an attraction for this business because there are long-term uncertainties.
Dignity is reporting its 2018 results on Wednesday 13 March and a trading statement has already flagged that underlying pre-tax profit is expected to decline from £77.8m to £53m.
Broker Peel Hunt expects profit to continue to fall for the next two years. The problem is a mixture of market dynamics and a CMA review.
Declining death rates obviously hampers a business such as Dignity and as the largest in its sector it is going to be hardest hit.
There was an 8% increase in death rates in England and Wales in the first quarter of 2019, but they were relatively flat in the next two quarters before a 3% fall in the fourth quarter. So far this year, there has been a 12% fall in the death rate, partly due to the spike last year and a much milder winter.
Death rates can change between quarters, but the general trend tends to remain. On its own, the latest decline would represent a blip, rather than a long-term problem.
The CMA review is a greater problem, particularly now that it might include pre-paid funeral plans.
The likely outcome of this competition review is control of prices. Dignity and the Co-Op are the two largest firms and likely to be harder hit by any recommendations. Dignity is already generating less per funeral than before. It is expected to fall from £850 to £730 this year.
Peel Hunt also says that Dignity has 19 out of the 20 most expensive crematoria in the UK. The current margin is 54% of the £650 charge per cremation. That is another area where pricing will come under scrutiny.
Pre-paid funerals are more than one-quarter of Dignity’s volumes. There are concerns about a lack of transparency and lack of regulation. These could be brought under the regulation of the FCA, with additional regulatory costs for the funeral businesses.
There is another problem. High debt.
Peel Hunt forecasts net debt of £511m at the end of 2018. It appears that even with a further dip in profit Dignity can make the planned debt repayments and keep within covenants, but this is uncomfortably high for a company with falling profit levels.
Peel Hunt forecasts a further fall in pre-tax profit to £44.5m in 2019 and £43m in 2020. This is due to a combination of lower revenues and lower operating margins.
Peel Hunt assumes that the 24.4p a share annual dividend will be maintained. While it will still be well covered on these forecasts, there could be an argument that it is more important to reduce debt.
At 746.25p a share, the shares are trading on less than 11 times prospective 2019 earnings, with little prospect of this multiple falling. The yield is 3.3%.
It appears that the bumper days are over for Dignity. Investors are left with a highly indebted business that is stagnating with plenty of uncertainty and little visibility on when it could return to growth. Not attractive.