InvoCare Limited (IVC)

A target market based on predictable events makes IVC one of the best defensive stocks on the ASX

Key Points

  • InvoCare (IVC) is a market leader in providing funeral, cemetery and crematorium services controlling around 34% of the Australian market where it generates around 86% of its geographical revenue. The Australian market is highly fragmented with the second largest operator controlling less than 5% of the market. InvoCare operates under a number of well-respected brands across the country with Mareena Purslowe and Chipper Funerals being the most recognised names in Western Australia. IVC also operates in New Zealand, Singapore, USA and has a small online funeral planning presence.
Figure 1. Regional Brands in Western Australia (Source: IVC Website)

Figure 1. Regional Brands in Western Australia (Source: IVC Website)

  • While it’s certainly a morbid business, we are attracted to IVC as an investment proposition with the defensive nature of its earnings stream. Unfortunately, two things in life are certain - death and taxes. The ageing and growing size of Australia’s population will be supportive for InvoCare with the number of funerals likely to increase with the trend in the number of deaths expected to rise over the long-term. According to projections from the Australian Bureau of Statistics, the death rate in Australia is likely to accelerate after 2022 and is expected to peak between 2% and 3% by 2032 before returning to the long run average of around 1.5%. As can be seen in the following chart, short-term fluctuations in the death rate can occur of up to 5% above or below the trend line.
Figure 2. Actual and Projected Death Rate According to the ABS (Source: IVC Annual Report)

Figure 2. Actual and Projected Death Rate According to the ABS (Source: IVC Annual Report)

  • In February 2017 IVC announced its Protect & Grow Plan which will see an incremental capital investment of around $200m over four years and will be funded through a combination of operational cash flow, sale of surplus properties and via additional debt facilities. $160m will be spent on Network, Brand and Optimisation projects which will refresh and enhance IVC’s existing facilities to better meet the evolving needs of their customers and will look to grow through the opening of new locations. The ultimate goal is to deliver the right product, in the right locations at the right price. A further $40m will be spent on operational efficiency projects which will renew IVC’s business systems and operational practices. This will assist with seeking to capture the operational benefits of scale and will standardise the quality of IVC’s service provisions to help the business cope with the increased level of demand. Management expect to see a favourable demographic backdrop and anticipated increase in market share over the next few years.

1H17 Financial Results Summary

  • InvoCare reported a solid set of 1H17 earnings in August. Sales revenue grew by 1.7% y-o-y to $218.2m as a result of increased funeral case averages and as markets improved in NZ and Singapore. This was despite a 1.8% drop in funeral services in Australia due a decline in market share. Management put the loss in market share down to factors including a regional management restructure, retirement of some long serving employees who were well regarded members of the community and price competition in traditional markets of NSW, QLD and WA. Management expect that the decline in market share will stabilise over the next year, before increasing in late 2018 as the Protect and Grow plan starts to take effect.
  • Operating EBITDA was 9.9% higher to $51.9m as margins on sales improved by 1.8% to 23.8% as the increase in case averages and improving cost management from its Protect & Grow program offset some losses in market share.
  • Net profit was seen improving by 50.1% to $41.7m. In addition to the growth in operating earnings, the reported profit benefited from gains of $17m on undelivered prepaid contracts from property investment revaluations. Around 14% of IVC’s funerals are prepaid with $508m of funds under management which IVC looks to earn a return on from its investments in equities (15%), property (27%) and cash & fixed interest (58%). This element of the business can create some volatility in statutory net profit. IVC currently pays a dividend yield of around 2.8%.

Management Outlook

  • IVC expect that for the remainder of 2017 there will be a continued improvement in financial performance with high single-digit growth forecast for operating EBITDA and operating EPS. Acquisitions are expected to contribute to IVC’s growth with a new focus in the regional markets. Over the longer-term, the outlook is for continuing improvement in operating EBITDA performance and for double digit operating EPS growth once all the benefits of the Protect and Grow investments have been fully captured.

Valuation

  • Morningstar have a fair valuation of $16.50 and consider that IVC is undervalued at the current price of $15.70 which differs to the average consensus price target of $14.28. Consensus has an average of a Hold rating on IVC which is in line with Morningstar’s recommendation. IVC has historically traded on a high level of forward earnings as investors are happy to pay a premium for the strong defensive qualities of the business which provides a predictable level of demand and earnings. IVC is currently trading on a forward PE of around 27x.

Technical Analysis

  • IVC has been in a strong uptrend since 2008, where the stock dipped to $4.04 during the GFC, and has continued to trend higher as investors saw the value in the defensive quality of earnings to push the stock to its recent highs of $15.81. In the near term, a pull back towards $14.00 could provide a better entry level into the stock which we expect will continue to trend higher over the long-term consistent with an increasing population.
Figure 3. 10 Year IVC Weekly Price Chart (Source: CIQ)

Figure 3. 10 Year IVC Weekly Price Chart (Source: CIQ)


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Recommendation Definitions

SPECULATIVE BUY – Potential 10% or more outperformance, high risk
BUY – Potential 10% or more outperformance
HOLD – Potential 10% underperformance to 10% over performance
SELL – Potential 10% or more underperformance
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Michael Ron

Research Analyst

Michael has been trading equities since 2003 and since joining DJ Carmichael in 2004 has worked in numerous roles in operations, trading, compliance and research. Michael’s expertise is in trading and equity strategy using a combination of both technical and fundamental analysis.

Michael holds a Graduate Diploma in Applied Finance, Diploma of Financial Markets, Diploma of Financial Planning, Advanced Diploma of Business Administration and is currently studying towards a Master of Applied Finance.