Okay, so funerals should be sombre affairs; maybe even a little dull. But who says that should apply to funerals’ operators? Where the UK’s second-biggest operator, Dignity (DTY), is concerned, adjectives such as ‘savage’ or ‘hilarious’ seem more appropriate.
For some years, Dignity has been a case study in how to mismanage a business; how to take a profits machine, where shareholders’ returns should be almost as reliable as inflation-linked government bonds, and reduce it to bloated mediocrity. Onto that, more recently, came the disruption of an investigation by the UK’s competition regulator followed by the misery of Covid-19. Now, hopefully reaching its denouement, is a venomous squabble between the company’s directors and its biggest shareholder. Talk about not raining but pouring.
Apart from the entertainment value of the slanging match, will investors benefit? Possibly. Whatever the outcome of its civil war – and, depending on when you read this, it may already be known – Dignity will still be around, with 12 per cent of the UK’s funerals’ market, almost as much for cremations and a £1bn-plus kitty for the pre-paid funerals of over 500,000 folk. So the raw material to make a richly profitable business remains intact.
Besides, there may be value to be gained in assessing the shareholder prompting the ructions, Phoenix Asset Management. It is no relation to the almost-eponymous insurance operator, Phoenix Group (PHNX), is boutique-sized with maybe £1bn of client money and is best known as the controller of Hornby (HRN), the model railways company. Are these people with whom to park money?
Partly, the answer depends on the credibility of the accusations made by most of Dignity’s directors. They have some choice things to say about their company’s 29.9 per cent shareholder and especially its boss, Gary Channon.
Dignity’s independent directors lay into him in a manner rarely seen in the dry circulars calling shareholders to a meeting. They have “real concerns about his judgement”. His working style “has been far from easy for certain members of (Dignity’s) management team”; not surprising if – as the directors say – he “has adopted an aggressive and disparaging attitude towards anyone who held differing views to his own”. He has “continually threatened the board with requisitions (for shareholders’ meetings)”. Perhaps worst, he “has demonstrated himself as lacking the skills and judgement required of someone seeking to be responsible for leading the executive function of a public company”; worst because Phoenix’s aim has been to sack Dignity’s executive chairman, Clive Whiley, and replace him with Channon.
Phoenix’s accusations have been slightly more restrained. Rather breathlessly, they did tell shareholders that “we uncovered what we believe are some very serious issues in (Dignity’s) pre-paid funerals-plan business”. When, by implication, Dignity’s chairman didn’t take them that seriously it “left us no choice but to seek his removal”. We can’t tell you more, they protest, we’re bound by a confidentiality agreement. But they can’t resist slipping in the knife. It begins with a mea culpa: “We must apologise because we were instrumental in Clive’s appointment (as Dignity’s chairman)”. Then comes the thrust: “We received advice from people we trusted to avoid working with him. Regrettably, we ignored them.”
Thanks for the lively copy, guys. It’s bitchy stuff from which no one emerges well, but at least it has put some oomph into Dignity’s share price, now at 675p and up 30 per cent since early March. That bounce stems from the slim chance that, resulting from this row, Dignity’s crematoria operation might be floated off. The resilience of crematoria in 2020 highlighted the division’s worth. Its operating profits rose 22 per cent to £45m while profits from funerals – usually Dignity’s main money spinner – crumpled from £55m in 2019 to £18m.
Obviously, 2020 was an exceptional year: lots of extra deaths but sad, lonely – and budget – funerals. Yet it also pointed to the annuity-like nature of crematoria’s profits and the notion – not completely stupid – that the division might be worth £1bn, if floated off; putting that into context, all of Dignity’s equity is currently valued at £346m. Certainly, if you annuitise those £45m of operating profits, deduct a bit for interest and tax, you don’t need a completely unrealistic rate of return to get a present value around £1bn. Something near 4 per cent will do the job and that’s a nice little earner in these days of near-zero interest rates.
It is for reasons similar to those that I can gross up the weighted average of Dignity’s operating profits for the past five years – about £59m – annuitise that amount and, after a bit of tweaking, find that Dignity is worth approaching £800m, or £16 per share. True, put a value on Dignity’s likely free cash flow – often a better, though more demanding measure – and the per-share value drops to about half that amount. Even so, the underlying message is clear – there is a lot of value in Dignity waiting to come out.
That the value got hidden in the first place owed much to the management team – now axed – that ran Dignity for years. They found a spot-on formula and stuck with it – grow by acquisition and leverage up shareholders’ returns by raising debt against the reliability of the group’s revenues. The debt raised could fund another round of acquisitions and so on. It was a great business model, worked for years and brought Dignity’s shares a sky-high rating. Until, that is, management starting paying insufficient attention to what they were buying and equally scant attention to improving what they had bought. As a result, and in a glorious put-down in Dignity’s 2020 results announcement, it led to “Dignity essentially becoming the industry retirement plan for independent funeral directors”.
So much so that in the seven years 2012-19, when this strategy was running full pelt, Dignity spent £237m on acquisitions against just £150m on internal capital spending. But those days, and that Dignity, have gone. They are replaced by a group lumbered by too much debt and heavy overheads. Net debt has averaged 5.6 times cash profits before interest and tax for the past five years – perhaps twice the level considered safe for a company to pay dividends, which party explains why Dignity hasn’t paid any since 2019. Meanwhile, head-office costs more than doubled between 2012 and 2019 while revenues put on less than half.
At least these matters are being tackled and the antagonists in the unseemly squabble seem to be focusing on similar ways to generate extra profit from Dignity. These include paying more attention to how the £1bn float held in trust for pre-paid funerals might be better used; exploiting consumers’ demand for simpler funerals and cremation services; growing the crematoria operation, while attacking those interest and overheads costs.
Do these things and Dignity should be moving in the right direction, especially as – paradoxically – the extra regulations and price controls now being screwed onto funerals’ operators actually favour the entrenched players by raising barriers to entry to the occupation, hitherto very low. In which case, and with no axe to grind, Bearbull is indifferent to who wins – or has won – this encounter. Almost a year ago when previously I wrote about Dignity (Investors' Chronicle, 5 June 202), I reckoned its shares look cheap at 240p. Even at today’s 675p, that assessment holds good. Still, thanks for the entertainment, guys.
Thanks also for drawing attention to Phoenix, a UK-based equity fund manager that is different chiefly because it runs comparatively small portfolios – 12 to 20 holdings – making correspondingly bigger-than-average bets. Linked to this, it takes positions for the long term and, as demonstrated by Dignity and Hornby (where it owns 75 per cent of the equity), it is prepared to get active if necessary.
Phoenix was founded by Gary Channon in 1998 and, reading between the lines of its website blurb, the impression is of a firm that fancies itself as a cross between Warren Buffett’s Berkshire Hathaway and Ray Dalio’s Bridgewater Associates – patient, value-orientated, willing to get hands-on, methodical, yet able to think outside the box. All this is good, even if I am sceptical about a fund manager who claims, as Channon does, to have had “an investing epiphany” when he discovered Warren Buffett. Admiration for Buffett is rightly huge, but the idea of Omaha’s best-known son as a God child is pushing it.
Besides, the best assessment of Phoenix is in its investment record. As the chart below shows, it is good without being jaw-dropping. From a start date at the end of 2015, both of the manager’s main funds – its flagship Phoenix UK Fund and its Aurora Investment Trust (ARR) – have outperformed the FTSE All-Share index and this through a period that has been unkind to value investing, under which label Phoenix’s strategies probably fall.
For ease of comparison, the chart uses capital values and thus ignores the effect on performance of dividends received. However, add these in and take the very long term, then the Phoenix fund has generated annualised returns of 8.9 per cent since its 1998 launch, not far short of twice the All-Share’s return of 4.8 per cent a year. Put these returns into context and the Phoenix fund turned £1,000 into almost £7,100 while the All-Share grew its £1,000 to not quite £3,000. Such is the power of even slightly superior returns and relentless compounding.
The Phoenix fund is for so-called ‘professional’ investors and has a minimum subscription of £100,000. Much more accessible is the listed investment trust, whose portfolio has much in common with Phoenix’s. That the trust’s shares trade fairly consistently at net asset value means investors don’t get the manager’s expertise on the cheap; alternatively – and taking the critical view – that expertise may not justify a premium, although Phoenix’s track record questions that notion. Perhaps I am drawn to it because it has several holdings in common with the Bearbull Income Fund – there is nothing like imitation to foster approbation. And – let’s face it – whatever the rights and wrongs of the undignified Dignity squabble, it’s good to see fund managers fight their corner.
