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Sell out of Dignity

The funeral provider is fighting to maintain its market position, but as debt markets contract this might become harder to do
November 21, 2017

For many years investors in funeral provider Dignity (DTY) had little more to worry about than the minor fluctuations in the UK's death rate; it being a case of high death rate good, low death rate bad. Meanwhile, a rolling program of bolt-on acquisitions and funeral price hikes have kept profits ratcheting higher, with progress further aided by opportunities to refinance debt on ever more favourable terms thanks to the low interest rate environment. But we think things have now changed and that investors would be best off selling out while the market continues to adjust its expectations about the business's long-term prospects.

IC TIP: Sell at 1,843p
Tip style
Sell
Risk rating
High
Timescale
Medium Term
Bull points

Good long-term track record
Acquisitions still on track

Bear points

Increasing competition
Shrinking market share
Reduced CAGR forecasts
High debt

In the past year, Dignity's investment narrative has been complicated by increasing levels of competition and subsequent price wars in the market. A recent third-quarter update prompted a downward jolt in the share price after the group missed some analysts’ earnings targets and spoke of further competitive pressures. Analysts' forecasts have already bstarted to come down, with expected medium-term compound annual EPS growth (CAGR) rates dropping from from 10 per cent to 8 per cent.

What’s more, given demand for funerals is depressingly dependable, the stability of the end market means it has made sense for Dignity to take on relatively high levels of debt. Net debt at the end of 2016 was equivalent to 4.4 times underlying cash profit. By using high levels of debt, Dignity has been able to enhance returns to shareholders from its predicable business on the upside, but the same dynamic risks increasing the pain on the downside.

There are reasons to think rivals will continue to muscle in on Dignity based on the fact the company produces high lease-adjusted returns on capital employed of almost 16 per cent. That is likely to prove more than enough to continue to entice competitors.

However, Dignity insists charging high and rising prices remains in its interest despite the loss of market share to cheaper rivals. While the rate of ‘lost’ funerals is increasing, Dignity estimates it would have to lose about 10,000 funerals to abandon the benefits of price hikes. Last year the 'lost' number crept up to 4,000. For now, price rises are keeping sales relatively buoyant (up 6 per cent in the third quarter), but we feel negative trends may worsen.

Dignity is not unaware that problems are lurking as more companies set up shop and it is investing in its service to keep ahead of the competition. It is evaluating its range of services and using new modes of marketing to attract customers. However, this is causing it to incur more costs as it expands its digital platform and the number of services on offer.

Regular bolt-on acquisitions have also been used by Dignity to enhance growth and protect market share. There are grounds to think this may become a less lucrative game, too, given that much of this activity is financed with debt and there is currently a tentative tightening of monetary conditions under way, as well as jitters at the riskier end of the international fixed-interest markets. 

DIGNITY (DTY)   
ORD PRICE:1,843pMARKET VALUE:£920m
TOUCH:1,843-1,845p12-MONTH HIGH:2,791pLOW: 1,818p
FORWARD DIVIDEND YIELD:1.5%FORWARD PE RATIO:14
NET ASSET VALUE:56p*NET DEBT:£521m
Year to 31 DecTurnover (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
201426958.585.819.5
201530572.211421.4
201631475.211923.6
2017**32778.012426.0
2018**34184.013528.5
% change+4+8+9+10
Normal market size:500   
Matched bargain trading    
Beta:797.00   
*Includes intangible assets of £379m, or 759p a share
**Numis forecasts, adjusted PTP and EPS figures