For years, Dignity (DTY) was on to a good thing. As the number two player in the UK's funerals market, it delivered high profit margins and smooth returns. Then things began to change. In 2016 and 2017, an increase in competition altered the market's dynamics and forced Dignity to make price cuts to protect its market share. The resulting hit led to a profit warning. Now, with the UK's Competition and Markets Authority (CMA) investigating the funerals market, we think the group – and its shares – are still at risk.
Margins still high, despite falling
Predictability of funerals market
Recent profit warnings
Falling profit margins
Debt may become a problem
Regulatory investigation into funerals
Dignity provides funerals and cremations in the UK and Channel Islands, with funeral services accounting for the vast majority of revenues – 68 per cent in 2018. It has historically commanded high margins but, as competition has increased, these have started to look more like the result of a poorly functioning market than a sustainable competitive advantage. In 2015, Dignity's operating margin was a fat 31 per cent, and it held 12.3 per cent of the funerals market. By 2018, management was reporting a market share of 11.2 per cent on a comparable basis and margins of 21 per cent.
Management’s response has been to take on the competition, slashing the price of its 'simple' funerals by a quarter and seeking to protect market share. It has had mixed success. The group reported a small improvement in comparable market share in 2018, but average income per funeral dropped from £3,222 to £2,973, leading to a 23 per cent drop in underlying operating profits to £80m. The product mix is continuing to evolve, but City analysts expect profits to fall in the coming year and remain subdued in subsequent years. Underlying cash generation also fell, which will make it more challenging for the group to address its mammoth debt pile.
More widely, funerals' operators are facing a day of reckoning. In March, the CMA announced it was launching a phase two investigation into the funerals market. Its initial review found that the price of essential funeral services had risen 6 per cent annually for the past 14 years – twice the rate of inflation. It added that the vulnerable state in which many people organise funerals can mean they “are not in a position” to evaluate a range of options - a predicament made worse by reluctance on the part of companies to provide clear information on prices, quality and range.
Dignity will be a target. The CMA’s initial review of the market noted the “larger operators” of crematoria had raised prices by 6-8 per cent on average over the past eight years. It added that meeting shareholders' expectations “has been the main factor” behind these increases. Dignity currently controls 10.9 per cent of the crematoria market, and broker Peel Hunt reports that the group has 19 of the 20 most expensive crematoria in the country.
The investigation has a statutory deadline of 27 September 2020, although Peel Hunt says that date might be extended if the scope is expanded to include pre-paid funerals. However, the broker notes that the CMA’s language is “very clear” in seeing price controls as necessary. Broker Panmure Gordon said such restrictions “could have a material impact” on Dignity, if introduced.
The group started the year with a shock profit warning, saying fewer deaths meant that adjusted operating profits could be £4m below previous expectations. While unwelcome, this will not have a profound effect since the number of deaths will inevitably revert to the mean. However, the forces of market disruption and regulatory intervention will not self-correct.
DIGNITY (DTY) | ||||
ORD PRICE: | 659p | MARKET VALUE: | £330m | |
TOUCH: | 659-661p | 12M HIGH / LOW: | 1,325p | 624p |
FORWARD DIVIDEND YIELD: | 3.7% | FORWARD PE RATIO: | 10 | |
NET ASSET VALUE: | 132p† | NET DEBT: | £506.8m |
Year to 28 Dec | Turnover (£m) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
2016 | 314 | 75.2 | 119.8 | 23.5 |
2017 | 324 | 77.8 | 128.1 | 24.4 |
2018 | 316 | 54.4 | 85.7 | 24.4 |
2019* | 307 | 41.0 | 64.8 | 24.4 |
2020* | 319 | 43.0 | 67.6 | 24.4 |
% change | +4 | +5 | +4 | nil |
NMS: | 3,000 | |||
Matched Bargain Trading | ||||
BETA: | 1.19 | |||
†Includes intangible assets of £385m, or 770p a share. *Peel Hunt estimates, adjusted profit and earnings |