Turkey of the week: defensive play lacking growth
By
Paul Hill Aug 21, 2009
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As the saying goes, just two things in life are certain – death and taxes. Chancellor Alistair Darling is the chief recipient of the latter, while this week's turkey benefits from the former. Dignity is one of Britain's largest providers of funeral services, with a market share of about 20%. It owns 545 undertakers (77% sales), runs 30 crematoriums (18%) and offers pre-paid funeral plans (5%), whereby punters can pay upfront for ceremonies before they die.
It's a classic defensive play in a relatively stable sector. This predictability was shown by last month's solid but less-than-inspiring interim results. Revenues grew 5.5% on the first half of 2008, while operating profits (Earnings before interest and taxes - Ebit) were up 9%, largely due to acquisitions. But the organic growth needed to justify Dignity's lofty valuation is missing – overall UK death rates have been pretty much static over the past few decades, running at 550,000 a year.
In response, management is trying to boost the top line by signing affinity deals with third parties (such as Age Concern, AXA Sun Life and Royal London), and by buying smaller rivals and local authority crematoriums. But this is a slow uphill task, so the main boost to earnings (up 7.7% in the first half) in recent years has been via clever financial re-engineering.
Dignity (LSE: DTY), rated a BUY by Panmure Gordon
Dignity has geared itself up and now has £246m in debt. Although this is currently manageable, there's not much breathing space left against its financial covenants. This could become an issue if profits fell, perhaps due to cuts in discretionary spending on items such as limousines, headstones and receptions.
The City expects 2009 revenues and underlying Ebit of £183m and £56m respectively, rising to £193m and £59m in 2010. I'd rate the stock on a 2009 enterprise value/Ebita multiple of nine. After adjusting for its loans, it generates an intrinsic worth of around 405p a share. So at 600p the stock currently trades at a 30% premium to fair value.
Dignity will never run out of customers and competes against lacklustre rivals. Yet at current levels the shares offer little upside. The chief executive and chairman seem to agree, as they have been selling stock over the past 12 months.
Recommendation: SELL at 598p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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