Carriage Services Targets Continued M&A And Ambitious Organic Momentum (NYSE:CSV)

Carriage Services, Inc. (NYSE:CSV) has continued posting stable earnings with its nationwide funeral home and cemetery assets. M&A has been quieter with no additional notable acquisitions, with only a non-core asset divestiture showing M&A transactions during the past year. The prior strategic alternative review process has also concluded without results. Carriage Services has ambitious financial objectives ahead, but I believe that organic growth should be priced cautiously despite the solid recent performance.

I previously wrote an article on the company titled “Carriage Services: Cheap After The Failed Buyout.” In the article, I noted Carriage Services to have an undervaluation as the company’s low-risk cash flows were seemingly overlooked by the market. Since the article was published on the 28^th of October in 2023, Carriage Services has returned 25% compared to S&P 500’s return of 32% – with a continued solid financial performance, the stock continues to trade at quite an attractive valuation considering the low-risk profile.

A Solid Financial Performance Has Continued

Carriage Services’ stable financial performance has continued as expected. The company slightly lowered its 2023 guidance’s upper bound with the Q3 report, but still reported good 2023 financials. Revenues ended up growing by 3.3% in 2023 to $382.5 million and reported margins stayed near stable with an $81.0 million operating income in 2023, up from $79.7 million in 2022. In Q4, the operating income margin was pushed up by 3.3 percentage points to 24.2%.

So far, 2024 has started well as Q1 results showed great revenue growth of 8.4% into $103.5 million, driven by a 38.4% increase in pre-need cemetery sales and including the prior 2023 acquisition of Greenland. The adjusted EPS grew by 33.9% to $0.75, while GAAP earnings declined due to one-off severance costs – underneath, Carriage Services shows great cost management, pricing, and shows good overall growth in operations. Funeral revenues grew by just 1.8%, but great cemetery growth of 29.4% carried the total revenues higher.

Carriage Services Has Significant Strategic Targets Ahead

Carriage Services has laid out a five-year strategic plan showing significant ambition – the company targets 5-8% in organic revenue CAGR, and $50-100 million in additional acquisitions to fuel earnings growth. The company also plans to continuously improve operations through automation and other improvements to drive a better customer experience, and ultimately to improve profitability. To finance the growth strategy and to improve the growth outlook, Carriage Services plans to divest its worst performing assets.

I don’t believe that investors should take the organic revenue growth target at face value. In my previous article, I noted the company to have had a CAGR of 4.2% from 2002 to 2022, below the targeted organic level despite acquisitions adding to the historical growth very notably – the target assumes a very dramatic jump in a highly stable industry.

Speaking for slower growth than the targeted 5-8%, Carriage Services expects revenues of $380-390 million for 2024, a low growth of -0.7% to 2.0% from 2023 as a Q1 non-core asset divestiture decreases expected revenues by $5.5 million. Adjusted for the divestiture, the expected 2024 revenues still show a weak expected top-line growth when compared to the five-year target. Continued momentum could raise the outlook throughout the year, but as the Q1 growth was partly a result of a prior acquisition that won’t drive comparative growth after Q1, such growth shouldn’t be expected going forward if no new acquisitions are made. As a base scenario, I don’t suggest estimating organic growth in the targeted range.

The adjusted EPS is expected at $2.20-2.30, up 0.5% to 5.0% from 2023 as the company expects slight margin leverage. Adjusted free cash flow is expected at $55-65 million. The EPS outlook shows results from Carriage Services’ great cost and pricing management strategy. The outlook was laid out with the Q4 report and was reaffirmed with Q1 results.

It’s Been Quiet on the M&A Front

After the company’s continued review of strategic alternatives to maximize shareholder value, Carriage Services announced the conclusion of the review in February with the Q4 report. The board ultimately decided that continuing to operate as an independent company is in the best interest of shareholders, despite Carriage Services receiving a number of proposals for transactions during the strategic alternative review. A company sale doesn’t bring immediate upside potential anymore, as being acquired is likely off the table.

The Greenlawn acquisition in March 2023 is Carriage Services’ latest announced acquisition – no additional acquisitions have been done in over a year, as M&A activity for the company has been silent. Carriage Services’ high debt, currently accounting for around $555 million, could potentially limit acquisitions for some time. The company’s stable operations should handle a large amount of debt, though.

In Q1, Carriage Services received $10.9 million from a divestiture of non-core assets as the company plans to divest its underperforming assets to streamline operations, being the most notable M&A transaction in recent history; instead of scaling, Carriage Services has recently only shrunk its total assets.

I still believe that Carriage Services should be able to execute the M&A growth in the future, as the leveraged balance sheet hasn’t historically been an issue in the acquisition strategy, and as the industry continues to be highly fragmented posing a good number of potential acquisitions.

CSV’s Valuation Is Still Attractive Considering the Risk Profile

I updated my discounted cash flow [DCF] model to estimate a revised fair value for the stock. In the model, I now estimate a 1% growth in 2024. The year is followed by a greater 5.2% growth in 2025, as I account for modest new acquisitions to fuel growth, along with very slight achieved organic growth in coming years. Afterward, the growth in the model gradually slows down into a perpetual 1.5%, similar as before, as I estimate the acquisition strategy to slow down.

Due to great cost management, I again estimate some margin leverage into a 22.1% sustained EBIT margin. While I estimate the acquisitions to slow down cash flows in the next few years, I overall expect a relatively good cash flow conversion excluding M&A.

The estimates put Carriage Services’ fair value estimate at $37.82, 43% above the stock price at the time of writing – the stock continues to have good upside with the incredibly stable cash flow profile and the company’s good growth strategy. The estimate is up from $29.80 previously due to slightly more aggressive growth estimates and a lower WACC.

A weighted average cost of capital of 7.23% is used in the DCF model, down from 7.63% previously. The used WACC is derived from a capital asset pricing model:

In Q1, Carriage Services had $8.7 million in interest expenses, making the company’s interest rate 6.28% with the current amount of interest-bearing debt. I now estimate a long-term debt-to-equity ratio of 70%. To estimate the cost of equity, I use the 10-year bond yield of 4.45% as the risk-free rate. The equity risk premium of 4.60% is Professor Aswath Damodaran’s estimate for the US, updated on the 5^th of January. I have kept the beta estimate at 0.88. With a liquidity premium of 0.5%, the cost of equity stands at 9.00% and the WACC at 7.23%.

Takeaway

Carriage Services’ stable financial performance has continued, aided by the prior Greenland acquisition. The company has achieved great adjusted margins through pricing initiatives and cost management, and targets an ambitious earnings growth in the next five years through automation, greater organic growth, and a continued M&A strategy. I believe that the organic growth target of 5-8% should be taken skeptically in light of the historical performance.

Continued M&A should aid growth, although Carriage Services has been quiet on acquisitions in the past year. The leveraged balance sheet could challenge the acquisition strategy, but it hasn’t caused issues historically, and the planned divestitures of underperforming assets should aid financing of additional acquisitions. Although the strategic alternative review process has ended without results, I believe that the stock has upside due to a conservative valuation. As such, I remain with a Buy rating for Carriage Services.