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Sell-off following growth target downgrade seems severe

A correction at funeral services provider Dignity (DTY) has created a buying opportunity in a quality company. We consider the mark-down of this defensive, cash-generative outfit overdone and believe any obituaries to Dignity’s market share gain potential are premature.

Not at death’s door

Sutton-Coldfield-based Dignity’s shares slumped on full year results (8 Mar), despite the delivery of better-than-expected pre-tax profits of £75.2m and a 10% total dividend hike to 23.59p, as 2016 UK deaths came in at an unexpectedly high 590,000 (2015: 588,000).

The £1.27bn cap warned the number of deaths in 2017 ‘could be significantly lower than 2015 and 2016’ as the abnormally high death rate of the last two years reverts to the mean. Given the size of the group and ‘increasing competition in each of our markets’, Dignity also revised its medium-term underlying earnings per share (EPS) growth target from 10% per year to 8%.

Competition concerns

Admittedly, Dignity is finding growth harder to deliver with each strong set of results. A larger funeral market share decline in 2016 than seen before, down from 12.3% to 11.8% of the UK market (excluding Northern Ireland) is cause for concern.

However, guided by CEO Mike McCollum, Dignity will continue to argue for regulation of the funeral and pre-arranged funeral industries, which have attracted some unscrupulous players.

Any future regulation, combined with Dignity’s unrelenting focus on customer service, implies the opportunity to consolidate a fragmented market remains attractive.

Dignity invested £56.3m in acquisitions last year. Its future funeral revenues are supported by the 404,000 (2015: 374,000) active pre-arranged plans in issue, and three new crematoria are set to open in 2018 and 2019.

In rude health

In any event, Dignity’s new earnings target is still very healthy for a consumer defensive stock. For the years to December 2017 and 2018, Panmure Gordon analyst Michael Donnelly forecasts improved pre-tax profits of £77.4m (2016: £75.2m) and £83.4m respectively, with EPS set to rise to 123p (2016: 119.8p) this year ahead of 135.1p
next year.

Panmure sees Dignity, which has an enviable record of cash returns, increasing the dividend from 22.2p to 26p this year. We also note Investec Securities has upgraded its discounted cash flow (DCF)-based price target from £27.95 to £29.40.

While the earnings target downgrade is unwelcome, Dignity remains a quality company whose resilient earnings and formidably strong cash flow justify the high rating. Keep buying at £24.98.

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