The stock market can have a nasty habit of dishing up unexpected news and we’ve seen many examples over the past few weeks.

Retailer Carpetright (CPR), logistics firm Connect (CNCT) and teleradiology services group Medica (MGP) are three examples of stocks that have taken the market by surprise with negative news this year.

You can now add funeral services provider Dignity (DTY) to the list.

Its shares fell 48% to 988.81p on 19 January 2018 after the company announced a dramatic change to its funeral pricing in order to deal with competitive pressures.

This decision was a shock to shareholders, analysts and the media including ourselves, as the company hadn’t previously talked about making such severe changes to its business.

Analysts were forced to downgrade their 2018 pre-tax profit forecasts by nearly 50% for 2018.

WHAT’S HAPPENED?

Dignity’s ‘simple’ funeral price has been reduced by 25%, from £2,700 to just below £2,000.

Furthermore, Dignity is freezing the price of ‘traditional’ funerals at circa £3,800. Stockbroker Numis says prices for these types of funerals would normally go up by 5% a year.

Dignity says the pricing changes could result in ‘simple’ funerals accounting for 20% of all its funerals performed in 2018 versus 7% in 2017. ‘Traditional’ funerals last year accounted for 60% of Dignity’s volumes.

Michael Donnelly, an analyst at stockbroker Panmure Gordon, believes ‘this aggressive and decisive action’ will provide a strong response to increasingly aggressive competition from both Co-operative Funeralcare and others. ‘That should, in due course, arrest the decline in Dignity’s market share and, eventually, allow (inflation-level) price rises to resume,’ he adds.

Based on forecasts from investment bank Investec, Dignity now has a net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) ratio of 5.7 times for 2018. Most companies try and keep that ratio below 3.5-times. Dignity’s net debt is forecast to be £494.1m at the end of 2018.

Essentially, the pricing amendments mean Dignity’s debt position compared to its forecast earnings is now at a much higher level, leading some investors to worry about its ability to service the debt. Investec says it has no concerns on that front.

‘According to the latest bondholder report (for September 2017) Dignity’s financial covenants require EBITDA to be at least 1.5 times the debt service cover, which is £33m each year out to 2049,’ comments Investec.

‘We now forecast EBITDA of £86.4m in full year 2018 and £89.3m in full year 2019, some 2.6-2.7 times the debt service cover. Indeed the crematoria business alone generates some £40m of EBIT each year.’ (JC)

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