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Can Dignity ever reclaim its defensive qualities?
Pull up a one year chart of funeral services provider Dignity (DTY) and you’ll be kicking yourself if you didn’t invest 12 months ago to generate a spectacular 200% gain. But draw a long-run chart and you’ll see the shares remain more than 70% below 2016’s £28-a-share peak, as the funeral director has endured a turbulent period in a history it can trace back to 1812.
Now under new management and with a fresh strategy, Dignity will be looking to take the next step in its recovery from a very difficult period for the business.
The UK’s sole listed funerals business, Dignity is a nationwide ‘end of life’ business operating funeral homes as well as crematoria, the latter division a valuable asset that recently attracted an unsolicited approach.
Dignity was highly prized by investors for years as the ultimate defensive. Due to the non-discretionary nature of the day-to-day business, the Sutton Coldfield-based company benefited from rising profits and the predictable cash flows to fund a stream of dividend payouts.
But then things turned sour. Dignity had to re-think its entire pricing model, alarming for a company that carries debt, triggering a massive profit warning in early 2018 and a severe share price slump thereafter as confidence in the stock crumbled.
It transpired Dignity had been charging the bereaved increasingly high prices for funerals while underinvesting in service improvements and the branch estate at the same time, thereby enticing cheaper competitors into an unregulated funeral market with low barriers to entry.
Dignity’s underlying pre-tax profit slumped by 30% to £54.4 million and £37.7 million in the years to December 2018 and 2019 respectively due to the funeral price cuts needed to fend off competition.
And despite Covid-19 directly contributing to a 14% increase in the UK 2020 annual death-toll of 663,000, adjusted pre-tax profit dwindled by a further 20% to £30.7 million last year, in large part due to government-imposed funeral attendance restrictions.
A Competition and Markets Authority (CMA) investigation into the funeral and crematoria industry has created additional uncertainty, while Dignity continues to ready itself for regulation of the funeral plan market by the Financial Conduct Authority (FCA).
But the business is demonstrating some vital signs. In May, Dignity reported a better than expected first quarter performance with underlying operating profit up 35% to £26.1 million, driven by a 27% year-on-year increase in the number of deaths due to Covid, although this has begun to reverse as Dignity laps last year’s period of elevated deaths and the vaccine rollout takes effect.
The company hasn’t paid a dividend since June 2019 and won’t be reinstating the shareholder reward until it returns to a sustainable and stable financial footing.
DIAGNOSING DIGNITY’S PROBLEMS
Having pushed for a strategic shake-up, Dignity’s largest shareholder Phoenix Asset Management Partners recently persuaded shareholders to oust executive chairman Clive Whiley and installed its own chief investment officer Gary Channon as executive chairman, sparking a wave of resignations from fellow board members.
Presenting at Dignity’s annual general meeting (23 June), Channon said the previous strategy had set the company up for long-term failure, with a focus on growing profits by increasing prices faster than volume losses. Rather than high-quality organic progression, growth was being purchased through acquisition, with Dignity paying ever increasing prices for new businesses.
Price increases under previous management led to a loss of competitiveness and many new competitors emerged, resulting in market share losses. Channon also argued that the transformation plan set-out by Whiley failed to tackle the core problem, resulting in a steady decline in per branch performance and market share.
Channon has outlined a new strategy to enable Dignity to realise its unlocked value. The vision is for Dignity to be ‘the UK’s leading end of life business, renowned for its excellence and high standards, represented and embedded in the community with strong local brands, whilst offering the best service for the best prices’.
At last count, Dignity’s funeral market share was 12% and its crematoria market share amounted to 11.5%. Under Channon’s leadership, the £407.2 million cap now aspires to achieve 20% funerals market share in 10 years’ time, including both pre-need (pre-arranged funeral plans) and at-need funerals.
The focus is on prioritising the sale of funeral plans through branches rather than telephony partners. Contracts have already been cancelled with five telephony partners assessed by Dignity as both uneconomical but also not representative of the high standards it expects.
Channon candidly concedes this move will lead to a loss of roughly 35% of Dignity’s 2021 budgeted funeral plan division revenue, yet he points out this is largely mitigated through £12 million in savings from 2021 budgeted telephony commission costs.
Under the new strategy, Dignity will also focus on growing the addressable market for funeral plans, growing percentage share of funeral plans sold and lowering the cost of acquisition. Channon explains Dignity will also prioritise investment into standards of care, facilities and the underinvested branch estate, alongside a combination of a competitive pricing and product mix, cultural change and stronger branding, to grow local market share.
In the crematoria business, Dignity will now concentrate on increasing both volume and yield per crematoria by increasing throughput and growing ancillary sales while continuing to build out the pipeline of crematoria and build additional capacity into existing facilities. Furthermore, Dignity will embrace direct cremation and cut prices to cater to ‘the location agnostic value segment of the market’.
According to Channon all capital allocation decisions in the future will aim to optimise cash return on core capital. For these purposes return equals the cash return to the business after funding capital expenditure, tax and other routine expenditures and core capital is the money and assets required to operate the business. The plan is to update investors on this key metric regularly.
THE FUND MANAGER’S VIEW
Dignity is the biggest holding in the Artemis Alpha Trust (ATS), managed by Kartik Kumar and John Dodd. Kumar stresses that the ‘very attractive’ fundamental characteristics of the end of life industry remain unchanged.
‘These were slightly forgotten with the issues Dignity was suffering from,’ he explained. ‘This is a very predictable market. I like the quote, “two certainties in life are death and taxes”, and this is catering to one of those.’
Kumar pointed out that for the last decade, effectively the death rate in the UK has been suppressed. ‘And for the next 10-to-20 years, because of demographics that were created 60-to-80 years ago, you know with a high degree of certainty that the overall industry will be growing for the next 20 years.’
The Artemis money manager added that the funerals and cremations industry has ‘some unique features. It is highly predictable, it is a-cyclical – the numbers don’t change so much with a recession – and slightly differently from the last 10 years, it will be growing for the next 10 years.’
Kumar believes the most unique feature about Dignity is that in the industry, it is the only operator of both crematoria and funeral homes. ‘About 79% of the roughly 600,000 people in the UK that passed away last year were cremated and that share has been growing,’ he explained.
‘But on top of that, in terms of actually servicing a funeral, Dignity has about a 10% market share and 800 branches here in the UK. So they are the only operator that is effectively vertically integrated both having funeral homes and crematoria.’
Artemis UK Alpha supported the change in the strategy and Kumar insists Dignity is ‘a business that has many of the building blocks to be a very successful operator in a very attractive market.
‘This company could be a price leader, a service leader, and have a growing market share in its funeral business, but also when you combine with that the attractive features of its crematoria and its pre-need funeral business, you can end up with some very interesting results.’
Dignity has conducted trials on what the impact of cutting prices would do, ‘and they’ve been really quite favourable’ according to Kumar, who believes there is ‘a lot of potential left in the business, we’re scratching the surface of each part of the business’.