The current recession has buried the North American death-care sector, and prices of companies’ stocks are now trading at all-time lows. However, an aging population and a major industry consolidation on the horizon are signs that the sector and its returns will soon be livelier than ever, analysts say.

Most companies in the sector have remained off the radar because 80% of the industry is made up of mom-and-pop funeral parlours and municipal-owned cemeteries. Only 20% of the death-care sector is publicly traded, with the market capitalizations of companies in the industry totalling US$2.7 billion, according to estimates from Toronto-based J.C. Clark Ltd., which manages Memoria Ventures LP, one of the only known death-care funds in the world.

“We see a lot of potential for consolidations, not only from larger players taking over independents but also from [public] companies buying each other out,” says Richard Innes, investment consultant for Memoria Ventures.

Driving the consolidation trend is a need to “cluster,” which is industry jargon for a company that acquires funeral homes and cemeteries that are close to each other so that it can pool its cars and employees for multiple locations.

“This is very much a fixed-cost business, so when you have more funerals and share resources among homes, it can have a disproportionate and beneficial effect on the bottom line,” says Innes, who was president and CEO of Toronto-based death-care company Arbor Memorial Services Inc. between 1996 and 2007.

Clustering won’t be the only way to grow the bottom line. Changing demographics as a result of an aging baby-boomer population means the annual number of deaths will continue to rise. In Canada, the annual number of deaths rose by 20% to 230,132 in 2005, up from 191,973 in 1990, according to Statistics Canada — and this trend is expected to continue. Likewise, the U.S. has, on average, 2.4 million deaths a year, according to the U.S. Census Bureau. By 2050, the population of those aged 85 and older in the U.S. is expected to more than triple to 19 million from 5.4 million in 2008.

Visible minorities in Canada are also increasing demand for the death-care sector’s services. Asian and Indian communities, in particular, have been driving the trend for cremation as their religious beliefs require the process as a part of the burial ritual. “We see a lot of upside with these groups,” says Brian Snowdon, president and CEO of Arbor. If immigration growth rates continue at the current rate, visible minorities will make up 20.6% of Canada’s population by 2017, according to Statistics Canada’s Study of Canada: Visible Minority Population report, conducted in March 2005. In the 2006 census, immigrants totalled 16.2% of Canada’s population — about five million people.

Capturing the ethnic market share is crucial to future plot sales for any company in the industry in Canada, says Innes, as immigrants don’t have any ties to specific burial grounds. “If you have fourth-generation Canadians, with their family buried in certain cemeteries, what chance do you have of selling them a different cemetery?” he points out.

To gain a greater market share, Arbor has equipped several of its crematories with viewing windows to accommodate certain ethnicities; as well, the firm has put an emphasis on hiring a multicultural sales force to connect better with clients.

Houston-based industry giant Service Corp. International, for its part, has launched Funeraria Del Angel, a brand of funeral homes in the U.S., to cater to Hispanics.

Making arrangements for pets also presents opportunities. “People are now asking for pet funerals and pet burials,” says Robert Fells, external chief operating officer and general counsel for the Sterling, Va.-based International Cemetery, Cremation & Funeral Association. SCI has already begun to grow the segment with its two pet cemeteries in Sun City, Ariz., and Falls Church, Va. This business is attractive, Fells points out, because pets’ lifespans are shorter than those of humans.

In addition, a change to the law that bans the building of “one-stop shop” cemeteries in Ontario will also present some opportunities. Under the Ontario Cemeteries Act, cemeteries are currently prohibited from building a funeral home on their premises, although they are allowed to build “reception centres” on their grounds, a strategy Arbor has used to get around the legislation for about 12 years. However, an amendment to the act has been passed that will permit the creation of one-stop shops, Snowdon says — although it has yet to be proclaimed.

@page_break@Yet, despite all the positive factors that make investing in the death-care sector potentially lucrative, for many, it is still a far-fetched proposition.

“You cannot help but get a smile or a snicker out of someone when you start talking about the death-care business,” says Sean Wynn, director of marketing with J.C. Clark. “North Americans don’t talk about death, so the idea of investing in death is really a stretch for people.”

But stigma alone is not what has deterred hard-nosed investors, Innes says. Rather, he points to the industry’s massive rise and subsequent fall in the 1990s.

The industry began ballooning in the late 1980s. Large players such as SCI, Arbor and now bankrupt Burnaby, B.C.-based Loewen Group Inc. were in the midst of building their massive empires, mainly with debt. From 1985 to 1988, Loewen grew massively, as it came to own 98 funeral homes and five cemeteries from none. A year later, it had 120 funeral homes and 10 cemeteries, making it the largest publicly traded death-care provider in Canada.

“There was a frenzy. The thinking was that if SCI didn’t buy this company in Ohio, for instance, someone else would,” Wynn says. “You had owners who sold their businesses at 15 times earnings.”

Despite many companies’ share prices skyrocketing, a bust was looming. “Loewen was the tipping point for companies to re-evaluate their debt levels,” Innes says. That’s because Loewen lost $175 million in a Mississippi lawsuit that forced it into bankruptcy. “After the lawsuit, instead of acquiring, companies were divesting. [Jefferson, La.-based] Stewart [Enterprises Inc.] had business in Canada, which it sold off; SCI had business outside North America that it sold off.”

When the bubble popped, the value of the North American death-care sector fell to $2 billion in 2000 from its peak of $20 billion just two years earlier. Since then, acquisitions in the sector have slowed so much that people don’t think growth is possible anymore, Innes says. Now, due to a lack of coverage, deals simply go unnoticed.

Prior to this recession, SCI had offered to acquire Stewart Enter-prises, the third-largest death-care provider in the U.S. However, those plans have since fallen by the wayside. This is where patience becomes a golden virtue, Innes says; if investors want payoffs, they need to buy and hold stocks for the next decade.

Of the 20 publicly traded firms in the sector in North America, only four or five are poised to survive another round of consolidations. SCI is at the top of the food chain, with 366 cemeteries and 1,329 funeral homes across the U.S. and Canada. Although SCI’s revenue for the nine months ended Sept. 30, 2008, fell to US$1.6 billion from US$1.7 billion for the same period in 2007, its net income rose to US$87.6 million from US$80.9 million.

Tampa, Fla.-based Keystone North America Inc., the second-largest funeral home operator in the U.S., hasn’t been doing as well. Although its revenue for the nine months ended Sept. 30 increased to US$94.2 million from US$75.3 the year prior, it had a net loss of US$40.3 million — a far cry from its US$7.3 million in net earnings in 2007. The overall loss was a result of a paper loss on the sale of two of its funeral homes, according to the notes in its third-quarter report.

Arbor is the second-largest death-care provider in Canada, next to SCI, with 132 funeral homes and cemeteries. Arbor, which opened for business in 1947, brought in revenue of $236.6 million for the year ended Oct. 26, 2008, from its funeral, cemetery and corporate operations, an increase from the $186.7 million in sales it generated in the year ended Oct. 28, 2007. Net income for the most recent fiscal year was $16.1 million, vs $13.5 million in 2007.

Potential investors in the sector want to look at the number of “calls” a service provider receives year-over-year rather than revenue. Calls refer to either requests for an at-need service, which occurs at time of the death, or a pre-need service, which is making arrangements prior to deaths, Innes says: “It’s like same-store sales in retail. Looking at companies in terms of calls, instead of revenue, takes out the effect of pricing. If the number of calls is going down, that’s a red flag as this is a service business.”

Finally, calculating the company’s debt/equity ratio gives you an idea of how they’ll be able to stomach an acquisition, says Harry Levant, owner of Vancouver-based www.incometrustresearch.com.

As revenue is usually quite stable — with three years’ worth of pre-need arrangements booked in advance, on average — accumulating debt could put a serious dent in a death-care provider’s cash flow, hindering its ability to make acquisitions. “If debt to equity exceeds 50%, you should be careful,” Levant says, because the credit crunch has made loan renewals and loans for acquisitions difficult to obtain.

Meanwhile, the challenge for industry players is growing organically when building new cemeteries. It can take five to seven years to begin selling plot spaces for a new cemetery, Snowdon says; this includes one to two years to obtain the permits and zoning requirements, which may involve public meetings with residents who don’t want a cemetery in their area. Then, up to five more years are needed to lay the grass, build the rows and let the gardens bloom at the actual cemetery.

Land prices also make building the construction of new cemeteries extremely difficult as land is scarce in most cities and, therefore, sells at a high price. As such, the cost of a prime location in a city might be more than the cost of acquiring an already existing cemetery in that same area. As a result, this makes acquisitions the preferred growth strategy for stalwarts such as SCI, Keystone and Arbor, which have the capital to make such purchases.

Although this situation may make it more difficult for the enterprises themselves to expand, it’s a good thing for their investors as they can rest assured that several new startup cemeteries won’t be entering the market and stealing market share from the larger players. Only a handful of business owners, if any, would have the capital to buy raw land and be willing to wait seven years before seeing a dime of their money back.

Another challenge for the sector is the increasing popularity of cremation. According to the Chicago-based Cremation Association of North America, the estimated percentage of deaths in Canada resulting in cremation in 2007 was 55.9%, a notable rise from 42.4% in 1998.

“You have a natural erosion of revenue per call that comes with the increasing rate of cremation,” Innes says. “A typical cremation ceremony, with an urn, doesn’t generate as much revenue as the typical traditional casket funeral.”

So, death-care providers will have to come up with new services to make up for lost revenue, Innes adds. These can range from custom-printed funeral guest books to estate-planning services. IE