Questor share tip: Dignity returns £54m in cash

Dignity
£14.55+23p
Questor says HOLD

DIGNITY [LON:DTY] is planning to make a surprise return of cash to investors as the listed funeral company carries out a major refinancing.

The company said yesterday it will return around £54m in cash to shareholders, or £1 per share, only 13 months after its last sweetener to investors. Dignity is looking to raise about £580m by issuing new corporate debt and with the cash raised it will repay the existing £406m in debts and return the rest of the cash to investors, less around £15m in fees.

The reason for raising the debt seems sensible, the company said: “The group believes that given the low interest rate environment and the narrow spreads implicit in the market value of the group’s debt, there is an opportunity to extend the life of its debt and raise new funds.”

The funeral operator likes to return cash. Investors who backed the company at the £2.30 IPO price in 2004 and held on would have now received £4.10 per share during the past 10 years, or about 180pc of the original investment, paid out as £3.30 in returns of cash and 80p in dividends.

That means from an initial investment of £2.30, investors would now hold £4.10 in cash and the shares, which are now worth £14.55.

The lower cost on the new debt will reduce annual interest payments by around £6m a year from £40m to £34m.

However, there will be a one-off accounting charge in this year’s results of around £110m related to the transaction.

The company uses funds from debt to grow through acquisition. The majority of funeral parlours in the UK are still independently owned businesses. The company added 54 new funeral locations last year, once branch closures had been subtracted, and has delivered steady growth for the past decade. Since the company floated in 2004, revenue growth has been 7.3pc a year, and earnings per share have increased by 16pc a year.

Dignity operates 698 funeral parlours and 39 crematoriums across the UK. The company completed 33,800 funerals during the first six months ended June – down from 37,200 the previous year – and performed 27,400 cremations, a fall of 9pc on a year earlier.

Britain has experienced a stable death rate of between 540,000 and 600,000 each year for more than half a century. Management at Dignity is predicting it will be at the lower end of that range, at about 543,000, this year.

It generates around two thirds of its profits from funerals and a third from cremations. However, the company still only provides funeral services for less than a quarter of the deaths in the UK each year.

Market consensus is for revenue to increase 5pc to £268.9m, pre-tax profit to rise 14pc to £57m, and earnings per share to advance 14pc to 82.2p. Investors are in line to receive 19.2p in dividends this year.

Questor is always wary of debt-funded expansion, but in this instance it looks sustainable. Dignity last reported net debt – debt less cash on the balance sheet – of £355.6m and this should rise to about £520m.

Dignity shares are currently trading at 17.4 times forecast earnings, falling to 15.6 times next year, and that looks high, given single-digit revenue growth and low double-digit earnings growth. Also, with the shares at £15 it would take almost half a century to get your money back if the previous decade’s cash return rate of £3.10 was repeated.

A meeting of bondholders will be held within the next three weeks to agree the refinancing and, following a shareholder vote at an extraordinary general meeting, the cash should be returned in early November.

Questor thinks this company is well worth watching and buying if we get a market correction in the future, but at this price it is looking a bit too rich. Hold. Questor thinks this company is well worth watching and buying if we get a market correction in the future, but at this price it is looking a bit too rich. Hold.