On the surface, StoneMor (STON) appears to be a sleepy cemetery business with little investment merit. But when you look under the hood, there's plenty for investors to get excited about.
For one thing, StoneMor's balance sheet is full of valuable assets hidden in plain sight. For another, the company's majority shareholder doesn't want those assets to remain hidden. Axar Capital Management, which owns roughly 75% of StoneMor's stock, sent a letter to StonMor's board late in 2021 inviting discussions regarding "strategic alternatives." That could mean a sale of the company.
StoneMor appears to be dramatically undervalued. Investors should take note before the rest of the market digs in.
Simple business, complex books
StonMor is a deathcare company that owns, operates, or manages about 300 cemeteries and 70 funeral homes. Sales are derived from funeral services, headstones, caskets, interment rights, and burial plots. The business is simple -- but StoneMor's accounting is complex.
Half of the cemetery services that StoneMor sells are "pre-need" sales. A pre-need sale is a cemetery service paid for in advance -- anywhere from five years to more than 20. This revenue is recognized ratably over an assumed life of pre-need contracts. StoneMor has ramped up pre-need sales over the last few years, so its deferred revenue is now a little over $1 billion, and the increase will not be reflected on the income statement for quite some time. On the other hand, funeral costs are recognized immediately, meaning the income statement understates gross margins and earnings.
Meanwhile, cash collected from pre-need sales shows up immediately in the form of two trust funds that are set aside to fund cemetery expenses when customers pass away. This cash is shown as a negative to operating cash flow, but a positive to the balance sheet.
StoneMor has more than $900 million in these trusts -- far more than its market cap around $303 million -- and this is where investors will ultimately find the company's value. While cash lies in trust, StoneMor compounds the capital similar to the way Berkshire Hathaway compounds its insurance float. So as with Berkshire, the nature of StoneMor's assets means it should be judged by book value.
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There's one more quirk here, too. StoneMor books 100% of pre-need sales as deferred revenue, which subtracts from book value. But since the company's gross margin is 52%, $520 million of that $1 billion in deferred revenue will eventually be gross profit. Only the remaining $480 million is really a liability to StoneMor. If we subtract $480 million in expenses rather than the full of deferred revenue -- and if we add $520 million back to book value -- StoneMor's book value leaps from -$145 million to roughly $375 million, or about $3.18 per share. At its recent share price around $2.50, StoneMor trades at a 20% discount.
Public competitors Carriage Services (CSV 3.88%) and Service Corp. International (SCI 1.10%) trade at a five-year average of around 3 and 5 times book value, respectively. Those companies do not account for deferred revenue the same way StoneMor does. Apple to apples, if StoneMor's stock were to fetch similar book value multiples, the stock would trade between $9.54 and $15.90.
What StoneMor investors need to know
If you're taking note of the complexity and worrying the market might never realize StoneMor's value, you have a good point. Investors may take the company's earnings and cash flow at face value, ignore the book value, and pass on the stock.
Also, the company has suffered through years of poor management that was careless with expenses, engaged in unthoughtful merger and acquisition activity, and lacked execution. On top of that, they cut the dividend October 2016, causing shares to halve.
In July 2018, StoneMor installed CEO Joe Redling. Prior to StoneMor, Redling held several marketing positions at larger companies like Vonage, Nutrisystem, and Time Warner. Seeing the importance of customer experience at StoneMor and the value of the company, Redling quickly took bold steps to right the ship.
During his tenure, he significantly cut unnecessary costs by reducing headcount, cutting corporate overhead in half, and refinancing high-interest debt. Previous management used trust distributions to pay for these unnecessary costs. Redling's moves allow the company to retain more cash in the trusts. Beyond that, pre-need sales have reached record levels under Redling.
Follow the plot
The company is in great shape and in great hands. On top of that, Axar Capital, the company's majority shareholder, has asked the board to seek strategic alternatives. That could mean a sale of the company or a take-private tender offer. If either of those things come to fruition, the stock may jump.
Possible buyers may include Carriage Services, Service Corp., or Axar itself. Another possible buyer could be private equity firms that might also be interested in StoneMor's $477 million in tax loss carryforwards. A buyer can use StoneMor's loss carryforwards to decrease future taxable income.
If a "strategic alternative" doesn't materialize, long-term investors may need patience for the market to realize the stock's value. It will take time for cash flows and trust investment return to compound the company's book value.