Markets are pretty efficient. That's why, when investors see a stock yielding a well-above-average 8.2%, you can't blame them for assuming that there's something wrong with the company. Usually, that's an accurate assumption.
But not this time.
Today I offer you StoneMor Partners
StoneMor's business is actually quite simple. The second-largest cemetery owner in the country, the company owns and operates 263 cemeteries and 62 funeral homes in 27 U.S. states and Puerto Rico. The company sells burial plots (either plots of land or cremation niches), merchandise (think burial vaults, caskets, and grave markers), and services (installation of the merchandise).
About 80% of cemeteries are still local mom-and-pop operations, and these small properties are the plankton on which the StoneMor whale is constantly feeding. While StoneMor is in no danger of running out of space on its existing cemeteries -- its average cemetery will take about another 260 years to fill up -- the company grows by tucking additional properties into its fold.
There are four other consolidators that do similar cemetery roll-ups, but StoneMor has a defined edge over them in its pre-need sales program. Most cemeteries simply sell burial plots and merchandise when needed -- at the time of death. StoneMor, on the other hand, makes 60% of its cemetery-related sales in advance of the time of need, called "pre-need" sales in industry parlance. This strategy, which StoneMor has bastioned with an 800-person national sales team, is unique to the company and offers a compelling advantage. Not only are pre-need sales more profitable than at-need sales, but the pre-need program allows StoneMor to acquire and operate even the smallest of cemeteries profitably, thanks to reliance on regional salespeople instead of expensive, dedicated staff at each and every cemetery.
What's so confusing?
This is a straightforward business. It's highly predictable, profitable, and recession-proof. What exactly is so confusing here?
Let me show you some numbers.
At first glance, this looks scary. After all, how can an unprofitable company with shrinking cash flow support such a massive -- and growing! -- distribution?
Easily, it turns out. The most important thing to know about investing in StoneMor is that the numbers in its financial statements don't reflect reality. They're practically meaningless.
StoneMor is subject to a series of bizarre accounting requirements that on paper thoroughly distort the underlying reality of the business. The source of the problem is trust requirements. When StoneMor books a sale, it has to put 15% of the sale price of the burial plot into a trust. If the sale was a pre-need sale (and remember that 60% of StoneMor's sales are pre-need), the company also has to put 75% of the merchandise and service revenue into a trust. These are legal requirements intended to make sure StoneMor is able actually deliver the stuff it sold when the customer eventually dies. Until then, the cash is managed in trusts by third-party investment managers. And none of the cash diverted to the trusts is counted as revenue -- so a bulk of the revenue StoneMor is generating never makes it to the income statement.
But here is the outlandish but critical point: StoneMor can basically pull that money out of the trusts whenever it wants simply by delivering what it sold. In other words, if it sold a casket, all it needs to do is own a casket. If it sold a burial-vault installation, it just needs to install the burial vault (the casket is later placed inside it).
StoneMor is run by four key executives who know this business inside and out. They know the accounting distorts their results, but they remain focused on the underlying strength of the business. That said, as deft capital allocators, they play within the accounting rules to withdraw cash from the trusts when they decide to make a new acquisition or increase the company's distribution.
Financials and valuation
Even though the financials are practically meaningless, the balance sheet is strong and the company's payout -- which is largely what I'm after by buying shares -- is secure. To illustrate just how secure, consider this: If StoneMor were to not book another sale ever again, I calculate that the company still has the financial resources to maintain its current distribution for another 12 quarters.
Of course, I don't expect StoneMor's highly predictable business to suffer. Assuming that future cemetery acquisitions perform similarly to past ones (and after 137 acquisitions, management has this down to a science) and that the company spends $20 million to $25 million a year on them, shares are worth $30 to $38. Although shares are undervalued, I'm buying them more for yield than appreciation.
The Foolish bottom line
StoneMor is a well-run, defensive business unfairly punished by a perplexed market. I'm taking advantage of Mr. Market's blundering to lock in the outsized yield these shares offer.
Note: StoneMor Partners is a master limited partnership. Before investing, you should review the tax implications for your personal situation.