With its 1999 bankruptcy well behind it, death-care provider and Motley Fool Hidden Gems pick Alderwoods Group (NASDAQ:AWGI) must now focus on achieving profitable growth in a highly competitive industry that just can't buck demographic trends. (The cure for death seems to elude us.)

Alderwoods announced fourth-quarter and full-year earnings after the market closed on Monday and held its conference call Tuesday morning. With earnings per share from continuing operations of $0.16 and $1.02 for the quarter and the year, the company reversed its 2004 loss of $0.09. Quarterly and full-year revenue rose 3.7% and 4.4%, respectively, while funeral revenue -- the company's largest segment -- grew 3% year over year in the fourth quarter and climbed 1.5% for the year.

Operating income for Q4 and the full year was up 17% and flat on an adjusted basis, respectively, partly because of timing related to some one-time items -- namely, asset impairments associated with the company's restructuring efforts. EPS comparability, meanwhile, was in part affected by the timing and realization of income tax refunds and debt reduction, which served to create differing effective tax rates across comparable periods.

Continued revenue growth will be necessary and critical -- the company has high fixed costs, and any revenue improvements will likely fall like manna from heaven to the bottom line. Let's have a closer look at the numbers.


Q4 2005

Q4 2004

FY 2005

FY 2004

Revenue (millions)





EBIT Margin*





Free Cash Flow (millions)**





EPS (diluted)***










*EBIT: Earnings before interest and taxes.
**The company defines free cash flow as cash flow from continuing operations, less restricted cash from continuing insurance operations, less maintenance capital expenditures.
***From continuing operations.

Under the lid
As Alderwoods emerged from bankruptcy in 2002, its top concern was its debt load. At the end of 2002, the company's debt-to-equity ratio was at 2, and that number now stands at a healthier 0.62, thanks to a $91 million debt reduction in 2005. Now, with an interest coverage ratio (operating income divided by interest expense, an indicator of the company's ability to meet its interest payments) of 2.4 at year's end and an undeniably stable revenue model, debt levels are no longer a threat to the company's viability. Management indicated that it will continue to focus on paying down debt this year, but there may be a dividend or a share repurchase on the horizon in 2007, as the company considers other uses for cash from operations.

Organic growth is often difficult to achieve in this industry, as reflected in the company's metrics (which inch along but never seem to jump). Competitors Service Corp. International (NYSE:SCI) and Stewart Enterprises (NASDAQ:STEIE) are, of course, generally eager to take their piece of the action. However, pre-need contracts (involving funeral and cemetery services purchased before the event) provide one place where Alderwoods and its peers can look for future revenue. In 2005, for example, more than a quarter of Alderwoods' funeral services performed were from pre-need backlogs. The value of pre-need funeral contracts sold in 2005 increased 6.4% to $191 million for a total backlog of $1.3 billion, while pre-need cemetery services increased 8.7% to $94.5 million.

As far as cash earnings go, the company puts free cash flow at $78 million for 2005. This metric doesn't include $47 million in "restricted cash from continuing insurance operations," but I think the omission is a prudent approach, since -- in compliance with insurance industry regulations -- this cash cannot be allocated to any purpose other than insurance operations. On the other hand, the cash is part of the insurance activity's capital, and thus an integral component of the business value. (Read more about the intricacies of calculating free cash flow.)

Adjusting the company's estimate of $78 million -- for what appear to be one-time items -- in a footnote to the FCF table, I obtain $59.5 million in FCF for the year, or $1.47 per share. Based on Tuesday's closing price of $16.45, Alderwoods sports a price-to-FCF ratio of 11.2, and I don't think that's unreasonable for a well-managed, stable business -- even one that is low-growth.

Fool contributor Alex Dumortier has a beneficial interest (long position) in Alderwoods Group and welcomes your feedback. The Motley Fool has a strict disclosure policy.