It's no secret that Australia, like many economically developed nations, has an ageing population. In 2016, 15% of Australians were aged 65 and over. By 2056, that percentage is projected to increase to 22% of the population, or 8.7 million people.
And although it might be a bit uncomfortable to think about, a population consisting of more elderly people should naturally result in a higher number of deaths. It's exactly this sort of shifting demographic that has underpinned the strong share price performance of leading Australian funeral company InvoCare Limited (ASX: IVC).
It is the dominant force in this sector, operating a number of well-known brands in Australia, New Zealand and Singapore, including White Lady Funerals.
However, after reaching an all-time high of $18.15 in late November, the share price of Invocare has basically fallen off a cliff. It's now down over 20% over the last three or so months to $14.21. This is despite the company reporting a 37.3% increase in annual profit for the year ended 31 December 2017.
So what happened to this market darling?
Investors seem to have responded negatively to InvoCare's outlook for FY18. Despite operating earnings after tax increasing 10.6% to $63.5 million for FY17, InvoCare has forecast flat operating earnings per share for FY18.
This stems from the fact that the company is currently embarking on its four year 'Protect & Grow 2020' program, which it estimates will cost a total of $200 million. A major part of the program is the refurbishment of the company's facilities. 22 sites were refreshed in 2017, and another 25 were in process as at the December reporting date.
The capital expenditure on facilities will be felt on InvoCare's income statement in the form of increased depreciation expense, which will depress operating earnings. Additionally, this massive refurbishment program will require some site closures, hurting InvoCare's overall revenues and possibly even its market share in the short term.
Management at InvoCare clearly believe that after a sustained period of success it is now time to consolidate the business and set it up for even longer term growth. But there is the obvious risk that it won't work – and that a short term drop in market share could allow competitors to permanently steal its business.
So who else is there?
Propel Funeral Partners (ASX: PFP), which listed on the ASX in November 2017, is just about the only credible threat to InvoCare's market dominance. Propel provides death care services across most of Australia and New Zealand. And there just may be some slight indications that shareholders fleeing from InvoCare might be jumping ship to Propel.
Since InvoCare released its results to the market on February 19, the Propel share price has risen around 2% to $3.21. It also helps that Propel released some strong financial results of its own on February 26. Revenues for the half year ended 31 December 2017 were $38.9 million, up 84% on 1H17. Net profit after tax was up 112% to $6.2 million.
Propel also issued an earnings guidance upgrade for FY18, increasing its EBITDA forecast by $2.7 million, or 15%, to $21.1 million. Although to keep some perspective it's worth noting that this figure still lags well behind InvoCare's FY17 operating EBITDA of $124.3 million.
Propel also recently claimed a small victory over InvoCare in the battle to acquire Norwood Park Limited, Canberra's only crematorium. InvoCare was forced to withdraw its takeover bid for Norwood, meaning that Propel subsidiary FV (ACT) Pty Ltd was left as the winning bidder. It plans to fully acquire Norwood Park during the fourth quarter of Propel's FY18.
Foolish takeaway
It's tough to bet against InvoCare. It currently has a market share of 39.5% in Australia and 19.1% in New Zealand, compared to Propel's 4.1% in Australia and 6.7% in New Zealand. This market dominance is what gives InvoCare's management the confidence required to carry out its massive refurbishment program.
However, the disruptive impact that this ongoing program will have on InvoCare's business still gives Propel an opportunity to claw back some of that market share. Alternatively, this dip in InvoCare's share price could also provide a great buying opportunity if you believe in the long-term potential of the 'Protect & Grow' project beyond 2020.
