Why traders are betting on InvoCare Limited shares falling further

The market has become increasingly bearish on funeral company InvoCare Limited (ASX: IVC) over the last several months.

After hitting an all-time high of $18.15 on November 29, the company’s share price has fallen 29% to $12.82 as investors weigh the prospect of intensified competition and an underwhelming earnings outlook for 2018. The steep share price fall has also been accompanied by a significant rise in the amount of traders shorting the stock, with short interest rising from 2.80% to 7.76% as at April 18.

UK foreshadowing?

The InvoCare equivalent in the United Kingdom, Dignity plc, has seen its share price fall 60% since November due to fierce competition from smaller competitors and increased transparency of pricing that has seen customers shop around online for the best deal.

As a consequence, the company has lost market share and has been forced to slash its prices for a basic funeral by 25% in order to maintain its dominant market position.

Dignity’s price cut announcement has resulted in traders pondering whether potential disruptors could enjoy similar success in Australia in upsetting the dominant industry leader. The Australian funeral industry currently lags the UK market in terms of online-only funeral operators. However, increased competition is possible given the relatively high profit margins Australian operators enjoy.

Foolish takeaway

InvoCare issued a disappointing 2018 earnings outlook when it reported in February. The company expects operating 2018 EBITDA to grow in the low-single-digit range and operating earnings per share to be flat as it closes sites for refurbishment as part of its Protect and Grow program which will lower market share and sales revenue growth.

The guidance offered by management was below the market’s expectations and has added to the selling pressure on the stock as its premium valuation multiple contracts.

At current prices, InvoCare trades at around 22 times trailing operating earnings, which appears reasonable when factoring in the defensive nature of the business and its modest outlook for 2018.

Newly-listed Propel Funeral Partners (ASX: PFP) remains InvoCare’s closest rival at this stage. The company has been active on the acquisition trail over the last several months and is a stock investors seeking exposure to the funeral industry should keep an eye on.

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Motley Fool contributor Tim Katavic has no financial interest in any company mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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