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Why the InvoCare share price could be facing a painful de-rating

The strong run in the InvoCare Limited (ASX: IVC) share price is under threat as the funeral industry could suffer a similar fate as aged care and large financials after damning revelations were made against the unregulated sector.

The funeral industry has been accused of price gouging, poor treatment of the deceased and unsavoury practices to squeeze extra profit from grieving families on the ABC’s Four Corners program last night.

InvoCare has been implicated in the report and that will put an unwanted spotlight on its share price, which has rallied by around 34% this calendar year compared to 21% gain by the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.

Its smaller rival Propel Funeral Partners Ltd (ASX: PFP) is doing pretty well too. The PFP share price is up by 24% over the same period as the defensive nature of these businesses have found favour with investors during uncertain global economic times.

Regulatory scrutiny

But both stocks could face pressure if state and local governments are pressured to act to impose greater regulations on the industry following the news report.

You only need to think about how the aged care sector is being marked down from the ongoing regulatory scrutiny, while the likes of AMP Limited (ASX: AMP) and IOOF Holdings Limited (ASX: IFL) suffered a big de-rating.

Allegations have been made that at least one of InvoCare’s businesses have unfairly charged a family who’s lost a loved one with the final bill coming in well in excess of the original price expectation. The accusation isn’t unlike what the Banking Royal Commission found the big banks had been doing.

Unsavoury practices unearthed

Our largest funeral group owns several brands such as Value Cremations, Simplicity, White Lady and Le Pine. Value Cremations offers services as low as $1,250, while its high-end brand White Lady charges anything from $7,000 onwards.

However, its White Lady brand may take a hit in its reputation as the ABC revealed that all the bodies and prepared at the same facilities and that men and women work on the body (the White Lady proposition is that only women would handle everything from start to finish).

It doesn’t help that InvoCare’s chief executive Martin Earp provided weak answers when interviewed – citing a restaurant kitchen example that made no sense and left an unsettling image when he linked embalming and kitchen services!

Foolish takeaway

To be fair, some of the most damning accusations were levelled at other operators in the industry but if government bodies are forced to impose new regulations on the sector, profit margins will hurt for everyone.

In the longer-run, InvoCare could perversely benefit if new rules force smaller operators to close, but that won’t be felt for a while (if at all). What is more likely to happen in the near-term is a de-rating of the sector (it trades at a premium to the market) as investors re-evaluate the risks associated with the industry.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. Connect with him on Twitter @brenlau.

The Motley Fool Australia has recommended InvoCare Limited and Propel Funeral Partners Ltd. 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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