TEXT-S&P rates Service Corp International notes 'BB-'
Nov 7 - Overview -- Houston-based funeral and cemetery service provider Service Corp. International (SCI) is issuing $200 million senior unsecured notes due 2020. The company will use proceeds to redeem its $181 million 2014 notes. -- Our 'BB' corporate credit rating remains unchanged. We are assigning the new senior unsecured notes a 'BB-' issue-level rating with a recovery rating of '5'. -- Our stable rating outlook reflects our expectation that SCI will maintain credit metrics that support a "significant" financial risk profile with adjusted debt leverage ranging from 3.5x to 4x. Rating Action As Standard & Poor's previously stated, on Nov. 5, 2012, Standard & Poor's Ratings Services said its 'BB' corporate credit rating on Service Corp. International remains unchanged. The outlook is stable. At the same time, we assigned SCI's proposed $200 million senior unsecured notes our 'BB-' (one notch below the 'BB' corporate credit rating) issue-level rating with a recovery rating of '5', indicating our expectation for modest (10% to 30%) recovery for noteholders in the event of a payment default. Rationale Our ratings on SCI incorporate the company's "fair" business risk profile, characterized by a narrow focus in the mature, competitive death-care industry, as well as the company's "significant" financial risk profile that reflects our expectation for leverage of about 3.7x in 2012 and 2013. We expect low-single-digit revenue growth and EBITDA margins above 23% in 2012 and 2013. SCI is the largest provider of death-care products and services in North America. Our 2012 and 2013 base-case assumptions incorporate limited volume-driven opportunities within the company's at-need funeral business, primarily due to enhancing product offerings in cremation. SCI's cremation rate is over 40% of total funeral revenues; we expect it to increase 1% annually. Cremation provides substantially lower revenue per contract, but produces higher margins. We expect flat revenues in its traditional funeral business because of ongoing death-rate trends. We expect revenue growth primarily will come from market-share gains through acquisitions and from accelerated delivery of cemetery merchandise from the growing preneed cemetery backlog. For the same reasons, we expect higher EBITDA margins of 23% to be maintained. We expect SCI's preneed backlog of about $7 billion to continue benefiting from its sales force investment. We also expect SCI to continue generating well over $200 million of free operating cash flow in both 2012 and 2013. We expect SCI will continue using free cash flow to fund both acquisitions and share repurchases. We do not expect debt repayment to be a priority during this period. SCI's "significant" financial risk profile reflects our expectation for moderate EBITDA expansion, primarily stemming from acquisitive growth. Absent any debt repayment or additional debt needs, we believe debt outstanding will remain level. In our view, this would result in leverage between 3.5x and 4x and funds from operations to debt between 15% and 20% in 2012 and 2013. SCI's "fair" business risk profile reflects the company's leading position in a fragmented competitive field, demonstrated by its large size (over 1,400 funeral homes and 380 cemeteries throughout North America), which affords it scale efficiencies. With more than $2 billion in annual sales (68% from funeral services and merchandise and the rest related to cemetery properties), SCI is by far the nation's largest cemetery and funeral home operator. However, it currently captures only about 13% of the funeral and cemetery market and faces a few smaller national and many smaller regional competitors. The second largest competitor, Stewart Enterprises Inc., is less than one-quarter of SCI's size. While SCI's business risk profile reflects its leading position, it also reflects the inherent risks of operating in the mature death-care industry, which holds limited growth prospects. Currently, death rates have declined, attributable to a mild winter and better preventive care. Lack of organic growth increases pressure to pursue acquisitions. Additionally, there is an industry shift in consumer preference for lower-cost cremation services compared with traditional burials, pressuring revenue expansion. However, over the longer term, the industry benefits from an aging baby boomer population, which should eventually support higher death rates. Liquidity We view SCI's liquidity as adequate, with sources of cash exceeding mandatory uses over the next year. Our assessment of SCI's liquidity profile incorporates the following expectations and assumptions: -- We expect sources of liquidity over the next 12 months to exceed uses by at least 3x. -- Sources of liquidity are supported by our expectation of about $350 million of operating cash flow, $152 million of cash on hand, and $390 million available under its $500 million revolver as of Sept. 30, 2012. -- Uses include about $115 million of capital expenditures and annual dividend of about $45 million. -- We expect liquidity sources to exceed uses even if EBITDA declines by 15%, but there may be limited ability to absorb a high-impact, low-probability event. -- We expect the absence of covenant step-downs to keep SCI's cushion on its debt covenants adequate at above 20%. -- SCI's sizable investments in trust funds derived from customer receipts for preneed funeral and cemetery services and merchandise remain subject to market volatility and can affect overall liquidity. -- SCI's ability to accelerate delivery of some preneed services/merchandise to release cash from its trusts is included in our assessment of liquidity. -- There are no significant debt maturities until 2015. Recovery analysis The issue-level rating on SCI's proposed $200 million senior unsecured notes is 'BB-' (one notch below the 'BB' corporate credit rating). The recovery rating is '5', indicating our expectation for modest (10% to 30%) recovery for noteholders in the event of a payment default. Outlook Our stable rating outlook reflects our expectation that SCI will maintain credit metrics that support a significant financial risk profile as it pursues acquisitions to offset slow organic growth. We also view the company's narrow business focus in a fragmented market as a fundamental business characteristic precluding any upside revision of our "fair" business risk profile, limiting prospects for a rating upgrade in the near term. Moreover, we do not expect a meaningful reduction in financial leverage due to our expectation that the company will use free cash flow to fund strategic acquisitions and share repurchases instead of debt repayment. Given the nature of the business, we do not expect a sharp decline in profitability. However, a rating downgrade is possible if SCI pursues a sizable debt-financed acquisition that causes adjusted leverage to increase above 5x, indicative of a "highly leveraged" financial risk profile. A squeeze in bank-calculated EBITDA by more than 10%, resulting in tight covenant cushions below 10%, could also lead to a rating downgrade. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 Ratings List Service Corp. International Corporate Credit Rating BB/Stable/-- New Rating Assigned Service Corp. International $200 Mil. Senior Unsec. Notes Due 2020 BB- Recovery Rating 5 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.