Funeral provider Dignity (DTY) is being heavily punished by the market as it announces a new strategy which effectively translates into a major profit warning. The shares are down nearly 50% to 967.5p.
The competitive threats which have driven the change in approach are nothing new and have been referenced in several of Dignity’s recent trading updates. We also acknowledged this issue when adding the company to our list of best ideas for 2018.
While we would accept the timing of this announcement is embarrassing for Shares, we also note that this stock has a loyal following and once the shock of the earnings downgrades comes through we would expect the share price to start to recover.
SIGNIFICANT DOWNGRADES
The downgrades are significant nonetheless. Although the company is waiting until its first half results to fully spell out the impact on margins and volumes, investment bank Investec cuts its sales forecast by 12% for 2018 and slashes both pre-tax profit and earnings per share estimates by 52%.
This reflects Dignity’s decision to hold the average price of its traditional full service funeral at £3,800 and to reduce the cost of its simple funeral from an average of £2,700 to £1,995 (£1,695 in Scotland). These new pricing points are in line with those of the Co-Op.
The cut in earnings forecasts will no doubt lead some investors to worry about the company’s ability to service its debt. Investec says there is no reason to be concerned as even under the downgraded earnings forecasts Dignity is creating more than enough cash to service its debt.
Dignity currently believes this will increase the proportion of simple funerals it carries out from 7% in 2017 to 20% to 2018, creating a double whammy effect.
Investec, which stays at ‘buy’ but more than halves its price target to £12.75, comments: ‘We believe the new strategy effectively resets the base revenues and profits for Dignity. Yet we feel that the longer term dynamics of the funeral market are unchanged and believe the new pricing strategy should enable Dignity to maintain market share over the longer term.’
