Death care business:
Melvin Payne outtakes
Sept. 17, 2004
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Wall $treet Week with FORTUNE contributor Michael Farr recently talked to Melvin Payne, CEO and chairman of Carriage Services Inc., a publicly-traded operator of funeral homes. A brief excerpt of their conversation will appear on our Sept. 17, 2004 program. Meanwhile, here are parts that won't appear on the air:
MICHAEL FARR: In the United States this year, about 2.4 million Americans will die. That happens just about every year, and that number is going up at a very slow rate of around 2 percent. There's growth in this industry of death care. It's become a big business. There are a lot of companies that are buying up and have bought up over recent years lots of Mom and Pop individually owned funeral homes. Funeral home business and cemetery business is becoming big business in this country. Today we're at the Hubbard Funeral Home in Baltimore, Maryland, which is owned by Carriage Services, Inc., a publicly traded company, and its chairman and CEO Melvin Payne. Melvin, thank you so much for joining us on Wall $treet Week with FORTUNE.
MELVIN PAYNE: It's a pleasure.
FARR: Tell us about your business and your industry. Is this a good business?
PAYNE: The death care business is all about caring for the dead, but caring for the dead is much more than that. It's about celebrating a life and creating a ritual that will kick off the grieving process for the living. And we view it as a calling and we view it as an honor to be involved in it.
FARR: The business part of it, the market capitalization of your company is around $90 million right now?
PAYNE: Yes.
FARR: A share is about $4.71.
PAYNE: Yes.
FARR: There's been a great deal of volatility in your share prices in recent years. What's the top and bottom price?
PAYNE: The reason the volatility has been there is that the death care industry in the '90s was viewed as a growth industry. The consolidation part through acquisitions created multiples that were more growth oriented multiples.
FARR: People were buying up a lot of Mom and Dad, Mom and Pop sort of funeral homes, and they were growing their revenue base and earnings base or thought they were?
PAYNE: Yes. They were growing by acquisition, not internally. And a lot of mistakes were made. The money was flowing into the industry and the industry was spending it and then going back for more. That didn't work, because the consolidation happened too fast.
FARR: What's wrong with consolidation happening too fast?
PAYNE: When consolidation happens too fast and there are too many bidders and people are selling for the money, it doesn't work because this is an entrepreneurial, local service business. And the integration of a family Mom & Pop business, as you put it, is so important to maintaining the health of that business so that it still serves the families and the community and not just the management, and the shareholders. You have to strike a balance.
FARR: For investors, the price per share of your company got up in the high 20s, through the bear market it got into the low single digits. It's now as we said around $4.00 or $5.00 a share. Tell me are you where you want to be now from an earnings point of view, from a corporate management point of view? And what can investors expect from Carriage Services?
PAYNE: Well, I'm a little bit unique. We had seven analysts in the heyday, seven or eight. I can't remember the number.
FARR: Wall Street analysts.
PAYNE: Wall Street analysts, not buy side analysts, sell side analysts. And today we have one or two. I don't pay a whole lot of attention, and your viewers might be shocked about this, on the stock price, even though I'm the largest single shareholder. Where I spend my time is on the business. I used to spend a lot of time on the stock price, but the business wasn't being served well when I was spending my time on the stock price. My theory is if you work on the parts of the business that matter -- and it is a long-term business. This is not a quarter to quarter business - that the business will be healthy, the business will grow, and the stock price will follow.
FARR: Most companies, your included, took on a lot of debt during this acquisition roll up sort of a phase. You still have a lot of debt. How do you get rid of it?
PAYNE: That's a good question. We've been getting rid of it the last four years by selling off underperforming properties and generating free cash flow from our retained properties, and we've actually paid down debt and potential liabilities about $100 million in the last four years. So if you went back four years, it looked like the company would be going bankrupt. Our stock actually hit $1. We'll never forget it. But now at $4.70 or whatever it is, you know we're back off the bottom, and I think nobody thinks anybody's going bankrupt. And our plan is to continue paying down the debt. And we're doing that quite rapidly.
FARR: It looks, though, that your debt has been fairly static on your balance sheet over the past couple of years. Is it really coming down?
PAYNE: Oh, yes. No, it's not static at all. We were close to $215 million senior debt and contingent liabilities, what I call contingent liabilities, $215 million at the end of 2000 or thereabouts, maybe mid-2000. And our plan by the end of this year is to be down to about $115. So that's $100 million in four years. That's dropping rapidly. We're the only company that's put out a five-year forecast. That forecast continues to show a rapid reduction in debt.
FARR: It does. I mean in fact you have around 12 percent earnings per share growth forecast in that release, in that projection. You really have to, if you're growing you also have projected revenue increases of around 2.3 percent per year. So 2.3 percent in revenue increases, you really do have to reduce that debt don't you in order to achieve that earnings growth?
PAYNE: That's correct. Not a major part of that earnings growth, but a meaningful part of that earnings growth is reduced interest because the debt's going down. The rest of it is just because operations are improving. Over time the margins are getting better, despite the rather modest revenue growth.
FARR: Operating income last year was $28 million, debt service was around $17 million. That debt service was down from around $20 million the year before. Is that right?
PAYNE: I'd have to go back and check the numbers, Michael, but I woudn't dispute those numbers if you've looked at them.
FARR: We're going to see that trend continue then of that debt service reduction?
PAYNE: Yes.
FARR: Okay.
PAYNE: The first half of this year was really a good year. We have reduced debt significantly in the first half of the year. I think it's close to $15 million.
FARR: Is that right?
PAYNE: Yeah.
FARR: That's pretty good. That's very good.
PAYNE: For a company of this size, that's pretty good.
FARR: You're considered a micro-cap company. You're a very small company at $90 million. I'm sure as the largest shareholder it doesn't look small to you. 11 times trailing earnings, 9 times forward earnings, with 12 percent earnings per share growth. It sounds like these shares are cheap.
PAYNE: I think they're cheap, but being a, you said micro-cap, I've heard others call it nano-cap, it's off the radar of most investors, and the liquidity is an issue. Fairly good sized investors have trouble getting in and taking a large position that's meaningful and then getting out. Over time we want to work on that. That is an issue to attract new investment. But I think the earnings are much lower than the other competitors. It must have to do with our size. And I have to believe that if we differentiate ourselves over time in terms of operating performance, we should catch up. So my own view is absolutely, we're undervalued.
The last five years are a classic cycle where people have been selling underperforming properties, paying off debt, and I think, I view cycles as long cycles, and this one is probably halfway through the cycle. The financial crises are over. And now we're looking at operations, how do people grow these businesses, not through acquisitions, that will also happen, but internally? And I think that's the challenge the industry has. If we can't, I think the market will view it in a negative light, and that's where we're trying to have a model that is different from the rest of the industry that will allow us to grow market share, and that's the key.
FARR: Market share in the funeral home industry I think sounds a little bit strange to people that listen to thinking about growing market share. How do you attract more people into using your funeral parlor?
FARR: That's a great question, Michael. It's been one we didn't have a good answer to until fairly recently. The funeral business is a entrepreneurial business, and when you think about it, you have these big consolidators that have a budget and control model to buy all these places and budget performance. That hasn't worked, and so our company, being small and nimble, we may be a nano-cap or a micro-cap, but we think we're pretty good thinkers and we think we're pretty good entrepreneurs. We started as an entrepreneurial enterprise, and what we're trying to do now is push that entrepreneurial spirit back down into the local operation, get rid of the obstacles of bureaucracy, get rid of the over management, and focus on more leadership and quality of people and empowering the local management and leader to grow the business.
You have to treat the customers that are heritage customers in a special way to grow the business.
FARR: What do you mean when you say "heritage customer?"
PAYNE: A lot of funeral homes have heritage. Mom was buried, Dad was buried. It's just where the family goes. And it's an interesting thing. It's almost like you have to mess up to break that heritage. But you can't take it as a given. You have to treat it with love and tender care. And if you don't do something different with that existing heritage, you won't really grow beyond that heritage. You have a risk of losing it to someone else who will be different, innovative and special. That's still not enough. You have to, like in any other business, have a competitive, winning spirit at the local level. That means going to, going and finding a way to take business away from the competitor. You've got to do it. It's not any different than any other business. The difference is you don't do it with price.
FARR: You talk a lot about the experience as being important, the most important thing that happens at a Carriage Services facility is going to be the experience for people going through the funeral process. Most people don't like this process at all. They hate coming into rooms like this. They feel like they're walking into the car showroom, and at a time at which they're vulnerable in their lives, somebody's going to sell them something high priced and take advantage of them emotionally. Are they right?
PAYNE: No, they're not right.
FARR: It doesn't happen? That happens in some places.
PAYNE: Well, of course it happens. It happens in any industry. You have bad operators, and those bad operators get the coverage from the media. But if you asked in local communities around the country who they trust and you put a list up there, multiple choice, a politician, a lawyer, a doctor, a reporter, a funeral director, who do you think would come out number one? It's going to be the funeral director.
FARR: Is that right?
PAYNE: Yes. And so that's a myth that I read about in the media, and frankly it makes me angry, because we're out there trying to do good things every day with the families, and they love it. I get cards all the time about how we're making a difference in their life by how we treat their dead. The car analogy is interesting, and I've thought about this a lot. I make a lot of speeches on death care. You're born once and you die once. In between you buy a lot of cars. This has nothing to do with the car business, with bells and whistles. However, it has to do with a life. Everyone is unique, and there's a certain segment of the population that probably care about price. I can tell you that's a very small minority.
FARR: A small minority care about price.
PAYNE: They care about price when they don't know any better and they're not presented with something of value. Then price becomes important. But if you take the offensive with a family who comes in, and most families think there are rules to this business because they don't come in here very often. There are no rules. The only rule is there are no rules. And so what you want to do is try to create something that is so special to them, and it could be celebration, it could be personalization, it could be best known features about that person, whether they're a golfer or a fisherman or it doesn't matter what it is. It could be something small, but very meaningful to the family. If it's a cookie cutter generic funeral, it doesn't work, and it doesn't kick off the grief recovery process, and that's the business we're in.
I've arranged four funerals personally, my mother, my father, my brother's oldest son, and my mother-in-law. I only got one right, and I was in the business when my father died. You know what? I still have regret and some anger that I didn't do some things that were so meaningful to me related to baseball and some other things. I regret that. I'm living with that knowledge. And when you deliver something like that to families who don't know they can do that, they value it highly.
FARR: How does the funeral director fill both roles as someone who is ministering and someone who is also selling?
PAYNE: If you ask a funeral director do they sell anything, you're going to find out they hate the word sell. We try to teach and train on presenting options. People like options, just like you like an option when you buy a car. As it relates to the casket, that is merchandise, and you do have options of price and quality, colors, you know, other things that you can put on there. We try to present all the options and let a family choose.
We have a lot of funeral directors that will take a family into a selection room, show them around and then just leave. They're not selling anything. They're explaining the options and letting the family choose. That's different than the service side. That's a lot harder work where we have to let them know and really try to get them interactively involved in the service itself so that it has meaning. That's the hard part, because you get into the emotions, but it's also the rewarding part. The merchandise side is different, so you have to bring the two together, and it's one total experience. But you can't, you can't choose for a family. They have to choose.
FARR: You're making the point I think that there's a right way and a wrong way to do this or any other business, that Carriage Services is really focused on the right way. And you bring to mind that expression by doing good he did very well indeed. Can we ask a little bit about your background?
PAYNE: Yes.
FARR: You grew up where?
PAYNE: I grew up in Newton, Mississippi.
FARR: Where is Newton, Mississippi?
PAYNE: You wouldn't know unless you needed to stop for a bathroom break or to fill up your car. It's between Meridian, Mississippi and Jackson, Mississippi on I20, east central part of the state.
FARR: Where did you go to grade school?
PAYNE: At a high school in Newton.
FARR: In Newton, a public school.
PAYNE: A public school. Played every sport, because we didn't have enough people not to play every sport. And the band.
FARR: And the band. You did both. You'd have to take a break at the halftime show and take off the uniform and go play the drum.
PAYNE: Well, I took off band in football season.
FARR: You were in Vietnam?
PAYNE: Yes. I was an engineer. I was good at math, and they said, back then we were trying to go to the moon, John Kennedy, and so I went to school and became a chemical engineer, and then I went to Vietnam. I had joined ROTC in school because I needed $40 a month to pay for my education.
FARR: You paid for your own education.
PAYNE: Yes, paid for my education. In ROTC that $40 a month meant a lot to me. And I had to go into the service for two years of active duty, and I went to Vietnam. That was a great experience for me. It changed my life. I learned a lot about leadership, learned a lot about risk, and I came home and decided I would do something different with my life, more entrepreneurial and more people oriented.
FARR: When did you settle in on Carriage Services? You had other careers before that.
PAYNE: Yes. I got an MBA…
FARR: From where?
PAYNE: From Tulane, and went into financial business as a lending officer for the Prudential for five years, and that's where I first saw what people could do with companies that were entrepreneurs and could build them. Wal-Mart was a customer. It was a small company back then. Others, Eckert Drugs, I mean back when their founders were involved, and it really struck me why some companies became successful, some failed, and some must were mediocre.
And so that's when the seed started growing of wanting to start my own company. Later on, and I tried for five years before starting Carriage, but the stars never lined up. And then in 1990, they lined up, sort of. I couldn't get a bank loan because the banks were all acting like they were broke, and the only place I could get a loan was in funeral service, so I started a funeral home company. I told my wife, I quit my job, and she said I was crazy and that could we not tell our friends.
FARR: That you were in the funeral service business.
PAYNE: Because it sounded depressing.
FARR: Right. We talk a lot about the importance of management when we talk about investments, and I think it's important to see that you are from rural Mississippi and that you are self made. What's the most important part of your background that affects the way you run this company and the vision that you have for it?
PAYNE: My mother, we didn't have much, but she told me can't never did nothing. That has never left me to this day. Through thick and thin, and we've had a lot of ups and downs, I'm an optimist, and I always see the glass as half full and looking for ways to fill it up. I can't tolerate people who see it as half empty and are waiting for it to drain out. I live my life that way, I try to surround myself with people that way, and this is a fun industry. It has great people. The surface, you know from the outside might look a little bit depressing. It's not. It's a wonderful business and a lot of laughter with families and so on.
And so I enjoy what I do, I'm passionate about it, and it's not just me. I mean it's anything but me, but we have a great team in this little company. We just don't get much notice. That's okay. We can live with that.
FARR: Baby boomers are getting older. The demographics are good for your industry or not?
PAYNE: Demographics long term are good. The demographics short term are uncertain. People are living longer, and the death rate has bounced around really surprisingly over the last two or three years compared to long term trends. I don't expect that's going to change the long term health of the business, but it makes short term predictions a little bit less certain.
FARR: Tell us about those predictions. Are they seasonal? Do they run in cycles as you would see in other businesses?
PAYNE: Generally in terms of demographics it used to be the rule of thumb was about 1 percent of the local population would die each year. That's been changed to be closer to 0.758 percent over the last five years. So you can generally count on that even as people are living longer.
If you look at the more recent demographic analysis, I think it shows that for the next five, 10 years, more like 10 years, you're probably going to have a fairly flat number of deaths, maybe ticking up a little bit, and then quite an acceleration after that. So I think that's really in my view not an issue in terms of an investment consideration. The deaths will be there, the country's growing, the population's increasing, and people are getting older, and there are more older people. I like that, because I'm becoming one of them. I don't want to get into the quality of life issue, but I don't see that as an issue really long term.
FARR: How many different facilities do you all have at Carriage Services?
PAYNE: We have 140 funeral homes operating as 100 businesses because we have some with multiple locations in 29 states. We have 30 cemeteries scattered across the country, concentrated mostly in Florida and California. California is where we have a huge amount of concentration in our funeral homes and cemeteries between San Francisco, east San Francisco Bay and San Jose.
FARR: In terms of the services you offer, it seems to me that, it seems that there's a trend towards more cremations. Is there a trend toward more cremations and how does that affect your business?
PAYNE: There is definitely a trend toward more cremations, and that's often misinterpreted. The reason people pick cremation is not generally price. It's because of the disposition method. They simply don't want to be buried in the ground. The challenge for our industry is the trend continues and it will, is to treat a cremation family like a traditional funeral family, except for the disposition method. In other words, there are no rules that say you can't have memorializations, you can do anything you would do in a traditional funeral except bury the person in the ground. And I think our training is addressing this, and I do look at this as an opportunity to address that trend.
FARR: There's a new HBO series, I guess it's not that new, Six Feet Under. We get to see a family-run funeral home. How accurate is it? Are we seeing the right sort of thing? And is that the way they really work?
PAYNE: I watched the first two episodes a few year ago, and the reason I did is, the funeral industry gets a lot of bad press. People come into it with an angle. I thought this would be one of those negative type things. But honestly after the first two, I said you know this is a good program. Not only is the acting good and the plot good, but it does demystify our industry. It takes you into the embalming room. It takes you into really a lot of emotional situations with families. I think it's a great series. I haven't watched it in the last few years because I deal with this every day. We could write a few plots for them, screen, some screen plots, but I think it's doing a good job of demystifying our industry.
FARR: Where does the data come from in your industry? How is it collected, and then how do you make your forecasts?
PAYNE: The data in our industry comes from different sources. There are Census Bureau data on deaths, and that's pretty much a (nationwide) thing in the U.S. It's hard for us to use that data because our locations are concentrations in parts of the country, and what we find, it's really strange, I mean you would think it was strange. Death rates can be low in one area and even in one region, and just the opposite in another, so it's really much more local in area and regional than you would imagine.
So what we do in terms of our own company is we look at the national data and compare what our experience is, but we don't get too excited about it. We look at every location, and we have five or 10 years of history, by month, and we have five years of history by competitor, and so we're able to see with our own data - we have great data, great systems - exactly how we're doing. And then we don't try to predict the whole company, we do it one individual market at a time, and then we simply roll it out.
FARR: What do you measure? Give us three or four important data points that you really look at when you scan the sheet.
PAYNE: Well, you first want to know how many funerals you're going to have, how many families will you serve, and the best way to look at that is look at the history and look at the trends. And so you go back, if you're in an area that's declining in population, the demographic trends are against you, it will show up in the long term data. In another one you may be growing. In California we're growing in a lot of markets, and in some other markets.
So you really have to look at it, and we have the data, you have to look at the number of families you expect to serve and which month you expect to serve them. That's where you start. Then you look at the averages of that particular location, and the average revenue per funeral is really a function of how many traditional funerals you have and how many cremation funerals you have. But then you look at the types within each category. It's you have to break it down, and our systems allow us to do that. We have great systems. And so you look at the number of funerals and then the average revenue per funeral, but you're not guessing. You're looking at the detail. And then you roll it all up. That's your revenues. Then you have to forecast your cost, and we're getting better at that.
FARR: So for a funeral home like this one in Baltimore, you have projections about how many people you expect to die and be served by this home over the next 12 months, how many families you're going to serve, and basically when those people are going to die. You know basically when you're going to see more of those deaths in certain months than others.
PAYNE: We can guess at that. It's an educated guess based on the seasonality trends and the total trends of families served over the last five years.
FARR: Does that help you when you're hiring? I mean do you say we're getting ready for our busy season and we need to add help?
PAYNE: The way the funeral industry and especially our company tries to address the seasonality is you want to hire full time people for the low part of the cycle or the season, and complement your good full time people with part time people. And this is an industry where part time people play a huge role. They're typically older. It's a social thing. They like to serve families that they know, and it gives them meaning, it gives them something to do, and the families really appreciate it. So that's a different side of this industry, but it's a huge side. That's the way you overcome the seasonality in terms of labor.
FARR: What will cause anomalies to your data and to your forecasts?
PAYNE: What can cause an anomaly is a strong flu season is the most likely, a surprise for the country, something that shows up and we didn't have the right kind of protection, vaccination, whatever. You can't plan for that if you're me or our people. So what we do is just look at the history and what is normal. If something comes along that's abnormal, you just deal with it. You can't really predict it, so you can't build that into any kind of plan.
FARR: Does the death rate of this war right now in Iraq affect your business? Has that caused an increase across your industry?
PAYNE: Not at all. You have more people dying from accidents than you have being killed in the war. It's just that our soldiers and the tragedy of one life lost gets all the media attention. There are people getting murdered and dying in accidents that, not only but we've had 1,000 soldiers lost in 18 months, and we have 2.4 million deaths a year, so you can't really plan for that. You deal with each one uniquely and make the most of serving that family.
You can't plan on anomalies like crime rates and things like that, but I will tell you that we have served families that have been victims of crime or criminals. It's our business, so we don't discriminate. And the interesting thing is some of them have big funerals, and you have to be careful to make sure those funerals go right.
FARR: High profile.
PAYNE: High profile.
FARR: The long-term data are showing that you're going to see about 8/10ths of 1 percent of the population die per year over the next 10 years and then it increases from there. Increases to what sort of a number after 10 years?
PAYNE: After 10 years, it increases fairly dramatically, and that's, between now and then I think the consensus is that the cremation rate will go up by the amount the deaths go up. So the number of traditional funerals will be flat to maybe slightly declining, and the real opportunity, the growth is coming from cremation. So that's where we're spending our time in both areas, but I think there's a great opportunity there.
We're not really looking out past 10 years at this point. We look out, you know, we can't do anything about that, but the operating leverage, and from an investment point of view, the operating leverage in this industry is terrific. So if the number of deaths increase after 10 years or sometime before that, I would imagine that the companies that have a good position in the country will do well.
It's very difficult to plan for secular trends in general in the population, whether it be obesity or heart failure or cancer. The only thing you can do is just look at the history. We're not that expert at looking at things like that and planning for it market by market in a local situation. So we respond to that over time of course, because it will show up in the data. But we spend our time really working on how to deal with each family in a special way. We think that's the best way to spend our time and our training dollars, and we view ourselves as a people development company that happens to be in the funeral and cemetery business. And so that's where we spend our time.
FARR: Cremation's more profitable than traditional funerals?
PAYNE: Cremations have a higher margin because there's not as much cost, it's not as labor intensive, but the total dollars are less. So we, we're dealing with less revenues, higher margin, and a trend towards more of them.
The consolidators who are national companies, such as us, have a real challenge. This has been a Mom & Pop industry, as you pointed out. The real challenge is to have our local management feel like it's their business, and the community sees it as their operation.
The technical ownership is less important if the people feel psychological ownership in it and they're running it according to their local customs and being involved in their local community. That's why we have gone to a decentralized operating model that really looks at the local manager as a partner, not an employee, but as a partner. And if we can have that local manager be a partner, be more of an entrepreneur and a leader, be involved in that community and have the employees motivated, it won't matter that the technical ownership is by a public company. The community will see it different. It's locally operated, and they don't see the suits from some corporation.
FARR: It's important that it feels the same to them.
PAYNE: It has to feel the same to them. They have to feel that the employees and the leadership of that operation care about them, it's not just for money. If they think that, it's a losing deal.
FARR: And from the top at Carriage Services, you're saying it's not just for money.
PAYNE: It's not just for money. If it were just for money, we couldn't be successful and there would be no trust. And every day I tell our people we don't exist if it weren't for the good work you do, and our job is to help you be successful, not to milk you for the money.
A funeral home business is a heritage business. The businesses we buy have names of people who have been owners and in those communities for 20, 50, 100, 150 years some of the places. And so the families keep coming back. These businesses have been built over generations, so they're going to come back to the heritage. On top of that, you do need to market, and the best way to market is not in the paper, it's not in the yellow pages. It's a personal relationship business, so you have to get involved. You have to give back. So we want our people and our leadership at the location to be leaders in their community. If they join an organization, don't just sit there at the table and eat a meal. Get up and make a speech. Do a good community project. This is all about relationships. It's not about price and marketing. It's all about relationships.
FARR: Do you have marketing people?
PAYNE: We don't have any marketing people in our corporate side. The location makes their own decisions about how they market their own in their business. It's theirs. If they want to put an ad in the paper, they put an ad in the paper and they say what they want to say. We don't tell them what to do, except we sure want to support them in growing it.
FARR: Melvin Payne, thank you so much for your time with Wall $treet Week with FORTUNE. We appreciate it a great deal.
PAYNE: I've enjoyed it, Michael. It's a pleasure.
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