Since peaking at $32.01 in July 2015, the MLP units of StoneMor Partners LP (STON) have lost nearly 90% of their value. The steepest part of the decline began in October 2016, just before STON cut its quarterly distribution in half and its CFO Sean McGrath resigned. In early 2017, the company delayed the filing of its financial statements with the SEC because of errors that it discovered in the reporting of cemetery revenues and deferred revenues. Subsequent quarterly filings were also delayed, and the company has not yet completely caught up on its filing requirements.
StoneMor caught up briefly in January 2018 after filing its 17Q3 quarter report, but had spent so much time catching up that it fell behind in the preparation of the 2017 10-K and was forced to delay that filing. That 10-K was filed with the SEC on July 17, but the partnership is now late in filing its 18Q1 10-Q. Although the partnership has received a delisting notice from the NYSE, that notice will likely be withdrawn when it ultimately files the 18Q1 report. The long delays have also resulted in the recognition of significant material weaknesses in STON’s internal controls by its auditors, Deloitte & Touche.
Since these accounting problems began, STON has changed CEOs twice (not including the reappointment of Chairman Leo Pound as CEO when Paul Grady resigned after less than nine months on the job). On June 29, the partnership announced the appointment of Joe Redling, formerly COO of Vonage Holdings, as CEO. It previously hired deathcare industry veteran Jim Ford as COO in March 2018. Mark Miller, who was hired as CFO in May 2017, continues in that position.
Besides the management changes, STON has had to obtain wavers repeatedly over the past year from its bank group, led by Capital One, because of failing to provide financial statements on a timely basis and most recently for violating a leverage covenant (debt-to-EBITDA). Based upon a very quick read of the loan documents, it appears to me that the term definitions (e.g. EBITDA) are sufficiently liberal to give StoneMor the ability to avoid serious covenant violations, as long as its financial performance does not continue to deteriorate; but the banks will almost certainly want to see some improvement in the partnership’s financial performance once StoneMor catches up on its financial reporting obligations.
Bond investors also do not seem to be worried much about the company’s recent financial performance and bank agreement violations and wavers. STON’s Caa2/CCC+ 7.875% Notes due 6/1/21 traded most recently at par which equates to a spread of 519 basis points over the comparable maturity Treasury note. By comparison, the average CCC-rated bond trades at a spread of 727 basis points, according to Merrill Lynch. The 7.875% Notes have traded between 98 and 100 for most of 2018, up from a trading range of 96 to 98 for most of 2017. If investors were concerned about a potential default, I would expect to see the 7.875% Notes trade at a significant discount from par value.
The latest plunge in STON’s LP unit price began on July 2, probably in anticipation of the filing of the 2017 10-K. Over the past 14 trading sessions, the units have fallen 40% from a high of $6.00 to the recent price of $3.57 on heavier than average volume. By most conventional measures, the units are now extremely oversold and due eventually for a bounce.
In the 2017 10-K, STON reported a 2017 net loss of $75.2 million or $1.96 per unit, more than double the loss of $30.5 million or $0.94 per unit reported for 2016. Although total revenues increased 3.7% to $338.2 million, total cost and expenses increased 6.0% to $348.9 million. Thus, the partnership’s operating loss (my definition since the partnership does not have such a line item in its statement of operations) increased from $2.9 million in 2016 to $10.7 million in 2017. The partnership also recognized other losses and expenses, including a loss on goodwill impairment of $45.6 million, other losses of $2.0 million and interest expense of $27.3 million, offset partially by a $9.6 million income tax benefit. The effort to catch up on reporting delays and management turnover undoubtedly had a negative impact on STON’s 2017 financial performance.
In the 10-K’s MD&A section, STON disclosed that $11.7 million of its reported $52 million of corporate overhead costs was attributable to the reporting delays (and the effort required to rebuild the financial statements from the ground up). Excluding those $11.7 million of one-time costs, the company would have posted operating profit of $1.0 million, but that was still significantly short of the $27.3 million of interest expense.
Even after excluding the $11.7 million of one-time costs, the partnership has recorded increasing net losses for five consecutive years. A quick check of STON’s profitability shows that its cemetery operations are significantly less profitable than competitors, Carriage Services (CSV) and Service Corporation Internation (SCI). STON is also much more heavily weighted in cemetery operations (vs. funeral homes) which require significantly more capital investment and typically generate a much lower return on assets. STON produces far less revenues per cemetery property than peers, which confirms the appropriateness of management’s focus on beefing up its sales efforts. The partnership also incurs much higher corporate overhead costs.
STON’s persistent operating losses appear to be structural. Consequently, it is still possible to make the case that STON’s units are overvalued, even after a 90% price decline. The partnership may very well require a significant change in strategy, change in asset mix, mergers & acquisitions and/or a restructuring of its capitalization to make it consistently profitable. New management has already signaled one potentially significant change: STON is considering converting from a partnership to a C-corporation. That would reduce the pressure for a big annual payout and allow STON to retain more capital to grow the business.
So far, the equity market clearly does not like what it sees but stay tuned: STON will hopefully restart regular communications with the investment community once it finally catches up on its financial reporting. When that happens, I hope to see the new management team of Redling, Ford and Miller begin to articulate a new strategy or execution focus for STON.
July 20, 2018
Stephen P. Percoco
Lark Research
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