Hillenbrand, Inc. (“Hillenbrand”) was spun-off from (old) Hillenbrand Industries on 2^nd April 2008 (simultaneously another division supplying the healthcare industry was also spun-off as the larger Hil-Rom Holdings).  Hillenbrand is a very simple niche business: it sells funeral caskets, cremation urns and remembrances to funeral homes. 

 

It is priced cheaply to earnings, at 6.7x EV/EBIT ’08 (6.3x ave. 03-07 EBIT).  At first glance this valuation, which is cheap on an absolute basis, might appear justified for an uncomplicated manufacturing company which produces a necessary but boring product, for a market which is not growing (unit sales have been flat over the past decade) and for an industry (death care) which is far from glamorous.  But in the same way that Coca Cola is not just a manufacturer of sugared water, Hillenbrand is not just a manufacturer of wooden boxes.

 

Firstly it truly dominates its industry, a good initial sign of barriers to entry and that this is not a commodity manufacturer.  It has grown over the last 100 years to be the world’s largest casket supplier with a dominant 50% US market share in caskets and a 35% US market share in cremation products.  Closest competitors Matthews (ticker MATW) and Aurora (privately held) each have less than 15% market share; below them are 100-200 small players.  Hillenbrand earns more than two thirds of the entire profits of the US casket industry.

 

Secondly its sustained record of high profitability suggests that it is in fact a good business.  Over long periods of time, through various economic cycles, it has delivered remarkably high and stable profits: 40%+ un-leveraged returns on equity, 23%+ operating margins, and 60%+ returns on capital (ROC = ebit/(net working capital plus fixed assets).  How did this manufacturer of what should be a commodity product get to be such a profitable business? 

 

Well there are two plausible answers.  The bearish view is that they have achieved this status through illegal methods, which are currently the subject of an anti-trust lawsuit, on which, more later.  The alternative view is based on several factors:

 

The product is not a commodity, but its cost-base is commodity-like.  Here I do not just mean that Batesville, Hillenbrand’s trading name in caskets, is considered the premium brand, although it is.  More importantly Hillenbrand sells a business-critical product that must be delivered exactly according to individual specifications, normally within 24 hours of order, which the funeral home then marks-up 2.5-3x.  Each of these ingredients contributes to a high quality business.

 

Let’s examine the casket manufacture and distribution business by working backwards from the ultimate point of sale in a funeral home, back to the manufacture of the casket. 

 

Funeral homes find it easier to mark up the essential casket, which is custom built and often personalized, than its other services, which most homes try to itemize at very reasonable rates in order to prevent giving the consumer any sense of gouging or greedy behaviour.  So right from the outset, the casket is a high-margin product in the eyes of Hillenbrand’s customer: the funeral home manager.  Now think about the logistics of delivering “made to order” caskets: the delivery cannot be outsourced (neither funeral home directors nor their future customers, who are almost all local and regularly walk or drive past their local funeral home, would like to see UPS deliveries of the next batch of wooden crates; instead Hillenbrand employees make daily deliveries to each funeral home with dignified, white gloved service).  So, if the front-end of transportation must be company owned and branded, the entire transport fleet must be dedicated to this one activity.  For a small player, they can never get the throughput of orders that would allow them to keep the required fleet size on the road (Hillenbrand’s delivery network uses 650 company owned trailers, making deliveries every day to the majority of its clients).  By logical extension, the biggest delivery network with the highest capacity utilization also becomes the most reliable supplier.  Funerals are stressful times for all involved, so ensuring the right casket gets delivered at the right time is business critical for a funeral home manager.  Hillenbrand’s scale makes it both efficient and reliable (delivering “the right casket at the right time 99.3% of the time”).  Finally, a combination of scale in transport and manufacturing means that instead of having to make a new customized casket for each order, existing inventory can be used to fill the majority of orders.

 

Hillenbrand could therefore be compared to a tailor selling off-the-peg inventory as a made-to-measure suit, with clear implications for pricing power.  Batch production, rather than individual customization, is more efficient and obviously cheaper.  This means that manufacturing processes can be streamlined to the most efficient methods available. Hillenbrand runs manufacturing out of six locations in the US and Mexico, and distributes through 94 distribution centres.  The plant in Batesville, Indianna, for example is run at full capacity from 7 a.m. to 1 a.m. five days a week, employing a total of 675 workers split into two shifts, turning out a thousand caskets a day.  Hillenbrand have based most of their manufacturing methods on Toyota, after extensive operational analysis and study in Japan by senior management.  Various US manufacturing journals have recognized the company’s plants as being among the top 10 in North America for efficiency, worthy of study by other manufacturers.  Each casket therefore makes the remarkable journey from an efficient, but commodity-like factory floor, via the dominant delivery network in the industry, to a shop front where the product is sold as a custom-made rush job.  No wonder they manage to keep margins high.

 

Funeral homes develop an increasingly dependent on Hillenbrand.  The North American funeral home market is remarkably fragmented, small scale and local in nature: 80% of the total 22,000 funeral homes are independent.  (This is unlikely to change soon, after previous attempts to roll-up the industry dramatically failed).  Just as Coca Cola provides free chairs and tables to café start-ups in return for exclusivity, Hillenbrand frequently redecorates funeral homes at its own expense, provides casket displays which relieve the funeral homes from carrying inventory, and trains the overwhelmingly Mom and Pop operators in more sophisticated merchandising and sales techniques.  In short Hillenbrand treats their customers like franchisees, and in return they gain near exclusivity as suppliers. 

 

So it can be seen that Hillenbrand occupies unusual territory: the dominant supplier where scale is critical selling to a highly fragmented, small-scale market.  This must be what suppliers to the retail trade looked like in the 1950’s.

 

 

Enterprise Valuation:

 

Price:               $18.18

Shares o/s:       62.3mm

Mkt Cap:         1,133mm

Cash:                  123mm

Total Debt:           250mm

Net Debt:             127mm

EV unadjusted :  1,260mm

Additional investments: 208mm

EV adjusted:      1,053mm

 

The additional investments are legacy investments held by (old) Hillenbrand Industries and transferred at the spin-off:

 

 

EV/EBIT 07:    6.8x

EV/EBIT 08:    6.7x

 

Price/sales: 1.7x

Price/book: 4.4x          (evidence of the high returns on equity the business enjoys, rather than overvaluation).

 

 

Matthews, is the number two in caskets, and is the closest publicly traded competitor to Hillenbrand.  Its casket business has inferior market position and profitability when compared to Hillenbrand, but its Bronze Division holds a very attractive position in providing bronze memorials for cemetery graves, which is in many ways similar but complementary to Hillenbrand’s position in caskets.  It dominates this smaller bronze niche with an estimated 75% market share.  So Matthews is a very similar business, operating in the same industry.