Recommend SCI, price target of $28.25, 51% upside, risk price of 16.1, 13.8% downside, with a 3.75 : 1.0 reward to risk.   Thesis predicated on upside to numbers pre and post recent acquisition announcement, earnings growth through deleveraging balance sheet, ‘public lbo’.  Secular industry tailwind due to the aging baby boomer population. 

Background:  Service Corp Intl is the largest company in the highly fragmented funeral and cemetery / death industry with over 1,800 locations (operations consist of funeral services locations, cemeteries, funeral service / cemetery, creamatoria).  Company also sells “pre-need” funeral and cemetery service whereby a customer agrees purchase merchandise / services to be provided in the future.   SCI has a mkt cap of ~4B, with only ~13% share of fragmented industry revenues.  Strong secular industry trends (chart below) of aging baby boomer population coupled with company’s cash flow / and capital allocation metrics make this in itself an interesting story.     

Strong Secular trends of an aging baby boomer population:

• In 2011, the 60+ population was 18.5%, it is projected to exceed 25% by 2030.  There is a great chart of this in the SCI investor deck, unfortunately, could not embed it in this write up.  
• The average preneed cemetery customer is 63 years old.
• The oldest baby boomers are 67.
• The baby boomers are just beginning to impact preneed cemetery, it will do so for over another 20 years.
• That shifts into preneed funeral, where the average customer is 72 years old, that will be shifting in the next five or six years and dramatically impact that channel.

On May 29^th SCI announced the accretive acquisition of Stewart Enterprises for $1.4B /7.9x pro-forma adjusted EBITDA, $60M in deal synergies.  The combined pro-forma portfolio consists of approximately 1653 funeral homes and 515 cemeteries.  Stewarts concentration in urban areas and greater mix of cemeteries (40% vs SCI’s 20%) help the overall portfolio mix.  The transaction is being financed w a mix of LT and ST pre-payable debt; leverage expected in the low 4x range post close, interest rate ~4.5% or $55M incremental to interest expense post acquisition.  Post the acquisition management will de-lever using FCF and divestitures to pay down debt to targeted range of 3.5x, then use excess FCF for share repurchases and small M&A.  

Thesis:  Anticipate upside to street numbers both pre and post the closure of the STEI transaction.  My numbers get to 1.26 and 1.45, roughly 26% and 44% upside to the street in in '14 and '15, respectively.  Company will de-lever the balance sheet to 3-3.5x target and then use excess cash for share repurchases or additional accretive M&A.     Baby boomer secular tailwind.  Public LBO implies 20% IRR’s.  Note that PE has previously shown appetite in the space.   

Valuation:

• Price Target: 15x 2015 base case FCF estimate of $1.75 gets to PT of $28.25
• Risk Price: 11.5x 2013 FCF of $1.40 gets risk price of 16.1.  Note that management has guided FCF to 1.48 for 2013.

Risks:

• Any negative arb on SCI divesting any STEI units at below 8x EBITDA, this would be done to achieve antitrust approval.  
• Mitiagnt:  reuters reported Service Corp is likely to get antitrust approval for its acquisition of Stewart Enterprises, according to 6 antitrust experts polled.  http://www.reuters.com/article/2013/07/19/us-stewart-sci-antitrust-idUSBRE96I15F20130719
• FTC regulatory risk on deal closing.
• Unforeseen reduced macro death trends.

Sentiment / Other:

• Company has impressive history of always beating street numbers, see surprise page from bloomberg.
• Ownership:  FMR, Blackrock and the London Company collectively own 30% of the shares outstanding.  Hedge funds own 8.3% and insiders own 3.5%. 
• Sentiment:  4 buys, UBS / BAML are the bulge brackets covering the name.
• Short Interest: Short interest is 1.7M shares / .85% and .9 days to cover.
• Dividend: 1.5% yld.