Benjamin Franklin once remarked “nothing can be said to be certain, except death and taxes”. While the latter can eat away at your returns, Kartik Kumar of the Artemis Alpha Trust is tapping into the reliable nature of the former in the hope of driving performance.
The manager likes companies that provide a product or service everyone will eventually need, and currently has 12 per cent of his portfolio in holdings that fit this criteria.
One of these is EssilorLuxottica, a manufacturer of ophthalmic lenses, with the manager pointing out presbyopia – which makes it more difficult for eyes to focus on nearby objects as they age – will become more widespread as people live for longer.
Yet while there is a strong chance most people will require some sort of vision aid at some point, the demand for a service provided by another one of Kumar’s holdings – Dignity Funerals – is guaranteed.
“Dignity does three things,” said the manager.
“First, it has a premium funeral business, selling plans to people ahead of when they will need it. And the benefit of that is it is not a distressed purchase: you do it yourself, your family don’t need to worry about it and you take away the need for a purchase in the future.
“The reason why that’s very attractive from the company’s perspective is it’s effectively like a float: it gets the cash up front, it can manage that float and it provides predictability of future revenues.”
The second part of the business is cremations: there are about 250 crematoria in the UK and Dignity owns more than 40 of them. Kumar said that although 80 per cent of people are now cremated, it is hard to obtain planning permission for crematoria, resulting in stable and predictable cash flows from these assets.
Last up is its high street shops – Dignity is the second-biggest player in the UK in this regard, behind only the Co-op.
Of course, just because demand for a service is guaranteed, this doesn’t mean that every company providing it is a good investment. Kumar said the opportunity in Dignity arose after it fell from £28 a share down to £9, when he bought in; it fell further in this year’s slump, troughing at below £3, when the manager increased his holding by 45 per cent.
Performance of stock over 5yrs
Source: FE Analytics
Kumar blamed this crash on short-sighted management.
“In the past, Dignity pursued a strategy where it increased prices above inflation for the reason that when you’re buying a funeral, you’re slightly price insensitive: it comes out of probate, the family are presumably not in a good state of mind and you can use pricing power – to the detriment of the long-term value of the business,” he explained.
“We started investing after it cut prices.”
Another reason for the slump was concern over the size of the company’s debt. This stands at about £550m, in the form of a mortgage, with the company paying £26m a year until 2049. This became an issue for Kumar’s peers when profitability fell from £120m to £80m, but the manager thinks it is something of a distraction.
“In the market’s view, the company had a debt problem and it might have needed to raise equity,” the manager said.
“In my opinion, this was an incorrect way to look at it. I don’t believe the business ever had a debt problem. It had a short-term profitability problem by not running the right strategy and the market was overlooking the value of its cremation assets and the value of its premium assets.
“For example, the price has been quite strong in the past couple of weeks and one of the reasons is that it disclosed a third-party valuation for its crematorium business at £460m. But if you look at the book value of the crematorium business, it’s £40m. You would never have seen that by looking at the balance sheet.”
In addition, Kumar pointed out the company has assets of £1bn in its premium funerals trust, which is revenue the company will receive in the future.
Yet the manager said there is more to Dignity than a simple recovery play. He believes the company is worth more than the sum of its parts and that the right strategy connecting the different parts of the business could deliver significant growth opportunities over the long run.
“If you look at the marginal costs of delivering an incremental funeral or incremental cremation, they’re relatively low compared with the revenue,” he said.
“Therefore, if you were to pursue a strategy where you deliver the best value for money, you could grow in a way that would rebuild profitability reasonably quickly and compete in an industry where 67 per cent are independents.
“Five years ago, approximately 0 per cent of the funeral industry was purchased online; today that is 50 per cent.
“There is huge digital change, which is prompting greater price awareness, transparency and feedback on the service. And you have a business that has 800 branches, 45 crematoria and scale that could provide the best digital service.”
He added: “I sometimes see people putting in forecasts for Zoom in 2032. I don’t know much about what will happen in 2032, but I can tell you that I don’t know how video conferencing will be done.
“Whereas I have a good idea about what deaths will be in the UK in 2032, because those numbers were created 70 years ago.
“But time horizons collapsed [this year]… and I had to watch that holding go from £6 a share to £2.50, despite being a funeral operator in a global pandemic.”
Data from FE Analytics shows the Artemis Alpha has made 19.48 per cent since Kumar became co-manager in May 2018, compared with 4.75 per cent from the IT UK All Companies sector and a loss of 4.01 per cent from the FTSE All Share.
Performance of trust vs sector and index under manager
Source: FE Analytics
The trust is on a discount to net asset value of 12.09 per cent, compared with 17.05 and 17.42 per cent from its one- and three-year averages.
It has ongoing charges of 0.95 per cent and is 9 per cent geared.