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Magic Formula Stock Review: Hillenbrand (HI)

Note: Hillenbrand recently fell off the Magic Formula screen after a long run. It is likely just off the screen and could return any day.

Hillenbrand (HI) is the parent of its only subsidiary, Batesville Casket. Batesville Casket is the largest casket provider in the United States, and sells other funeral products like urns, funeral home displays, and other funeral services. Batesville has a long and distinguished history of being the top player in the casket industry, with a well established and well-known brand. Hillenbrand as it exists today was spun off from Hill-Rom (HRC) in April 2008.

There are a lot of things to like about Hillenbrand. Let's go through the 3 points of investment and see how this stock stacks up: competitive position, financial strength, and growth prospects.

On competitive position, Hillenbrand is very strong. The company has long been the market leader, and today holds about 45% market share of what is estimated to be about a $1.2 billion dollar market. The market overall is a virtual oligarchy: along with York Group and Aurora, the triumvirate controls over 70% of all casket sales in the U.S. (90% are controlled by the top 7). Batesville has significant brand strength and recognition, an important and durable competitive advantage. Given the dominance of a few players and the rather limited and non-dynamic nature of the industry, it's unlikely that any significant new players will come on the scene. Batesville's market position is secure.

Financial strength is also no problem. Hillenbrand has $43 million in cash and no debt. The business is a strong cash producer, running an average free cash margin of 14%, very solid. Operating margin averages around 24%. Returns on invested capital are outstanding: over 30% on a standard ROIC basis, and over 60% using a Magic Formula calculation. Hillenbrand is also one of those Warren Buffett "inevitable" businesses - there will always be demand for caskets, regardless of economic conditions or trends. This fact keeps margins and revenues fairly stable - sales have been right around the $660-680 million level for 5 years and operating margins have been between 22-25%. It is a pretty predictable business. Oh, and the dividend yield is excellent: a 4% yield with a reasonable 40% payout ratio.

Another favorable factor for a Hillenbrand investment is the fact that this is a relatively recent spin-off. In Joel Greenblatt's first book, You Can Be A Stock Market Genius, he outlines how spin-offs are usually good investment opportunities as they are often ignored by, or cannot be bought by, institutions. Clearly that's the case with Hillenbrand. There is very little analyst following here, and a 12% earnings yield valuation is low for such a predictable, cash generating asset.

Growth is the one point of investment that is unexciting. On one hand, demographic trends favor an increased number of funerals in the coming years due to the aging of the baby boom generation. However, an important trend will temper the benefits to Hillenbrand. Have a look a the percentage of funerals utilizing cremation instead of burial over the past 40 years:

1970: 4.6%
1980: 9.7%
1990: 17.1%
2000: 26.2%
2005: 34.0%
2010: 42.0% (estimated)
2025: 58.0% (estimated)

Regardless of demographics, the outlook for increased casket sales is fairly poor given the sharp increase in cremation over burial. The main reason is cost - cremation can cost as much as 75% less than a casket burial. Space is another issue, as plots fill up at established graveyards and few new ones open. Crowded countries such as England and Japan have cremation rates approaching 90%.

So, while Hillenbrand has outstanding returns on invested capital, there just are not many opportunities to re-invest capital at those rates going forward. This fact prevented me from picking up Hillenbrand as a MagicDiligence Top Buy. That said, MagicDiligence has a favorable opinion of the stock. This will still be a great cash producer for many years, and an excellent recession-proof stock. Dividend investors may be especially intrigued. A good MFI stock for the conservative investor.

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