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Morningstar | InvoCare to Raise AUD 85 Million to Bolster the Balance Sheet, and Fund Ongoing Growth Initiatives. See Updated Analyst Note from 07 Mar 2019

Wide-moat InvoCare is undertaking an institutional placement to raise AUD 65 million, and an additional share purchase plan, or SPP, capped at AUD 20 million. The institutional placement is underwritten with a AUD 13.30 floor price, a 7% discount to the last closing price, and a 17% discount to our unchanged AUD 16.00 per share fair value estimate. The SPP is not underwritten and will be priced at the lesser of the issue price of the Institutional Placement, or the volume weighted average price, or VWAP, of InvoCare shares traded in the five working days prior to final acceptance of the SPP. We have assumed AUD 13.30 per share for both. We will provide a recommendation on the SPP once the company reveals its timing and details.

The impact on our valuation is negligible, despite raising equity at below our fair value estimate, InvoCare's equity capital base will increase by just 5% and broadly offset by the interest cost savings on debt reduction from the equity raising. As such, we maintain our fair value estimate and continue to believe the shares are attractively valued at current levels. Our EPS projections are largely unchanged over the next three years. The recent decline in the death rate is unsustainable, and we continue to expect 2% annual growth on average over the next five years. Beyond this the outlook is even more positive, with the Australian Bureau of Statistics forecasting 240,000 deaths per year by 2034, compared with approximately 160,000 in 2018, supported by ageing population.

The recent earnings weakness and accelerated acquisitions have resulted in debt levels exceeding management's desired levels. While we we’re not alarmed by the firm’s financial health, the equity raising is a prudent decision in our view, especially given shares in InvoCare have rallied by almost 50% since the start of 2018. This capital raise should alleviate any balance sheet concerns and, based on our projections, fiscal 2019 net debt/EBITDA should fall to around 2.7 times, down from our previous estimate of 3.3 times. As earnings continue to recover, capital expenditures moderate, and the company divests noncore assets, net debt should fall towards 2 times EBITDA by fiscal 2022, a much more desirable level.

Along with fortifying the balance sheet, the proceeds will also provide additional flexibility, particularly important as the firm progresses with its growth initiatives. Protect and Grow is management’s primary focus, and we are encouraged by the strong growth demonstrated by sites which have already gone through the refurbishment process. At the current pace, 43% of the locations are on track for completion by the end of 2019, while the majority should be wrapped up by the end of 2020. Additionally, the capital raising is supportive of the regional acquisition strategy, which saw AUD 73 million deployed during 2018 to acquire 11 businesses which are performing ahead of management expectations. The firm’s share of the regional markets remains negligible, and this is a huge growth opportunity for the company which should benefit from the additional scale.

We forecast the top line to grow at around 7% per year on average during the next five years, supported by: (1) a resumption of 1%-2% growth in the number of deaths; (2) a return to around 3% per year pricing increases, which should be achievable as the new shops open and industry volumes grow which should stabilise competitor behaviour; and (3) incremental market share gains. As revenue resumes growing, operating leverage and efficiency gains should help EBITDA margins to improve from the current 25% (fiscal 2018) back above 26% within the next three years.