-- StoneMor’s unit distributions have meaningfully exceeded reported operating cash flow for the past three years.
-- We expect that operating cash flow will not cover distributions until 2014 or 2015, despite anticipated growth in both GAAP and accrual revenues and EBITDA.
-- We are lowering our corporate credit rating to ‘B-’ from ‘B’, reflecting our expectations of ongoing negative discretionary cash flow, as we define the term.
-- At the same time, we are revising our recovery rating to ‘4’ from ‘6’ and raising our senior unsecured issue-level rating to ‘B-’ from ‘CCC+', based on a change in our valuation to an asset-based approach from an enterprise approach.
-- Our stable outlook reflects our expectation that negative discretionary cash flows will continue to be funded from external sources, including revolving credit borrowings or equity raises.
Rating Action On Feb. 29, 2012, Standard & Poor’s Ratings Services lowered its corporate credit rating on Levittown, Pa.-based StoneMor Partners L.P. to ‘B-’ from ‘B’. The rating was removed from CreditWatch, where it was initially placed with negative implications Nov. 29, 2011. The rating outlook is stable.
At the same time, we raised our senior unsecured issue-level rating to ‘B-’ (the same as the corporate credit rating) from ‘CCC+'. In addition, we revised our recovery rating on the debt to ‘4’ from ‘6’. The ‘4’ recovery rating indicates our current expectation for average (30% to 50%) recovery of principal in the event of payment default, compared with our previous expectation of negligible (0% to 10%) recovery.
Our ratings primarily reflect our opinion that StoneMor’s business model, growth strategies, and ownership structure will result in negative discretionary cash flow that will require ongoing external funding. We define “negative discretionary cash flow” as operating cash flow less capital expenditures and cash distributions. We expect the company to continue to pursue growth through expanding pre-need sales, supplemented by modest acquisitions. Historically, pre-need growth initiatives have an extended cash conversion cycle and can result in negative operating cash flow when booked, a trend we expect to continue. We are forecasting reported operating cash flow of about $20 million in 2012, up from about $10 million from the nine months ended Sept. 30, 2011. We expect unit distributions to modestly expand from 2011 levels of $44 million and the cash flow to distribution ratio to be about 0.5x in 2012. We are not expecting this ratio to exceed 1.0x until 2014.
We expect the company to produce double-digit growth in GAAP revenue and EBITDA growth in 2011 and 2012, primarily supported by 30% growth in pre-need cemetery revenues from StoneMor’s acquisitive growth efforts over the past few years. We expect organic growth from established cemetery and funeral properties will be around 3%. We also expect the company to continue to be acquisitive in 2012, although to a lesser extent than in previous years, and believe that 2011 and 2012 acquired properties are likely to contribute to its growing preneed revenue backlog and at-need interments. Our $20 million reported operating cash flow expectation for 2012 reflects expanded EBITDA as well as working capital efficiencies related to conversion of pre-need cemetery revenues booked in 2011 or earlier.
In our view, the company’s financial risk profile is “highly leveraged” (as defined in our criteria), primarily reflecting slim operating cash flow, combined with the MLP ownership structure. We believe cashdistributions in the MLP structure are an important, if not critical, return to shareholders, and will continue to be paid out at or near current levels. In our opinion, conventional debt to EBITDA measures are less relevant given the embedded nature of the company’s negative discretionary cash flow.
StoneMor’s “weak” business risk profile reflects the characteristics of operating in the mature, competitive death care industry that has some prospects of benefiting from a projected long-term rise in death rates. However, industry growth prospects are somewhat offset by a rising consumer preference for lower cost cremation services over traditional burials. The company, similar to its peers, has limited ability to grow organically and must rely on growth through acquiring cemeteries and funeral homes at attractive prices. While its national platform provides scale efficiencies, the company’s weak business risk profile is also supported by its position as the third-largest U.S. death care provider and second-largest cemetery provider (much smaller than Service Corp. International (BB-/Stable/--) and Stewart Enterprises Inc. (BB/Stable/--) and slightly larger than Carriage Services Inc. (B/Stable/--)). The four companies combined represent only about 20% of the death-care market share, with the remaining industry comprised of small local competitors. StoneMor, however, does benefit by primarily operating in niche middle markets that are less competitive where there is acquisitive growth potential.
We view StoneMor’s liquidity as “less than adequate” (as defined in our criteria), primarily reflecting the company’s large cash distributions to its unitholders, which we believe are an important component of the company’s capital-raising ability. We believe sources of cash are likely to exceed mandatory uses over the next two years.
Relevant aspects of the company’s liquidity profile, based on our criteria, are:
-- StoneMor was able to amend its credit agreement in January 2012 and replace the prior fixed-charge ratio covenant with an interest coverage ratio covenant. We anticipate headroom on all bank-calculatedcovenants over the next two years.
-- We expect StoneMor’s sources of liquidity over the next 12 months, including limited cash reserves and about 70% available on its $130 million revolver (approximately $60 million available, due to covenant limits) will exceed its uses by at least 1x.
-- However, we expect StoneMor to continue making distributions around $47 million annually, which will require the company to use all available free operating cash flow plus borrowings against working capital and available debt.
-- StoneMor has sizable investments in trust funds that it uses for pre-need cemetery services and merchandise. These investments remain subject to market volatility and can affect overall liquidity.
-- The company’s ability to accelerate delivery of some pre-need services/merchandise to release cash from its merchandise trust is included in our assessment of liquidity.
The issue level ratings on StoneMor’s unsecured notes are ‘B-’ (the same as the corporate credit rating). The recovery rating on the notes is ‘4’, indicating our expectation for average (30% to 50%) recovery in the event of payment default. (For the complete recovery analysis, see the recovery report on StoneMor, to be published shortly after this release on RatingsDirect.)
Our rating outlook on StoneMor is stable. We expect the company to continue to generate negative discretionary cash flows and will remain dependent on funds from external sources,based on our opinion that the company will pursue growth while returning cash to unitholders.
An upgrade could occur if we believe reported operating cash flows will be sufficient to cover its unitholder distributions by 1x. Conversely, a downgrade would likely be predicated on the company’s inability to access capital markets. This could be triggered by an inability to raise equity or a possible debt covenant violation.
Related Criteria And Research
-- 2008 Corporate Criteria: Our Rating Process, April 15, 2008
-- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
StoneMor Partners L.P.
Corporate Credit Rating B-/Stable/-- B/Watch Neg/--
StoneMor Operating LLC
Senior Unsecured B- CCC+/Watch Neg
Recovery Rating 4 6