Mainland China

Fu Shou Yuan (1448 HK)

Death care at a discount

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Fu Shou Yuan (1448 HK － US$1.4 billion) is China’s largest death care provider, conducting funerals and operating cemeteries across 40 cities in 19 provinces.

The company was founded in Shanghai in 1994 by taking over assets from a collectively owned enterprise. And its Shanghai operations continue to be important for the business, representing close to 50% of revenues.

Fu Shou Yuan’s main business is selling burial plots to families of recently deceased individuals. It also sells funeral services, sells its landscaping expertise to third parties and constructs cremation machines for sale in China and beyond.

Its pricing power is strong. Families tend to look for cemeteries close to where they live. In China, filial piety is a virtue and caring for the elderly is taken seriously. In addition, people will typically want to be buried close to their deceased partner or other family members. And finally, the decision on where to bury your loved one is often taken in haste and during emotional duress. In other words, price is not the key determinant in people’s decision on where to buy a burial plot.

In his 1987 book One Up on Wall Street, Peter Lynch mentions that one of his favorite stocks was funeral services operator Service Corporation, which had been a 40-bagger in the previous decade. Service Corporation was a serial acquirer, buying up small funeral homes at low multiples and consolidating them into a single entity.

Fu Shou Yuan has some of the same characteristics. It’s acquired cemeteries and funeral operations across China, compounding revenues at +16% per year and earnings per share at +12% per year. One key driver of that performance is that prices for burial plots have increased roughly 5-6% per year. Fu Shou Yuan’s operating margin is now 52%, among the highest in the global death care industry. The return on equity has been steady at around 16% despite a large net cash position representing almost 100% of shareholders’ equity.

There’s every reason to think that growth will continue. China’s elderly population will grow at roughly +4% per year － making it one of the fastest-aging populations in the world. Supply remains restricted, with no new cemetery land approved in Shanghai since 2009. And the company’s land bank remains large. Finally, Fu Shou Yuan is also moving towards the international practice of pre-selling burial plots, partly in cooperation with insurance companies. That has increased the number of potential customers multiple-fold.

I expect a short-term pullback in earnings due to the exceptionally strong pent-up demand for funerals and burial plots in 2023 after China’s zero-COVID lockdowns were lifted. We already saw weak numbers in the second half of 2023.

Assuming a soft 2024 and a recovery thereafter, I get to a 9.2x P/E by 2027 － much lower than the historical average of 21x. With the new guidance of a 60% dividend payout ratio, I foresee a dividend yield of around 6.5%.

Its valuation multiples are significantly lower than its peers. For example, privatizations in the global death care industry have historically taken place at around 15.8x EV/EBITDA － a huge premium to Fu Shou Yuan’s current multiple of 4.7x.

So what are the risks? I think they’re mostly political. Fu Shou Yuan was formed in 1994 when Chairman Bai Xiaojiang took over a collectively owned enterprise. In 2003, he was accused of misappropriating state property and detained for two years. Many institutional investors refuse to touch Fu Shou Yuan for that reason. That said, many of China’s greatest enterprises were formed in this way － by privatizing state assets, with certain insiders benefitting disproportionately.

It’s also clear that the ruling Communist Party prefers cremation over burials. Cemeteries occupy valuable urban land that can be used for housing and other purposes. The Party doesn’t like superstition or religious practices that are at odds with Marxist ideology. Visiting the graves of opposition leaders can be seen as a political statement. It was for that reason that many Cultural Revolution-era cemeteries were razed to the ground.

But I don’t want to overplay these issues. Fu Shou Yuan is clearly a best-in-class cemetery operator, bringing international practices into China. I doubt that the government will want to disrupt the status quo.

I think it’s more likely that the government will simply not allow new cemeteries to be built. That would be a positive development for Fu Shou Yuan. It would cause supply to become even more scarce and enable them to charge even higher prices. For that reason, I expect Fu Shou Yuan’s earnings to continue to rise at a steady rate.