My thoughts on Fu Shou Yuan(HK:1448)


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Fu Shou Yuan is the largest burial(Rev: 83.8% OPM: 54.4%) and funeral service(Rev: 13.9% OPM: 10.2%) provider in China. It is the only listed death care provider on HKSE after the privatization of Nirvania Asia in 2016. It is a counter cyclical business where increased death and aging overtime can potentially equate to more business.

FSY as of December 2019 has 24 cemeteries in operation and 26 funeral facilities throughout the PRC. Their business coverage has now expanded to thirty plus cities, across 16 provinces. Even though they are the largest in China, they have less than 3% revenue of the total market share(1.8bil out of 85bil) in China. The growth potential is substantial.

They have also been embracing technology and the cloud which enables them to consolidate and monetize certain aspects of their business.

 "The Group also vigorously promoted the construction of informatization and launched a new integrated “Death Care Services+ Internet” online system namely “Fu Shou Cloud”, internally realizing the synergy of all levels and units inside the Group and externally establishing the on-line/off-line connection between server side and client side."

This innovative technology that they have created enables people in China to "sweep grave" digitally during the pandemic(click here for article). We can get a hint on how they are monetizing this technology from this article here.

Inherited second generation owners tend to cash out due to the distasteful nature of the business and typical real estate companies tend to become quickly cash strapped as cemetery cash flow is different from typical real estate projects(long gestation vs short gestation). FSY being an efficient operator, is able to achieve 10-20% operating margins for every acquisition they make.

This is a highly fragmented market nationwide filled with inefficient small providers having very limited brand recognition. FSY is capitalizing on that and is firmly entrenched in the premium space(50.5% exposure to Shanghai, 10% in Liaoning).

They are able to control cost and yet acquire cemeteries efficiently overtime using internally generated funds. This is shown from their net profit margins, free cash flow and cash holdings over time.

2015 NPM: 25.67%  FCF: 0.19  Net cash: 1.28bil
2016 NPM: 26.74%  FCF: 0.22  Net cash: 1.53bil
2017 NPM: 28.25%  FCF: 0.30  Net cash: 2.14bil
2018 NPM: 29.58%  FCF: 0.32  Net cash: 2.23bil
2019 NPM: 31.27%  FCF: 0.33  Net cash: 2.53bil

This is a low capex and working capital kind of business. Less than 5% of sales goes to capital expenditure and it has an element of upfront cash collection(pre-need contracts). That is why their Cash Earnings Return on Equity is consistently at low 20% range every year. Due to efficient management, their cash conversion cycle is also improving for the last three years.

2017 CCC: 383
2018 CCC: 150
2019 CCC: 137

Growth drivers

The continued growth of FSY is dependent on a few catalysts. One major factor is the Chinese government and how they want to deal with the private providers. The more they open up to private companies and the more regulations they impose on this sector, the more dominant FSY will be, as that would weed out the small players. FSY has always been at the fore front of innovation and the benchmark for what the government wants to achieve.

FSY holds a massive burial land supply that can last them more than 20 years. The value of the burial lands are appreciating every year due to land constraint in China(link here). This segment will give them good returns with increased margins over time.

Another catalyst that FSY has is their environmentally friendly cremation machines which they have already patented and beginning to scale for sale. With increasingly stringent environmental protection requirements from the PRC government, this will bold well for FSY as their competitors are forced to become their customer if they wish to switch out from their old machines.

"During the Year, we continued to enhance the installation and sales of environmental-friendly cremation machines. As of December 31, 2019, we have, in aggregate, installed 44 sets (internally: 21 sets; externally: 23 sets). The cremation machines installed and in operation were all operating smoothly with exhaust gases complying with environmental standards. Currently, the cremation machines contracted but not yet delivered amount to nine sets. In 2020, the Group will deepen our presence in key target markets by increasing investment in the sales and system optimization of cremation machines, so as to consistently refine our products and promote market competitiveness. We expect that the cremation machine business will bring about considerable contribution to the Group’s revenue in the foreseeable future."

The increasing consumption power of China, coupled with active urbanization push would continue the trajectory of 17% CAGR for death care market in China(euromonitor). FSY is also actively promoting pre-needs contracts for funeral service as an important strategic pivot.

 "As of December 31, 2019, the Group has been offering pre-need contracts for funeral services in 18 cities of 10 provincial regions. We signed a total of 4,873 contracts during the Year, representing an increase of 96.1% as compared to Last Year (Last Year: 2,485 contracts), with contract amount of approximately RMB18 million."

Risk

The market is pricing in some of these growth drivers at current price of 6.91. That equates to 23.91x PER and 4.72% FCF yield(21.17x p/fcf). Hence current price may not be cheap if their growth drivers are disrupted. Basing on a historical trajectory basis, their FCF tends to double every 4-5 years.

This company is well managed solely due to its key management. Any departure of these key members will potentially affect the company's performance.

The loosening of the barrier to entry would increase competition and potentially reduce margins due to price war.

Disclosure: At the time of this posting, I own shares in this company. 

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