Why I believe the Dignity share price could soon return to 1,500p

Shares in Dignity(LSE: DTY), the UK's largest and only publicly traded funeral business, jumped by as much as a fifth in early deals today, after the company announced that trading during the first quarter was significantly better than initially predicted.

Management was expecting a sharp deterioration in earnings this year following the company's decision to slash the value of some of its funeral plans to protect market share after years of steadily rising prices. However, it seems that the most consumers are still willing to pay more for a better send-off.

Better than expected

The group said today that "the anticipated mix of simple funerals as a percentage of total funerals has continued at levels lower than the board's initial forecast." Initially, management had expected that the percentage of so-called simple funerals, for which the price has been reduced to below £2,000, would increase to 20% of overall revenues.

But so far, demand has not been as high as expected and the number of simple funerals as a percentage of all funerals conducted has remained steady at around 15%.

Thanks to this better than expected performance, Dignity's first-quarter revenue was approximately £95m compared with £93m last year. Earnings before interest and tax (EBIT) came in at £35.7m, in line with 2017.

Nevertheless, despite Dignity's upbeat performance in the first quarter, management remains cautious about the group's outlook for the full-year warning that the "board still believes it is too early to conclude that the trading experienced in Q1 is indicative of the likely funeral price/volume mix going forward." And trading throughout the rest of the year is expected to be "volatile."

Indeed, the company benefitted from an 8% year-on-year increase in deaths during Q1, a trend that is expected to moderate throughout the year. The Office for National Statistics expects a decline of 0.2% for the year as a whole.

Time to buy?

Even though I believe it is too early to say that Dignity has fully recovered from its problems, it's clear that the group isn't heading for the full-year bloodbath City analysts were expecting.

Analysts have pencilled in a decline in earnings per share of 48% for the full year, but considering Q1 EBIT is unchanged year-on-year, it now looks as if these figures are too pessimistic.

That said, I would be amazed if the company didn't experience at least some earnings decline this year (the firm has cut the price of the cheapest funeral by 25%, after all). So I believe it's too early to crack open the champagne just yet.

However, a decline in full-year earnings per share of nearly 50% looks too aggressive, and it is now likely that analysts will revisit their figures in the next few weeks and months.

Even a small upward revision in forecasts could result in a substantial share price reaction. For example, if analysts revise earnings forecasts higher to 97p per share (a decline of 25% year-on-year), I believe shares in Dignity could be worth as much as 1,500p based on the fact that the shares have historically traded at a forward P/E of 15.5.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.