H&R Block Faces High Costs, Industry Changes

For H&R Block (NYSE: HRB  ) , the term "earnings season" really only applies to the first half of the year -- the first quarter, more specifically. The company makes the vast majority of its money during tax season and spends the rest of the year mitigating losses. However, as it releases its earnings for the recently ended quarter, investors and analysts are looking at its ability to cope with industry changes, as well as management's efforts to cut costs. While shares are near their highs (both 52-week and record), investors with a long-term outlook need to consider the future of the tax preparation business.

Earnings
H&R Block, the storefront and web-based tax prep service company, reported its second-quarter earnings after Tuesday's market close. As expected, it incurred a loss -- $0.40 per share on an adjusted basis -- but showed growth in revenue. From the year-ago quarter, the top line went from $96 million to $127 million this year. However, as noted in the company's press release, much of the sales gain was related to a timing circumstance for its Australian business.

Operating costs on both a corporate and tax service level increased by $11 million and $35 million, respectively.

One item of note was the company's expected transition of banking services from its own in-house bank (H&R Block Bank) to Republic Bank and Trust Company. The move will not take place in time for the coming year's tax season -- a move expected to aid in cutting costs and delivering shareholder value.

The big question
For H&R Block and its investors, the question is how it will cope with the expanding prevalence of free e-filing software that already holds much of the industry and how it will expand. Intuit's TurboTax and Blucora's TaxAct are both very well-received products on the high and low ends of the market, and H&R Block's web presence is threatened by both. Turbo Tax holds 60% of the market, with Blucora making up 12%. Sure, that leaves plenty for H&R Block to hold and build upon, but the product itself does not have much of a moat. As far as full-featured, brand-heavy TurboTax goes, it likely won't lose much to the near-identical H&R Block, which holds less of a name in e-filing space. As mentioned, TaxAct is nailing down the lower end of the spectrum.

How will the company address this challenge? Currently, management's efforts have lied in cost-cutting the business as a whole. This low-hanging fruit will certainly help boost margins and the bottom line in the short to medium term, but its long-term viability is in question.

One good sign, as pointed out by fellow Fool Dan Caplinger, is that  the tax code is getting more complicated, especially with the pending full implementation of Obamacare. Though the trend shows individuals and small businesses quickly drifting to e-filing (for free), the increasing complexities of taxes may delay the transition.

Overall, H&R Block's management is doing what it can as part of an industry in midst of disruption. However, the long-term macro fundamentals, at this point, are questionable and keep this stock from being a necessity in your portfolio.


 

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