Taxes. It's that time of year again. And two names probably pop into your mind -- H&R Block (NYSE:HRB) and TurboTax from Intuit (NASDAQ:INTU). I covered Intuit a while ago and concluded that the company was probably fairly valued back then. H&R Block is possibly a better story.
The Block brothers basically stumbled into the tax-preparation industry 50 years ago, but their business has become an empire. The company was already universally known but now has turned into something of an icon after becoming the question to an answer that stumped 74-time winner Ken Jennings on TV's Jeopardy!
H&R Block is involved in more than just taxes, however. Even though taxes provide the lion's share of revenue and income each year, the company does have other segments, including:
- Mortgage services: It provides mortgages that are bundled and sold as securities. This is a decent moneymaker for the company, and applications are still rising, even with increasing interest rates.
- Business services: H&R Block offers financial advice plus accounting, tax, and consulting services to mid-size businesses. This segment lost money in fiscal 2003, but it has turned profitable over the past two years.
- Investment services: The company supplies advice-based brokerage services and investment planning. This has lost money each of the past three years.
- Corporate services: By far the company's smallest segment, this is also losing money.
Per the company's last full-year financials, tax services provide roughly half of the revenue and 65% of the pretax income, while mortgage services account for 28% and almost 50%, respectively. Income of 115% looks odd, but remember it has two segments losing money. The tax-services revenue and income is extremely seasonal, and it runs negative all year until the very large positive fiscal fourth quarter, which falls during tax season. The mortgage business, meanwhile, provides a smoothing influence to the revenue and income streams.
For tax services, H&R Block competes with Intuit, Jackson Hewitt (NYSE:JXT), and Liberty. But by far, H&R Block is the largest player. For business services, it competes with Intuit and Paychex, among others. The investment-services and mortgage segments have competitors all over, among them banks and brokerage houses.
Intuit's TurboTax is probably H&R Block's most formidable threat right now. But the company is defending its turf pretty vigorously, with even a lawsuit having been filed against Intuit challenging the latter's claim that TurboTax is used to file more claims than H&R Block's offices are. Either way, though, one clear advantage H&R Block has over TurboTax is the personal touch, with many clients returning year after year to work with the same preparer.
The company offers several ways to obtain a refund early, but if you use these services, read the fine print carefully and remember: TANSTAAFL. H&R Block and the loaning bank charge fees for the convenience of letting you get your hands on your refund early. And a lot of people who apparently didn't remember or pay attention to that fine print are suing the company over deceptive business practices. They allege a conflict of interest regarding the interest rates charged on those early refunds -- which were loans, after all. This and H&R Block's recent ironic announcement that it miscalculated its own taxes have put downward pressure on the stock recently. And to the extent that this doesn't portend a material decline in H&R's business prospects moving forward, it might well create an opportunity.
Looking quickly at a valuation, we see that Thomson First Call's polled analysts estimate H&R Block to grow by 8% to 12% annually over the next five years. (These are the low and median values; I do not use the high estimate.) If we take those rates and apply them to trailing-12-month earnings of $545.6 million, we get earnings of $801.7 million to $961.5 million in five years. Using the current outstanding share count of 327.6 million and ignoring any possible buybacks -- and H&R Block has been doing some buybacks -- gives an EPS figure of $2.45 to $2.93 in five years. Applying a P/E of 12.4 (the average of the past three years) gives a share price between $30 and $36. Stock price appreciation would be 6%-10% from the current price of about $22. Add a forward dividend yield of 2.3%, and we're looking at a possible return in the vicinity of 8% to 12%.
The question now is the extent to which the company will be able to deliver on these expectations, given that pressure from Intuit and other tax preparers might erode growth, while a broader bear market might push its multiple downward. As always, this is a rough look at things -- I'd encourage a more detailed look into the valuation before acting, folks.
Despite its current difficulties, or maybe even because of them, H&R Block deserves a place on my watch list for a possible purchase in the near future.
The taxman cometh:
Intuit is a Motley Fool Inside Value pick. For more of the bargain stocks that Philip Durell is following, try out Inside Value free for 30 days.
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Fool contributor Jim Mueller does his own taxes, but he's going to try Block's TaxCut software this year. Don't forget, taxes are due Monday, April 17. He does not own shares in any company mentioned. The Motley Fool has a disclosure policy.
