Shares of H&R Block
Right now, it's hard to tell. As I'll demonstrate below, the stock looks very reasonably valued, but Block's core tax preparation and mortgage businesses, which collectively account for about 80% of total sales, are struggling to grow. The company just reported first-quarter results, but did this offer any insight into where the business may be heading?
Not really. The tax preparation business is seasonal, and the first two quarters of the fiscal year are always the slowest for Block and competitors such as Jackson Hewitt
The issue in the mortgage unit relates to delinquencies, where investors effectively "put," or return mortgages that Block has sold to them to the company as high-risk borrowers fail to pay their loans. Analysts detailed that about 40% of the $102 million related to first-quarter loss provisions, while the rest was mostly related to previous quarters.
Barring any more specifics on the charge, the difficulties demonstrate that the mortgage business is becoming much tougher as interest rates rise and the U.S. housing market cools after a historic run of price appreciation. That clearly is not a positive for Block, nor is the fact that its core tax preparation business has had difficulty expanding in recent years.
As a result of rapid historical growth, H&R Block has become the largest tax preparer in the U.S. But right now, that success has become a liability in terms of growth as Block's size and 20% market share are making it difficult to post the double-digit sales and earnings advances investors had become accustomed to. And competitors are constantly at Block's heels; Jackson Hewitt is much smaller with only about 10% of Block's sales, making it easier to grow much faster, while Intuit dominates the online tax-preparation space.
To keep growth chugging along, Block has expanded into other service businesses. In addition to mortgages, it now operates in financial, accounting, and other business services such as consulting, investment advisory, and, more recently, banking. In an example of their current efforts to try just about anything, today the company announced plans to open 1 million bank accounts where clients will be able to direct deposit tax refunds.
But overall, the diversification beyond tax preparation has proven frustrating, as witnessed by the above mortgage charges and multiple past snafus that include accounting restatements and New York Attorney General Eliot Spitzer's accusation that Block hid fees in certain financial services products. This has resulted in negative publicity, very uneven growth, and even more volatile profitability, not to mention the complexity in trying to understand what is driving Block's financial results.
Sounds pretty grim, but investors keep hanging around because of the stock's 2.5% dividend yield and solid cash generating abilities. Mainly because of the increased mortgage reserves, Block also reduced fiscal year 2007 guidance by $0.20, to a new range of $1.60-$1.85 for a modest forward P/E of only 12-13. The trends in profitability and cash flow growth are not promising, but if H&R Block can return to its past glory, the stock price will follow. The million dollar question is just when that might happen, as the wait has already been taxing.
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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.
