Whether it be selling its advisory unit, RSM McGladrey, or attempting to acquire 2SS Holdings, H&R Block (HRB) is rightfully starting to focus more on its successful digital and retail businesses. Given my expectations for dramatic changes to the federal income tax code, it is my hope that this focus reinvents the company around a more sustainable model. If simplicity is the way of the future in tax policy, then H&R Block is in for some challenges unless it makes quick changes.
Management plans on unveiling its capital allocation strategy sometime in December. At the first quarter earnings call, CEO William Cobb stated:
Clearly, capital allocation remains very important to us. First, I'd like to point out that we were restricted from buying shares in the most recent quarter due to the ongoing negotiations with M&P. Second, we have an authorization from the board to repurchase shares in fiscal 2012 that we fully intend to utilize.
Following last week's announcement, a recurring question was, "what will you do with the cash from the sale of RSM?" We must be mindful not to get ahead of ourselves by discussing the potential uses of cash until we have definitive resolution on both the pending acquisition of TaxACT and closing on the sale of RSM. We will have more to say about our capital allocation plans on December 8. With that, I'll now turn the call over to Jeff.
While it has always been my belief that management should operate continuously and not on a meeting-by-meeting basis to release news, in this instance, management is making the right decision to wait. This is so for two reasons. First, the company will soon have its credit facility refinanced and its equity restructured. Second, because an approval of the 2SS Holdings acquisition would result in H&R Block gaining a 25% market share against Intuit's (INTU) 65%, thereby raising the relative importance of share buybacks in the capital deployment strategy.
H&R Block currently offers an attractive dividend yield of 4.23%, although management has indicated that it is now seeking to find an alternative way to grow shareholder value. First quarter earnings were roughly in line with consensus, although it is important to note that nearly all revenue comes from fourth quarter results.
Last tax season proved to be successful with digital return volume up 13.5%. It is likely that expenditures on marketing has increased in this area, since the strategy has worked well in the past. The tax preparer's free 1040EZ program helped traction in the retail segment, while the sale of RSM will improve margins and focus going forward.
As many smaller competitors are likely to sell themselves given tax changes, H&R Block should consider expanding its portfolio through acquisitions. A more global and corporate offering would help de-risk the business while growing scale. While the $287.5M pending purchase of 2SS Holdings will be beneficial if it ever passes, integrating TaxACT into retail is far from the revolutionary change that the company needs.
For around a decade, the stock has gone nowhere due to weak fundamentals and poor adaptation. With respective past and forward earnings multiples of 11.6x and 8.2x, incredible free cash flow generation, and an opportunity to exploit changes in tax policy, the stock is cheap with the market price trading below intrinsic value.
Since the start of 2001, Intuit has more than doubled while H&R Block has only gone up by a third in value. Were it not so large, H&R Block would be a poster activist target yet again. SEC Chairman - turned - activist investor Richard Breeden may have proclaimed "mission accomplished" since stepping down from the board, but that remains very much to be seen for shareholders. The stock has been down by more than one quarter since his campaign began.
Consensus estimates for EPS are that it will grow by 20% to $1.62 and then by 7.4% and 6.3% in the following two years. Analysts currently rate the stock slightly better than a "hold", while I rate it more towards a "buy".