H&R Block: A Risky Opportunity

| About: H&R Block (HRB)

H&R Block, Inc. (NYSE:HRB) describes itself as the world's largest tax preparation service. It also provides a range of financial products through H&R Block Bank. Operations are primarily conducted in the United States but also include Canada and Australia. In 2012, the company sold off two subsidiaries: RSM McGladrey for net cash of $523.1 million and a long term note of $54.0 million and McGladrey Capital Markets LLC, a subsidiary of RSM EquiCo. HRB has been closing offices and cutting staff.

The company, and its franchises, prepared 25.6 million tax returns worldwide during fiscal year 2012, compared to 24.5 million in 2011 and 23.2 million in 2010. HRB offers a comprehensive range of online tax services, from tax advice to complete professional and do-it-yourself tax return preparation and electronic filing, through their website at hrblock.com. The services available at this website allow clients to prepare their federal and state income tax returns using the H&R Block At Home™ Online Tax Program, access tax tips, advice and tax-related news, and use calculators for tax planning.

HRB Bank provides products and services primarily to the company's tax preparation customers and does not compete directly with retail banks.

The company faces stiff competition from accounting firms, Certified Public Accountants and other tax preparation service firms. In the do-it-yourself segment, the biggest competitor is Intuit.

The catalyst for H&R Block is its decision to avoid the onerous regulations being imposed on the banking industry by divesting itself of its banking operation. HRB has engaged Goldman Sachs Group to explore options. Getting rid of the bank might place HRB into play as an acquisition target.

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HRB reports on an April fiscal year. For the year ending 4/2012, sales were $2,893.8 million or about $51.2 million less than F11 sales of $2,945.0 million for a 2.0% drop. In the twelve months ending 1Q13, sales continued to drop to $2,889.6 million.

Sales declined 4.1% in 1Q13 to $96.5 million from the year ago quarter of $100.6 million. For the three prior fiscal years, sales declined at the rate of 10.8% and over the last five years, at the rate of 4.8%.

For FY13, analysts estimate that sales will be in the $2,917.21million to $3,951.0 million range. The average estimate is $3,134.84 million. If the analysts are right, sales may increase 8.3% this year over last fiscal year.

Forecasts for FY14 are not so optimistic. Analyst estimates range from $2,978.4 million to $2,990.0 million and average $2,985.42 million.


In 1Q13, HRB reported a loss of $107.6 million or $0.38 per share. In the year ago period, the loss was $175.2 million or $0.39 per share. EPS for the TTM ending July was $1.21 or $333.0 million compared to $1.31 or $360.4 million in the year ago period. The company reported F12 earnings of $1.16 per share.

This is a very seasonal business and profits are reported only in the fourth quarter of the fiscal year.

The analysts are projecting earnings in the $1.55 to $1.71 range for F13 with a consensus estimate of $1.64. They see further growth into F14 with estimates ranging from $1.75 to $1.88 and averaging $1.81.

Earnings have been hurt by competition, principally Intuit and also by the end of refund anticipation loans.

HRB is a generator of free cash. As of 1Q13, we estimate free cash to be $298.7 million.


Gross margin edged up in the trailing twelve months to 41.8% from 41.2% in F12. In fact, the gross margin is the highest it has been in the last five fiscal years and is markedly above the five year average of 38.72%.

The operating margin also showed improvement and stood at 20.7% in 1Q13. It is above the five year average of 20.42% but below the 23.7% reported in F10.

The net margin is 11.5%, more than two percentage points better than the net margin reported for F12 and above the five year average of 10.9%.


HRB has $939.9 million of cash against $409.0 million in long term debt. Long term debt to total capital is 32.6% compared to the industry median of 31.2%. Long term debt to equity is 48.4% compared to the industry median of 33.9%. Long term debt to free cash is about 136.93% which means the company can pay off its debt from free cash in about 16 months.

The cash balance dropped to $939.9 million from $1,944.3 million in 4Q12. We also see a steady decline in accounts receivable. As of 4Q06, A/R stood at $971.9 million and has dropped each year since to the 1Q13 level of $116.4 million. Accounts payable have experienced a similar trend dropping from $1,391.3 million in 2006 to $414.6 million in 1Q13.

Short term debt has fluctuated very widely over the years. It peaked in 2007 at $1,576.4 million and dropped to a low of $25.6 million in 2011. As of 1Q13, short term debt grew back to $600.6 million, just a little less than the $631.4 million at the close of F12.


HRB pays an indicated dividend of $0.80 per year. The five year dividend growth rate is 5.7%. The indicated dividend provides for a 4.7% yield at the current share price and is above the five year average yield of 3.4% and the seven year average yield of 3.0%. The payout ratio is 66.4% which suggests little room for additional growth. The dividend represents 74.3 of free cash.

The company has also been aggressively buying back shares. The average number of shares outstanding as of 1Q13 was 277.1 million. At the end of F12, the average number was 297.8 million. Since 2009, the average number of shares outstanding was reduced by 55.6 million or 16.7%.


HRB is very profitable as measured by return on equity. ROE 12m is 34.7% compared to the industry median of 8.2%. Return on invested capital 12m is 47.41% compared to the industry median of 10.13%. The cash return on invested capital is 23.81% whereas the industry median is 11.17%.


The company has a trailing PE of 14.1, a 17% discount to the S&P 500. The forward PE, of 10.5 is also low. On a price to sales and price to book basis, HRB is selling at a premium to its industry median.

I also look at three enterprise value based metrics. The company has an enterprise value to free cash ratio of 16.11 and an enterprise vale to sales ratio of 1.67. These are substantially above the industry median values.

On the other hand, HRB has an enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio of 7.92. This ratio is below the industry median and is low on an absolute basis.

By most valuation measures, HRB seems richly valued relative to its industry median. However, I believe the above high levels of profitability, both earnings based and cash based, justify higher valuations.


I think H&R Block represents a good value for a company that is as profitable as it is. The company has definite challenges and needs to stabilize its long term decline in revenues. Its expansion into India may lift expectations. Competition from companies like Intuit may abate with future changes to the tax laws making it even more difficult for the D-I-Y crowd to prepare their own taxes.

I think HRB has a low valuation based on PE and EV/EBITDA. When I combine these low valuations with high levels of profitability and analyst projections of revenue growth, I see a compelling opportunity. Divesting HRB Bank may make this company a tempting acquisition target.

Disclosure: I am long HRB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.