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Jelly Roll Capital Equity Research |
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Market Analysis, Education, and Wall Street-Quality Stock Reports |
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H&R Block |
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Selected Analyst Coverage: William Blair — Market Perform Ativo (BIR) — Hold
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HRB Closed at $23.46 on 5-21-07 |
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Released 5-21-07 |
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H&R Block (ticker: HRB) is a provider of tax and investment advice and related services. The company primarily provides income tax preparation to individuals, although it also offers similar service to small businesses. Additionally, H&R Block also provides brokerage tools and investment information as well mortgage origination and similar services. · H&R Block’s core business is its tax preparation unit, which has seen sequential declines in customers at retail locations for five consecutive years since peaking in 2002. Retail clients in FY2006 was at an all-time low for the decade. Weakness in customer volumes at both company-owned and franchised stores has been offset only by increases in customers served with H&R Block’s TaxCut software. · With customer trends on the decline, we find it puzzling that H&R Block has continued to expand its store base, with total stores growing 30.4% in the last five years to 13,548. This growth is largely due to company-owned stores, which increased 50% over that time. · The combination of lower client volumes and higher fixed costs from investing in new stores has resulted in declines in several important financial metrics for H&R Block, namely an erosion in gross margins (down a full 8% since FY2005) and a large decrease in return on invested capital (using EBITDA, down to 13% from well over 50%). · In late April, H&R Block announced it had reached an agreement to sell its sub-prime lending unit (Option One) to Cerberus Capital. Cerberus will pay H&R Block $300 million less than net tangible book value on the closing date. The sale of Option One and H&R Block’s concurrent decision to close H&R Block Mortgage will effectively remove the company from that business, and the company expects full year profit to be negative due to charges from those actions. · With the mortgage units contributing hundreds of millions in pre-tax income over the last several years, the combination of their business loss along with the charges that H&R Block will take will lower both the earnings power of the company as well as its equity for years into the future. The timing of the deal seems especially poor, as we believe H&R Block is selling when industry conditions are at a trough - a seemingly sub-prime solution to a sub-prime issue. · Given the headwinds H&R Block is facing with sub-prime writeoffs, dimishing returns on capital, and changing customer trends in tax preparation, HRB still sells at a fairly elevated valuation. Intuit (ticker: INTU), which makes TurboTax and holds greater than a 75% share of the personal finance software market, sells at only a slight premium to HRB. · While we generally do not put much weight on market timing, we would note that in each of the last five years, HRB shares have rallied around tax season. We would view this strength as something to sell into, or even a short opportunity for the more aggressive. · Given H&R Block’s anticipated earnings growth, its balance sheet position, cash flows, and business risk, our fair value target for HRB is $15.80, putting HRB shares as being overvalued by approximately 31.90% based of Monday’s closing price of $23.46.
Disclosure: The analyst has no position in HRB or its derivatives. |
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