A Buying Opportunity at H&R Block

by Will Ashworth | April 27, 2012 10:35 am

H&R Block (NYSE:HRB[1])  released its preliminary fiscal 2012 financial results[2] yesterday — as well as the strategic realignment of its business.

The effect on HRB was palpable — it dropped more than 10% on Thursday, to $14.95 at the close. The general consensus seems to be that this dog won’t hunt. I respectively beg to differ. In fact, I hope HRB drops some more because that will only make the buying opportunity that much more profitable.

Let’s look at each of the negatives raised in yesterday’s announcement. I think when you take in the big picture, you’ll see that the news isn’t the death knell some mistake it to be.

350 Full-Time Jobs and 200 Company-Owned Offices Cut

No one likes to read about job cuts, especially in an environment where unemployment is still historically high. However, these are 350 cuts out of approximately 100,000 employees across the country. Furthermore, they’re voluntary. I doubt that 100% of the employees eligible for this voluntary separation love the work they do. According to a Forbes article last November, 70% of employees hate their jobs. So there will be more than enough takers.

As for eliminating 200 company-owned offices, I believe they should have been closed a long time ago. While CEO Bill Cobb’s only been on the job for a year now, he’s been a director since August 2010. As soon as Cobb took over as CEO, he made it crystal clear that HRB was returning to its roots in tax preparation, both at the retail level and digitally.

But just because the company has this focus doesn’t mean it’s going to keep poorly performing offices open indefinitely. Retailers close stores all the time. More often than not, it’s because the location isn’t right. At the end of the third quarter, HRB had 5,787 company-owned locations. So cutting 200 is only about 4%.

Given the growth of Block’s digital business, only the best-performing locations — and probably the biggest — should remain open. And while the ideal number of locations is still to be determined, that number has to be fewer than Block has now. The company expects to reap annualized savings of $85 million to $100 million from its strategic realignment, much of it from staffing and office cuts.

This is in line with a very smart move Bill Cobb made in his first year on the job that sheds light on his decisiveness — he sold RSM McGladrey, HRB’s business-services unit, for $610 million. Since his focus was on HRB’s core business of tax preparation, it made no sense to own a consulting practice.

It puzzles me why investors view Cobb’s latest moves to address the company’s weaknesses as a negative. In time, investors will come to realize that they strengthen the core business.

Retail Tax Services President Resigns

As part of its strategic reorganization, it’s clear that Jason Houseworth, formerly in charge of HRB’s digital tax operations and now head of U.S. Tax Services, won the leadership battle between himself and Phil Mazzini, who has resigned as President of Retail Tax Services and is moving on as of April 30.

Digital continues to play a bigger role at H&R Block, and Houseworth has led it since 2008. If HRB had not rewarded his good work, it’s likely he would’ve walked. Now it appears he’s HRB’s CEO-in-training, in preparation for the day Bill Cobb decides to retire — for a second time. Shareholders should be very happy with the strength of HRB’s bench. The company is in good hands for the first time in a long while.

Full-Year Revenue $100 Million Shy of Analyst Estimates

There’s no doubt that when you first glance at its $2.9 billion in expected revenue for fiscal 2012, you’re looking at a business in transition. That’s not necessarily a bad thing. At its pinnacle in 2006, HRB generated $4.9 billion in revenue, which is 69% higher than what it will deliver for shareholders at the end of this month.

However, back then its mortgage business was generating a lot of revenue but was also a ticking bomb. Now, the amount of mortgage loans outstanding is getting smaller every quarter. A couple of more years of focusing on the core business — while also delivering useful financial products through its H&R Block Bank subsidiary — and HRB will have fully recovered from its past misdeeds.

Full-Year Earnings $0.30, or 22%, Below Analyst Estimates

Beauty is in the eye of the beholder. HRB’s earnings from continuing operations in 2012 will be approximately $319 million. That’s a net margin of 11%, which is higher than in 2011. Hidden amongst the bad news is the realization that HRB prepared 4.5% more tax returns this year — almost 1 million additional clients.

HRB also took market share in both the digital and assisted categories. Most important, online tax returns grew by 20% this year, continuing a very positive trend.

Bill Cobb has it moving in the right direction. It’s only a matter of time before Intuit (NASDAQ:INTU[3]) starts to worry.

The bottom line: Investors such as Don Yacktman, who are able to look beyond today’s firestorm, see a strong franchise that’s bowed but not broken. And the big money is always made where everyone else fears to tread. Buy away.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 

Endnotes:
  1. HRB: http://studio-5.financialcontent.com/investplace/quote?Symbol=HRB
  2. preliminary fiscal 2012 financial results: http://www.sec.gov/Archives/edgar/data/12659/000121721112000014/exh99x1-041912.htm
  3. INTU: http://studio-5.financialcontent.com/investplace/quote?Symbol=INTU

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