H&R Block: Tax Filings Climbing, Profits to Follow

by Dan Burrows | March 11, 2013 1:42 pm

It might be too late to get in on the really big gains, but boring old H&R Block (NYSE:HRB[1]), the nation’s largest tax preparer, has become a hot growth stock … at least in the estimation of some investors and analysts.

Shares in H&R Block have jumped 46% for the year-to-date and more than 70% in the last 52 weeks, crushing the S&P 500 by 38 percentage points and 58 percentage points, respectively. True, the stock now looks a bit pricey, at least on a forward earnings basis — trading at fat premium to its own five-year average — but the bulls say there’s still ample upside ahead.

Late last week, H&R Block rallied sharply even though it posted a wider-than-expected loss for its fiscal third quarter. But the company got a pass on the nasty results for a number of reasons.

For one thing, the damage was largely the fault of the Internal Revenue Service, as the stalemate in Washington forced it to open the filing season about a couple weeks later this year.

More importantly — to the Street’s thinking, anyway — H&R Block is making progress on paring expenses, taking market share away from Intuit’s (NASDAQ:INTU[2]) TurboTax. But the biggest boost for HRB comes from its current-quarter outlook.

After all, the current quarter is key. Tax-filing season is responsible for about three-quarters of H&R Block’s annual take. Trickier taxes for everyone, courtesy of the expiration of the Bush-era tax cuts and the phasing in of the new national healthcare law, are expected to drive business to the tax preparer.

As CEO William Cobb said on a conference call with analysts last week:

“We continue to believe that industry filings this tax season will grow in line with historical levels of approximately 1 percent to 2 percent. While it’s still early in the season, we believe we are outperforming the market [read: TurboTax] thus far in both the assisted and digital categories.”

At the same time, earnings are expected to rise rapidly though the end of next fiscal year, thanks to cost cuts. In the most recent quarter, H&R Block’s total expenses dropped more than 15% to $564.6 million. Indeed, for this fiscal year alone, H&R Block said cost cuts will yield anywhere from $85 million to $100 million in in pretax earnings.

Another big boost for shares has been a relief over waning risk from liabilities tied to its wholly owned but legally separate mortgage subsidiary, Sand Canyon Corporation — formerly known as Option One — says BTIG analyst Mark Palmer in a new note to clients:

“The most significant overhang on the HRB story is the potential impact from mortgage putbacks at Sand Canyon Corporation … SCC reported just $16mm in new claims during 3Q13, a benign figure that followed a similarly inoffensive $10mm in new claims in 2Q13 … As the risk associated with SCC continues to wane, the removal of the overhang should be supportive of multiple expansion, in our view.”

If Palmer is right, then we can throw out the argument that H&R Block is expensive compared to its own five-year average price-to-earnings multiple.

It also helps the bull case that H&R Block has a much stronger long-term growth forecast than the broader market. Analysts, on average, expect the tax preparer to increase earnings by more than 12% a year for the next five years. The S&P 500’s growth rate stands at less than 9%.

Topping it all off is the thesis that H&R Block is a total return stock, or price appreciation plus dividends (currently yielding 2.9%) plus share buybacks. Palmer notes that a successful sale of H&R Block Bank could free up as much as $400 million to repurchase stock, which would be a key driver of earnings per share growth in fiscal 2014.

There’s a compelling bull case to be made on H&R Block’s stock; however, it’s likely to be one of more muted gains ahead.

As much as it might be set up for market-beating returns, the 46% jump this year alone probably means the silly easy money has already been made.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

  1. HRB: http://studio-5.financialcontent.com/investplace/quote?Symbol=HRB
  2. INTU: http://studio-5.financialcontent.com/investplace/quote?Symbol=INTU

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