I predicted on September 21st that H&R Block (HRB) would rally from $14 to $16-18 within a month, and to $25 by June. It did not disappoint, closing October 21st at $18.15. After trading flat for the last month, I am still confident that HRB will be back to $25 or higher by June and believe the December 8th FY21 forecast will be very bullish.
H&R Block trades between 6-7x free cash flow and returns the majority of it to shareholders via dividends and share repurchases. Considering the stable, recession proof nature of the business and the extended zero interest rate environment, H&R Block could double and still be considered reasonably priced.
If this wasn’t enough reason to be bullish, I see additional cash flow drivers over the next year as HRB brings expenses under control and benefits from a abnormal year that will complicate individual tax situations. Longer term, H&R Block will benefit from depressed commercial rent prices.
I see multiple incremental positives for H&R Block that could drive revenue growth this year.
1. New traders filing for capital gains
I agree with David Jackson that the elimination of brokerage commissions coupled with many out of work due to COVID-19 led to a boom in new brokerage customers. Robinhood increased its user base from 10 million to 13 million in the first 4 months of this year, half of which identified as first time investors, and E*Trade added almost 10x the number of new accounts than it added a year earlier. This all leads to more complex taxes many new investors could seek help for.
2. Taxable unemployment income and potential future stimulus
H&R Block estimated 7-8 million EIP (Economic Impact Payment) filers last year during their Q1 conference call. These are filers that claimed $1 in income to be eligible for Coronavirus relief payments. The majority of this group did not file a tax return and simply registered on the IRS’s website here.
The IRS considers unemployment insurance as taxable income and I believe most of these recipients will file FY20 taxes, even if they have no tax liability, in order to be eligible for any future stimulus over the next year.
3. Pricing Optimization
Both in Assisted and DIY, H&R Block was conservative in pricing last year, including offering free state e-file over the entire tax season. Because of the pandemic, price optimization was not an area focus, but from many questions and comments in the last conference call, it will be for next tax season.
We often see an external shock like COVID-19 act as the catalyst that forces companies to go through the painful but necessary process of streamlining its operations and getting spend under control.
At HRB, expenses (ex-occupancy/marketing) have ballooned from $394 million in 2018 to $471 million last year with revenue being flat. I believe that needs to get under control, so I was happy to see this addressed by CFO Tony Bowen during the Q1 Earnings Call
We’re also focused on driving cost efficiencies in order to fund our growth imperatives. These reductions include a hiring freeze, the elimination of merit increases, examining vendor spend, renegotiating rent across our retail footprint and limiting capital expenditures.
Q1 saw expenses flat year over year despite credit card charges being $10 million higher from the high Q1 volume.
I believe H&R Block could have line of sight into $100 million of savings this year.
- $15-20 million savings from credit card charges from the switch to Metabank as already announced (increasing to $25-30 next year.)
- $20 million in savings from Consulting, Outsourced Services, and Software IT and maintenance, which has ballooned to $187 million last year from $138 million as recently as 2018.
- $20 million in savings from employee travel being curtailed due to COVID-19.
- $10 million from legal fees returning back to the 5 year average.
- $30 from reduced occupancy expense (my conservative estimate of a 7.5% rent savings across their portfolio.)
H&R Block guided to a 24-26% EBITDA margin for the past two December quarters, and I think they could guide higher than that on December 8th.
Wave returning to growth
Wave’s business is small even within HRB, but any positive news about Wave would be helpful. Wave ended July on a good note, notching 20% YoY growth. Considering many businesses were still closed last quarter, this was a strong result.
Alexa site traffic hints Wave may have returning to an even higher growth rate this quarter as businesses reopened, which could be a bright spot on the December 8th report.
Powerful Incentives to get out of Wall St’s doghouse
H&R Block’s management team must be furious. The S&P500 is making all-time highs, the Fed has signaled an extended zero interest rate environment that should benefit high cash flow companies like they are, and they navigated COVID-19 better than most anyone could have expected – yet their share price is still down 30% year over year!
Seeing stock grants from prior years 50% underwater has to be frustrating and I expect HRB management to provide a bullish outlook when it reports on December 8th.
Another reason I believe H&R Block management is eager to tell its story and have the stock return to a higher valuation: they’re recruiting for a VP of Investor Relations.
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In the past few weeks, we’ve seen many deep value stocks re-rate higher very quickly. The KBW Nasdaq Bank Index (BKX) is up 20% in 2 weeks. Refiners like Marathon Petroleum (MPC) and Phillips 66 (PSX) are up nearly 50%. At some point, I believe HRB shares move far higher. In the mean time, I hope HRB management is repurchasing shares at these discounted prices.
I believe bullish guidance on December 8th coupled with the end of the tax loss selling season could see this stock back into the mid 20’s in a hurry.
Disclosure: I am/we are 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.