H&R Block Seeing Hedge-Fund Buying

 | Jun 05, 2013 | 10:00 AM EDT  | Comments
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Last quarter, a number of hedge funds and other notable investors initiated positions in H&R Block (HRB), the $8 billion market cap tax-prep company. Among them were the legendary investor and billionaire Julian Robertson (formerly of Tiger Management) as well as Lone Pine Capital, a hedge fund managed by billionaire and Robertson protege Stephen Mandel. Viking Global, which is also managed by a billionaire "Tiger cub," Andreas Halvorsen, increased its holdings of the stock by 10% to over 25 million shares. Viking Global alone owns close to 10% of the company.

H&R Block would seem to be a rarity in the modern U.S. economy: a (mostly) brick-and-mortar, labor-intensive business that is thriving, even in the midst of competition from software, primarily Intuit's (INTU) TurboTax. H&R Block does also provide its own tax software, but according to the company's report, more than 60% of tax returns in the first nine months of its fiscal year were prepared in either company-owned or franchised physical locations, roughly even with the previous year.

During this period, revenue fell 21% compared with the first nine months of the previous fiscal year, and almost all of that decline occurred in the quarter ending in January 2013. However, operating losses showed little change.

Of course, what might be called "the rest of the year" is not that relevant for H&R Block -- the fiscal quarter ending in April (the fourth of the company's fiscal year) is key. Analyst consensus is for earnings of $2.60 per share, which would be a large improvement from last year's $2.04 per share. To some degree, higher earnings could reflect delays in tax-prep activity this year as a result of Congress' late passage of tax legislation rather than organic growth. However, analysts are expecting EPS to be $1.61 in total for the fiscal year, which would be an increase of 26% from the last fiscal year, and then another 17% increase in the current fiscal year.

These forecasts imply a current-year price-to-earnings multiple of 15, as the expected earnings growth comes alongside a rise of more than 90% in the stock price in the last year. At that pricing, H&R Block would then need to continue at least modest earnings growth in order to justify the current valuation. Frankly, we'd be concerned that Wall Street is setting too optimistic a target for the company. We've noted that H&R Block remains focused on physical locations, and the proliferation of not only TurboTax but also a number of "free to file" programs should continue to be a competitive threat.

In addition, TurboTax's ad campaign this past year that slammed H&R Block for advertising for employees with "no tax experience necessary" and mocked the company's tax preparers for having regular jobs as retail workers and plumbers was harsh, but it is a line of attack that might be more persuasive if better presented.

H&R Block currently pays a dividend yield of 2.7%, and in the first nine months of its fiscal year it returned more than $500 million in cash to shareholders through stock repurchases and dividends. This was a large increase in percentage terms from the same period in the previous fiscal year, particularly in terms of buybacks, and it's possible that Robertson, Mandel, Halvorsen and the rest take this as a sign that any increase in earnings would be coupled by an even more aggressive program to return cash to shareholders.

The moment of truth for H&R Block's fourth quarter comes on June 12, when the company announces earnings. We'd hesitate to buy ahead of that event, as there's at least moderate risk that the numbers will come in below expectations. If the company does hit its targets, the current valuation will still incorporate a good deal of future growth, and we'd want to dig through what H&R Block's sources of earnings growth were and whether those factors would remain in play over the next couple of years.

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