Wednesday, December 19, 2012

Intuit is An Undervalued Cloud Play

Intuit (NASDAQ: INTU) delivered results in line with estimates and affirmed full year guidance, but its next quarter was seen as ‘weaker’ than expected. I use inverted commas because the reason for this is that revenues in its core tax division tend to move around based on the timing of tax legislation. This year it has caused revenues to move more into the third quarter. This is not really an issue for me, but you never know how the market will react to this sort of thing. In summary, I think the stock remains a compelling mix of growth and value that should attract any GARP based investor.

Intuit’s investment Case

The case for Intuit is fourfold and offers a nice mix of cyclicality and secular growth. I’ve put the main points in bullet form.

  • Cyclically growth in its core tax revenues as the economy improves
  • Secular and cyclical growth in its small business group as it increasingly cross sells its solutions and transitions clients to the cloud
  • International expansion
  • Improving operational metrics overall as a result of increasing software as a service (SaaS) revenues

Frankly I think the numbers speak for themselves with Intuit. You can think of it as a business growing its tax revenues in the mid-single digit range with some growth kickers from any economic improvements and mid-teens growth in is small business group leading to overall growth in the low teens. Throw in its high free cash flow conversion, which is forecast to grow in line with operating income this year, and the stock has good upside potential.

A look at how the individual segments of the Small Business Group are growing.

Growth is pretty strong here, and the company continues to diversify its revenue and income streams from do-it-yourself consumer tax revenues. We can see this in the breakdown of revenues and income for the full year.

Consumer Tax remains the most profitable income generator and the highest margin business, but employee management margins are now pretty similar. Going forward, if Intuit can continue the mix of mid teens growth in the small business group and single digits in consumer tax, then the opportunity of diversification (and therefore a re-rating based on risk reduction) is obvious.

Get Into the Cloud with Intuit and Others

The key to Intuit’s growth strategy is going to be further integration of its solutions across new platforms such as mobile and tablet. As such, it is a continuation of how the company has been transformed in recent years. It has delivered a sound competitive thrashing to H & R Block (NYSE: HRB) in the tax preparation market. As he is wont to do, Warren Buffett does sometimes invest in value stocks that are about to be overtaken by a technological erosion of their business moats. Such was the case with his position in H & R Block.

Intuit is the poster child for companies moving to the cloud, and you can see others like Adobe Systems (NASDAQ: ADBE) and Autodesk (NASDAQ: ADSK) trying to follow in its footsteps.

These two haven’t exactly found it easy going. Autodesk has been battling with a cyclical slowdown in manufacturing, and a shift in its model seems to have been met with some customer resistance as many of them were buying individual solutions rather than packages.

As for Adobe, the switch to SaaS has caused a short term reduction in growth as initial revenues are less for services. I’m bullish about Adobe’s prospects, because I think the shift will generate more lifetime value and, in common with Autodesk, there will be many enticed to pay the smaller initial upfront fee rather than continue to illegally download/copy software.

Where Next for Intuit?

Longer term there is a question mark over where Intuit will be, but short to mid-term its prospects look excellent. The shift to the cloud has improved its cash flow generation and ability to generate more bang for its marketing buck. On the basis that free cash flow generation will match operating income growth next year, Intuit could generate around $1.25 billion, and this comprises around 7.4% of its enterprise value. Not bad for a company growing earnings in double digits.

Headwinds are coming in taxes and other areas, but the stock seems to have enough margin of safety to justify buying. At last I think so, because I happen to hold it!

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