Wednesday, February 27, 2013

Intuit Still Looking Good Value

Despite the mini fall in the markets recently I’m still finding it hard to find stocks with the golden combination of free cash flow yields in excess of 5% and reliable mid teens earnings prospects. The good news is that one of my long term holdings Intuit (NASDAQ: INTU) is offering those metrics and more. In summary, I like the recent results. The company confirmed the full year guidance so the upcoming tax season looks okay, and its small business group solutions continue to grow in the mid teens. It’s not too late to pick some up.

Intuit Deserves a Re-rating

I think so and not only because of the favorable employment picture dropping into the bottom line of its DIY consumer tax offerings. The other big stories are the gradual acceleration in its small business group solutions (Employee Management, Financial Management and Payment Solutions) and its opportunity to grow margins with the shift to Software as a Service (SaaS) based revenues. I know the company well, and there is a useful primer post on the company linked here from which readers can get more background information.

Going back to the current results I want to demonstrate how they signal continued diversification by breaking down 2012 operating income here. The small business group solutions are broken out in the second circle. The group made up 35% of revenues in 2012, and this will increase in 2013.

The point is that Intuit is diversifying its earnings away from the cyclicality of Consumer Tax. Moreover, the small business group is consistently growing revenues at a strong clip.

Furthermore, the shift towards online based solutions continues apace. To give an idea of what can be expected, Intuit explained that the tax software five year CAGR was 7% as compared to tax stores being down 1% and pro’s being up 1%. In that time period Intuit has trounced H&R Block (NYSE: HRB) both as a company and as an investment. Within its US Federal TurboTax business, Intuit reported 72% share from web based units and only 23% from desktop. This changed from 69% and 25% respectively in 2011. So it is all about the web for TurboTax.

Similarly, it is managing a shift in its Financial Management Solutions (Quickbooks) towards a subscription based model and away from desktop units. Online subscribers increased 28%, and desktop subscribers were up 25% too with desktop units down 18%.

Intuit’s Secular Growth Drivers

A key part of growth in the future will be Intuit’s market leading mobile applications. Its share with mobile is higher than with other channels but it remains a small part of the business. Nevertheless, when a company declares that it is achieving 3x the number of mobile downloads this year then it is clear that the long term opportunities are significant.

As for the shift to SaaS based revenues, this isn’t just about expanding the top line. Cloud based solutions encourage margin expansion because companies can cross sell their solutions to subscribers and therefore make marketing more efficient while consolidating technology costs. For example, a company like Adobe Systems (NASDAQ: ADBE) is engineering this shift because it increases the lifetime value of a customer. It also encourages certain users to sign up for the product when they may have been using it illegally. Adobe is seeing a fall in upfront revenues as this transition takes place, but interestingly Intuit has been relatively unscathed with this issue. I think both companies will succeed.

H&R Block is trying to fight back, but so far it doesn’t appear to have taken any market share away, and with Intuit declaring that its own tax advice support operations were working well now, HRB has lost a small window of opportunity to take share.

Where Next for Intuit?

The next quarter is where Intuit usually makes 88% of its income so it is too early to definitively say how the year will go. However, the early indications for the tax season are positive. Employment is up, and online monitoring suggests that Intuit is at least holding market share on consumer tax. Looking longer term, it estimates that there are 40 million tax filers who could potentially use its service because their tax returns are simple enough to use software.

In addition, I like the strong growth in the small business group and the ongoing cash flow generation, I will continue to hold with a $71 price target.

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