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Investing is often about weighing the possibilities of various
outcomes and then trying to assign a value to the stock on a balance of
probabilities. With Intuit,
I think investors are getting a fundamentally cheap company that has
disappointed in its core activity this year but is performing very well
in its fast-growing non-core businesses. Furthermore the question marks
over its core activity (tax returns) won’t be at the forefront of
investors’ minds until next year. Time to pick some up?
Intuit explains itself
Having previously been rather positive over its prospects for its
core tax-return business this year, the company managed to disappoint
the market by announcing that it would only grow 4% this year. This is
below the 8-10% analysts had penciled in. For an idea of how important
tax returns are to its full year, readers can take a look at the charts in the article linked here.
Naturally, investors will want to focus on why and how its tax-return
revenues came in lower than expected. Here are the reasons cited.
Overall tax returns were 1%
lower this year against Intuit’s previous expectations of 1-2% growth.
The IRS has not yet come to a clear conclusion as to why this was so,
therefore it would be remiss to expect Intuit to have a clear view
either at this time. Obviously this is an industry issue which could
normalize in future years.
More worrisome, the software
category only took 1% market share from manual when it had expected it
to come in at 2%. This could be an indication of a slowing of growth in
this secular trend or it could be a reflection of issues with Intuit’s
software.
Intuit claimed that it
didn’t grow its online share as it had expected (although it did well
with mobile and retail) and smaller competitors took some share. With
60% of the market Intuit is obviously vulnerable to future erosion.
In summary, it wasn’t as good as expected. But the reasons for this
are a combination of structural and company-specific issues.
Nevertheless there were some plus points. Mobile is performing very well
and Intuit has clear leadership in developing mobile-app solutions. In
addition it is competing well against H & R Block . In addition its main rival reported in its press release that the industry had "experienced
unprecedented delays and changes to the timing of taxpayer filings this
tax season which created significant challenges."
It then went on to argue that it was essentially flat in terms
of overall market share of tax returns. So while H & R Block is
pleasing investors because it has managed to fight back against Intuit
by developing its own online operations, this is not really a story of
Intuit notably losing market share. Moreover if there are some
structural reasons why manual tax returns can stabilize their market
share then H & R Block is going to be a relative winner out of this.
Intuit's Small Business Group continues to grow
If tax returns disappointed, then there was no such let down
with its Small Business Group (SBG) results. This group made up 35% of
revenues in 2012 and is growing in the mid-teens. A graphical depiction
of its ongoing growth is shown below.
These results have been achieved in an otherwise weak
environment for small business and they attest to the cost-effectiveness
of their offerings. In addition, Intuit has the capability to
cross-sell solutions across its customer base. There is a natural
correlation between financial management solutions (QuickBooks, etc.)
and HR services
Indeed, this space is getting somewhat more competitive now with Paychex and Automatic Data Processing chasing growth in order to offset slow growth in their core offerings. I’ve discussed these companies in more detail in an article linked here. Paychex’s
payroll service market is only growing in low single digits but its
human resources services operations are growing in double digits.
Paychex's key attraction is its dividend yield, and even though it has
more limited pricing power than in previous recoveries, it still has
upside from the jobs recovery working its way down into small
businesses. Meanwhile ADP’s growth prospects come from its professional
employer organization services group. The environment is clearly getting
more competitive, but for now Intuit is performing well.
Where next for Intuit?
I think investors need to keep things in perspective here. Intuit is a
huge cash generator and is on a good cash-flow yield. This hasn’t been a
good year for its core tax revenues but it still recorded 4% growth
while growing its SBG in the mid teens. If it only replicates this
performance next year, then I think the stock is a good value. Indeed,
there is some upside potential from some of the structural issues
(falling tax returns) being resolved.
By my calculations Intuit has generated over $1.2B in
free cash flow on a trailing year basis and as I write. That puts the
stock on a free-cash-flow yield of 6.8%. In other words, if you buy the
stock now and it keeps generating this kind of cash then in 14 years
(and this is conservatively assuming no real growth) it will have
generated its evaluation in cash. I think that is attractive for a
business that – despite slowing growth in its core activity – is still
capable of revenue growth in the high single digits. In addition, the
market's focus is largely going to be on its SBG until the next tax
season comes around.
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