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Praveen Chawla
Praveen Chawla
Articles (84) 

Investment Note: H&R Block Has Strong Upside Potential

The company's strong free cash flow and a renewed push to serve small business are not yet recognized by the market

January 15, 2021 | About:

H&R Block Inc. (NYSE:HRB) is the leading "assisted" tax preparation company in the U.S., Canada and Australia.

The Covid-19 situation had resulted in the 2020 tax season being delayed, and this has hammered the stock. The price recovered somewhat over the summer and fall last year, but has since fallen back to an attractive level again.


There are two main forces impacting the tax preparation industry. On the one hand, we have greater automation with do-it-yourself (DIY) tax software (dominated by Intuit's (INTU) TurboTax), and on the other hand, we have greater complexity induced by the tax code, which require professional and expert help.

Due to these conflicting forces, H&R Block's revenues during the last five years or so have been flat. However, H&R Block has been consistently buying back shares and over the last 20 years, and its share count is less than half of what it was in 2000. The company produces solid cash flows and has high return on invested capital. It is also very shareholder friendly with high dividends and consistent share buybacks.

It should be noted that the company's market capitalization has declined considerably over the last 15 years. A big part of the reduction in market capitalization is due to reduced investor sentiment, in my view. The price-sales ratio has gone down from around 2 in 2004 to around 1 in the present day.

H&R Block's bread-and-butter business is income tax return preparation, operating primarily within the United States and, to a lesser extent, in Canada, Australia and other parts of the world.


H&R Block has also been divesting itself of peripheral businesses for several years. Its mortgage operations were discontinued, with the sale of Option One's servicing portfolio in 2008. Its Block Financial Advisors business was divested later that same year, while H&R Block Bank was sold in 2015.

H&R Block also runs a mobile banking and debit card business called "Emerald Card," oriented towards the underbanked clientele. Clients can load funds from tax refunds, government benefits and payroll on to their emerald card accounts and then spend it wherever master card is accepted. H&R Block earns a transaction fee with every purchase.


H&R Block also acquired Toronto based, Wave financial in June 2019 for $408.4 million to refocus on small business.

PCMag.com gives Wave an Accounting "Software as a Service" offering an Excellent rating and describes Wave as,


Wave is priced like a freelancer accounting application (it's free) and it's an excellent service for that market. But it also offers enough extras that a small business with employees could use it—with some caveats.

I personally use Wave in my small business and can vouch for its excellence in getting the job done.

The Wave acquisition expanded H&R Block's product and client portfolio with Wave's accounting, invoicing, payroll and payments software solutions to H&R Blocks suite of products.

As a result of the Covid-19 pandemic and its impact on Wave's small business customers, H&R Block evaluated the Wave reporting unit's goodwill for impairment during the fourth quarter of 2020. The fair value was less than the carrying value, therefore it took a goodwill impairment loss of $106.0 million.

Balance sheet

As a result of the pandemic, H&R Block drew upon a $2 billion unsecured line of credit, which was reduced to $70 million in Q1. The line of credit will mature on Setp. 23, 2023.

This diagram shows the evolution of H&R Block's liability and equity side of the balance sheet. Long term debt has grown considerably due to the company's continued share buybacks. The following table summarizes HRB's long term debt.

(in thousands)

As of

October 31, 2020

October 31, 2019

April 30, 2020

Senior Notes, 4.125%, due October 2020



Senior Notes, 5.500%, due November 2022




Senior Notes, 5.250%, due October 2025




Senior Notes, 3.875%, due August 2030


Committed line of credit borrowings




Debt issuance costs and discounts







Less: Current portion






The estimated fair value of H&R Block's long-term debt, including the current portion of long-term debt totaled $1.7 billion as of Oct. 31, 2020 compared to $1.7 billion in the same period of 2019 and $3.5 billion on April 30, 2020. The debt, though high, is comfortably covered by operating cash flow, as the debt-to-Ebitda ratio is less than 3.


H&R Block pays a very nice dividend of 6.45% and consistently buys back stock. Stock buyback for the last three years has been 2.4% . The dividend has grown at a rate of 6% per annum for the past five years.


I arrived at a ~$20 fair value for H&R Block using the Gurufocus Discounted Free Cash Flow calculator. I used $1.67 as earnings per share (based on trendline and analyst consensus EPS, which is $3.34 for 2021 and $2.58 for 2022) and projected a growth of 5% for the first decade and 3% for the second decade. I used a 10% discount rate. It should be noted that H&R Block's EPS and free cash flow per share have been erratic in recent years.



I think in spite of the high debt load of $1.7 Billion, H&R Block has the potential to deliver a double-digit return in the next three to five years. Free cash flow (FCF) is high, and normalized FCF of ~$475 million a year. With a market cap of ~$3 billion, this works out to an FCF yield of around 16%.

Apr15 Apr16 Apr17 Apr18 Apr19 Apr20 TTM/current Median
Free Cash Flow 503.45 444.63 462.942 751.42 511.048 27.276 474.123 474.12
Current Market Cap 3003
FCF Yield ~16%

H&R Block has an asset-light business model. Recently, it has innovated by integrating banking with its recently acquired Wave accounting application. This has the potential to become a very sticky platform for small business clients. In my opinion, it is likely that H&R Block will make further acquisitions to build out its small business platform.

My short to medium price target is $25, as the stock price normalizes and reverts to mean. I am optimistic about the new Wave accounting acquisition. I think this acquisition has the potential to move H&R Block forward into a relatively higher growth area, i.e., professional services for small businesses.

Disclosure: The author owns shares of H&R Block.

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About the author:

Praveen Chawla
I am a full-time investor now, investing my own money. I spent most of my working life in the pharmaceutical industry.

Rating: 3.0/5 (1 vote)



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