H&R Block Inc. $25 – New York symbol HRB

H&R BLOCK INC. $25 (New York symbol HRB; Conservative Growth Portfolio, Finance sector; Shares outstanding: 329.2 million; Market cap: $8.2 billion; WSSF Rating: Above average) is best known for its income tax return preparation business. The company provides these services through over 14,500 company- owned and franchised offices in the United States, Canada and Australia. It also sets up temporary offices in major retailers such as Sears and Wal-Mart in the weeks before the April 15 tax deadline. The tax preparation business accounts for about 70% of the company’s total revenue. H&R Block also provides tax, accounting and consulting services to businesses through wholly owned RSM McGladrey Inc., which is the fifth-largest accounting firm in the U.S. Services to businesses account for 20% of H&R Block’s revenue. The remaining 10% of H&R Block’s revenue comes mainly from its H&R Block Bank subsidiary, which provides loans and credit cards to its tax preparation clients. The company now aims to expand its long-term earnings potential by focusing on its main tax and accounting operations. The biggest part of this plan involves quitting the home mortgage business. It also plans to cut its annual expenses by $110 million.

Sale helped H&R Block cut its debt

In April 2008, the company sold its mortgage servicing operation, which collects loans on behalf of other lenders. It used the proceeds of $1.2 billion to repay $986.2 million in debt related to the mortgage business. Long-term debt now stands at $1.0 billion, which is just 12% of H&R Block’s market cap. H&R Block also recently agreed to sell its financial advisory subsidiary for $315 million. This business provides brokerage and wealth management services to 376,000 clients. While profitable, the company feels this business is too small to compete with larger wealth management firms. To put these sales in context, H&R Block’s earnings before one-time items fell from $1.95 a share (total $704.3 million) in 2004 (fiscal years end April 30) to $1.15 a share ($374.3 million) in 2007. Thanks to the success of its new strategy, earnings in 2008 improved to $1.39 a share ($454.5 million). Revenue rose from $4.2 billion in 2004 to $4.8 billion in 2006. Revenue fell to $4.0 billion in 2007, but grew to $4.4 billion in 2008. H&R Block’s tax preparation business served a record 23.5 million clients in fiscal 2008, up 2.6% from 22.9 million in the prior year. The 2008 figure excludes 291,000 clients who only filed a tax return to qualify for government stimulus checks. Average revenue per client grew 4.3%, to $172.18 from $165.06. The company uses refund anticipation loans to help attract new clients. Clients expecting a refund can receive a loan equal to the value of the refund, less transaction fees, without having to wait for the Internal Revenue Service (IRS) to process the return. H&R Block is also expanding its tax software operations. Last year, it acquired the company that makes the TaxWorks program for $24.8 million. Tax- Works helps small tax preparation firms file returns for business clients. Demand for H&R Block’s business services is also improving. Tax preparation revenue grew 8.2% in fiscal 2008, while consulting revenue rose 13.0%. That’s mainly due to an increase in the number of tax advisors, as well as higher productivity per advisor.

Strong dividend growth continues

Thanks to its improving outlook, the company has increased its dividend for the 11th consecutive year. It now pays a quarterly dividend of $0.15 a share, up 5.3% from the previous rate of $0.1425. The implied annual dividend of $0.60 yields 2.4%. H&R Block also plans to resume share repurchases after suspending them in fiscal 2008. It’s now authorized to buy back $2 billion worth of its stock over the next four years. The stock has responded favorably to the company’s new focus, gaining nearly 50% since the start of 2008. Despite the rise, the shares still trade at a reasonable 15.1 times the company’s likely fiscal 2009 earnings of $1.66 a share. H&R Block is a buy.

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