HRB : An update

Since my last report on HRB, the stock has risen nearly 30%, past my original conservative valuation of $13.11. With the tax early filing season now nearly over, I thought that this would be a good time to do an update on the second largest position in my portfolio.

At the start of the filing season, when the OCC banned Block’s RALs, it was anticipated that Block will lose large numbers of early filers to Jackson and Liberty. Block adopted a strategy of lowering retail fees and steering customers towards its Emerald card product. Then, midway through the filing season, the FDIC banned RALs for Jackson as well, which led a sharp dive in the its stock price, since a much larger slice of Jackson revenue depends on their RAL product. Today, Block announced that contrary to popular belief, the company actually gained early season tax filers, mainly eating into Jackson’s market share. Even more promising, Block reported a 7.3% increase in the digital return segment, a key battleground market.

It is now clear that Sheila Blair/FDIC/OCC considers RALs to be a predatory product and a tax on the poor, and it is highly likely that this product will be banned outright or regulated out of existence in the future. In the post-RAL world, Jackson is highly unlikely to be able to fund its enormous debt load, and appears to be headed for the dust heap of history. The most probable scenario is a chapter 11 reorganization, with assets being purchased on the cheap by Liberty. The retail tax market appears to be heading towards a duopoly dominated by a huge Block and a much smaller Liberty. The investing public also appears to take this view, with the JTX stock diving 40% since the beginning of the year, while the HRB stock is up 30%

With the economic moat derived from having a monopolistic market share in a recession resistant business, I am willing to assign HRB a higher multiple of 15. I expect free cash flow to still remain at $420M annually despite the gain in market share, since the market share was acquired partly by lowering fees. This translates to a market cap of $6.3B, reduced by $200M for mortgage portfolio losses, to a final valuation of $6.1B, or $20.22.

Disclosure : I own HRB shares.