H&R Block Stock: Time to Consider Selling? (HRB, TAX)

Shares of H&R Block, Inc. (HRB) are up 33.6% year to date and 19.8% in June alone following strong earnings releases. The company has delivered solid results, laid out a promising outlook and raised its dividend. However, the underlying business fundamentals are unlikely to have changed enough to warrant the gain in the course of six months. The increase could mark the appropriate time to take gains, assuming the stock was not substantially undervalued before the run-up.

H&R Block has reported relatively flat revenues since discontinuing its business services segment and mortgage operations in fiscal 2012. Since then, annual sales have ranged lower, hovering between $2.89 billion and $3.08 billion. The top line expanded 1.3% in the most recent quarter, and analyst outlook is similarly modest. The latest results featured rising average charges offset by falling volume. (See also: H&R Block Beats Q4 Earnings and Revenue Estimates.)

H&R Block has had relatively stable gross margin performance, although the most recent results are slightly below decade highs. After moving away from lower-margin elements of its portfolio, the company was able to drive gross margin as high as 48%. Since then, there was decline of 350 basis points through 2016. The downward trend reversed in fiscal 2017 with a gain of 130 basis points. This line was heavily influenced by lower bad debt expenses and shifting toward more profitable locations, which cut down on personnel and facility expenses relative to revenues.

H&R Block's operating and net margins have followed a similar pattern as with gross margins. There was a substantial gain from shedding the business services and mortgage departments, at which point the top line fell before ticking upwards in fiscal 2017. Management attributed major gains to general cost-controlling measures and lower bad debt expenses, which fell from the gross margin level. (See also: H&R Block Gets IBM's Watson for Your Taxes.)

The above swings in revenue and margins have caused H&R Block's profit levels to be inconsistent in recent years, although the company has reliably delivered accounting and cash profits. Operating income and free cash flow in fiscal 2017 were both below the levels achieved in 2014 and 2015, but they were also slightly higher than in fiscal 2016. Company management and analysts expect profits to expand from this point due to cost-containment efforts.

H&R Block's efficiency ratios reveal generally positive trends. Asset turnover reached a decade-long high at 1.09, having previously fallen as low as 0.59. The company's closest rival, Liberty Tax, Inc. (TAX), managed only 0.56 over the trailing 12 months. H&R Block's move away from business and mortgage services has also helped with cash collections. Days sales outstanding (DSO) is 13.91, a mark surpassed only by the results from fiscal 2016. (See also: Understanding the Cash Conversion Cycle.)

H&R Block's basic financial health metrics do no indicate anything alarming, but investors should be aware of several factors. The company now has negative book value, as its cash inflows from operating and investing activities in fiscal 2017 were not enough to fully offset cash outlays for dividends and share repurchases. Negative book value is not necessarily a bad thing, but it does mean that all of the company's financing is now debt. Debt-heavy capital structures can open equity investors to additional risk in the event of liquidity problems caused by protracted business weakness. H&R Block's current ratio, which measures liquidity, is healthy at 1.43. While this trails rival Liberty Tax's current ratio by a significant margin, H&R Block still has ample short-term resources. (See also: Liquidity Measurement Ratios: Current Ratio.)

Investors seeking exposure to the tax preparation industry must pay a premium for H&R Block shares over the closest alternative. H&R Block stock is more expensive based on nearly every relative valuation metric. Forward price-to-earnings, price-to-free-cash-flow, PEG ratio and enterprise-value-to-EBITDA are all substantially higher for H&R Block than for Liberty Tax. Liberty Tax also pays a higher dividend yield. H&R Block appears to be functioning more efficiently than Liberty Tax at the moment, and its profit outlook is strong. However, analysts do not expect H&R Block to grow more quickly than its peer.

H&R Block shares could be attractive for income investors who are seeking a stable company that is a market leader in its niche, albeit in a fragmented market. But H&R Block has limited growth potential, and if both companies benefit similarly from positive market conditions, Liberty Tax is likely to enjoy higher upside due to its cheaper valuation. (See also: Liberty Tax: Should Value Investors Pick This Stock?)