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Author: kishpj01 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 461  
Subject: Re: Around the H&R Block Date: 12/21/2003 6:32 PM
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Built with blocks, for sure. Not only is this a very healthy company with great growth prospcets but is appears to be undervalued at this time, also

There a are a number of changes in the tax code this year and changes almost always work to HRB benefit. If HRB continues to target higher-income individuals with more complex returns, it will allow for grater leverage from its cost structure because of the higher fee, per return.

HRB's mortgage business should move along well as the volume of mortgage applications still remains healthy. In addition, the company is involved with debt consolidation loans now and these efforts will serve HRB well as consumers continue to have a big appetite for easy credit and HRB can help heal the associated issues with big time consumer debt.

The prospects for the HBB investment advisory services looks bright and in line with the recent activity in the stock market. As more investors become comfortable with investing again, after this prolonged bear, HRB will benefit from their cross-selling strategy as most people trust HRB more than a “pure brokerage firms”.

Just doing a little due diligence, IMHO, if HRB per share earnings are $3.37 for the 2002 fiscal year, and earnings continue to grow at a rate of 14.90% annually, as they have for the past 10 years, and the company continues to pay out dividends at a rate of 52% per share, then we can project that in ten years HRB will have per share earnings of about $13 (pre-split)on a linear basis.

Projected pre-tax annual compounded rate of return over the next ten years will be approximately 18% at the current share price on a linear basis.

With a Sustainability Score (measures ability to sustain competitive advantage) of 27 (30 max) HRB revenue grew at 13%, 2002 over 2001, with Gross Margins of 49.64% and Net Margins of 17%. Cash is currently 1.12 times Total Debt with a Flowie (measurement of cash management) for HRB now standing at 0.99 representing a 3% change over last year, but well under our benchmark of 1.5%

Currently the Cash Margin for HRB is 16% representing a -24% change over last year, but still ok.

Over the last 10 years, management has been able to translate $1.00 in retained earnings to $2.20 in Market Value for HRB. Average Return on Equity over the past 10 years has been 24.64% compared to the current ROE of 7.00% for the S&P 500.

A well managed company should achieve good returns on equity while employing little or no debt. Comparing the Cash to Debt Ratio to a ROE of 37.00 for this year, we see a ratio of 32.95...the closer to 1 the better, so HRB should de-leverage some.

More importantly, however, it is "owner-earnings" or Return on Invested Capital that tells us the true story. Its not profit margins alone that determine a company desirability, but how much cash can be produced by each dollar invested by the "owners". The true test of management is how well they have grown "owner-earnings" over time. Now with HRB we see that over the last 10 yrs management has not been able to increase "owner-earnings (ROIC) as evidenced by a -2.42%. However average ROIC is still 17%, which is not bad.

Over the last 5 quarters we see the Flowie changing from 1.22 to the current 1.28 so the trend is going up which is not good, but still below our benchmark of 1.5%. HRB can be considered a "good" company and deserving of a 10 year Excess Return Period over the Weighted Average Cost of Capital on a Free Cash Flow basis.

With a conservative projected EPS growth rate over the next 5 yrs of 10 percent and a most recent fiscal year NOPM (net operating profit margin) of 41%, and a 30 Yr T-Bond rate of 5.00% plus a Beta of 1.2% and an Equity Risk Premium of 3.00%, and a Weighted Average Cost of Capital of 8.23% (given the most recent fiscal year Revenue numbers, Tax, Depreciation, Investment and Working Capital Rates as a % of Revenue) plus a 1.5% Bond Yield Spread and Debt Levels and Senior Claims, we conclude an Intrinsic Value of roughly $94 per share.

At $54 per share the Margin of Safety is pretty good. This is a 40 to 42% discount to IV, so the stock really appears to be undervalued and now may be a good time to pick up shares. I know I will.

Cheers
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