A Stumbling H&R Block
DIY products take charge in retail tax prep, but don't count out industry giant.
For decades, H&R Block (HRB) dominated the tax-preparation market as by far the leader in the number of returns processed. However, this dynamic has changed. According to our estimates, TurboTax-maker Intuit (INTU) is now clearly on top, processing approximately 17% of the returns in the retail tax-prep market. Intuit steadily has increased its market share and the pace of these gains has been impressive, in our opinion. This trend also highlights the changing preferences of the industry's customer base. Taxpayers are becoming increasingly comfortable with do-it-yourself products, given their ease of use.
However, Intuit's market share gains have not necessarily come totally at the expense of H&R Block, there has not been a corresponding one-for-one decrease in the number of tax returns processed by the traditional tax-prep firm. Instead, we believe DIY products may cause long-term growth to stagnate for both the number of returns processed and the price charged by the traditional tax-prep firms. The imminent death of legacy tax-prep products is therefore not in the cards, as a significant number of taxpayers always will find them appealing. Over the long term, however, we believe the price of legacy products will start to converge with the price of DIY products until the value proposition becomes more compelling to the average industry customer. This dynamic was hinted at during the last tax season, as H&R Block ran a program where it processed basic 1040-EZ returns for free at its branch offices. Including these free returns, the average price per legacy return decreased 3.3% to $182.96, according to our estimates. In addition, we estimate the price per DIY return fell 5.8% to $34.58 and the blended price of all returns was down 6.4% to $135.98.
This trend most likely will continue over the long term as the price between legacy and DIY products converges on a relative value basis. Given the strong growth trend in the DIY market segment and H&R Block's initial reluctance in embracing these products, we believe the firm needs a relatively robust strategy in order to capture any meaningful value from this market niche.
H&R Block's Moat Is Drying Up, but There Is Still Opportunity
Retail tax-prep customers have been steadily demanding more value for each dollar spent on services. This means that H&R Block's core service may no longer provide the kind of returns it once did. Compounding these challenges has been a zealous federal government that is focused upon making the tax-return process as inexpensive as possible. The tough challenges that face traditional tax preparers are daunting and most likely will mean lower returns on invested capital moving forward.
However, we do not believe this necessarily means H&R Block's future ROICs will fall below its weighted average cost of capital during our modeling period. If the firm can properly align its cost structure and asset base to reflect the pricing and demand changes that have occurred for its legacy products, then H&R Block will be able to leverage its asset-light operations into decent investor returns. In addition, if the company can formulate a consistent DIY strategy, then it should be able to scale that business. We believe the 2011 tax season is a precursor to future market trends and gives credence to our downgrade of H&R Block's moat to narrow from wide in March 2010.
Vishnu Lekraj does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.