Shares

H&R Block, Inc. (NYSE:HRB) Shares Could Be 22% Below Their Intrinsic Value Estimate

Key Insights

  • H&R Block’s estimated fair value is US$66.54 based on 2 Stage Free Cash Flow to Equity
  • H&R Block is estimated to be 22% undervalued based on current share price of US$51.80
  • Our fair value estimate is 26% higher than H&R Block’s analyst price target of US$53.00

How far off is H&R Block, Inc. (NYSE:HRB) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by estimating the company’s future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they’re fairly easy to follow.

Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for H&R Block

The Model

We’re using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company’s last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$577.2m US$520.1m US$487.8m US$470.1m US$461.5m US$458.9m US$460.3m US$464.6m US$471.0m US$478.9m
Growth Rate Estimate Source Est @ -15.15% Est @ -9.89% Est @ -6.21% Est @ -3.63% Est @ -1.83% Est @ -0.57% Est @ 0.32% Est @ 0.94% Est @ 1.37% Est @ 1.67%
Present Value ($, Millions) Discounted @ 6.8% US$541 US$456 US$401 US$362 US$333 US$310 US$291 US$275 US$261 US$249

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.5b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.4%. We discount the terminal cash flows to today’s value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$479m× (1 + 2.4%) ÷ (6.8%– 2.4%) = US$11b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$11b÷ ( 1 + 6.8%)10= US$5.8b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$9.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$51.8, the company appears a touch undervalued at a 22% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.

NYSE:HRB Discounted Cash Flow June 18th 2024

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at H&R Block as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we’ve used 6.8%, which is based on a levered beta of 0.954. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for H&R Block

Strength

  • Earnings growth over the past year exceeded its 5-year average.
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness

  • Earnings growth over the past year underperformed the Consumer Services industry.
  • Dividend is low compared to the top 25% of dividend payers in the Consumer Services market.
Opportunity

  • Good value based on P/E ratio and estimated fair value.
Threat

  • Total liabilities exceed total assets, which raises the risk of financial distress.
  • Annual earnings are forecast to decline for the next 2 years.

Moving On:

Whilst important, the DCF calculation shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For H&R Block, we’ve compiled three fundamental items you should assess:

  1. Risks: To that end, you should learn about the 3 warning signs we’ve spotted with H&R Block (including 1 which makes us a bit uncomfortable) .
  2. Future Earnings: How does HRB’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we’re helping make it simple.

Find out whether H&R Block is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Valuation is complex, but we’re helping make it simple.

Find out whether H&R Block is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

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