For a company to not be taking part in this strong bull market, particularly when its revenue and earnings are growing, tells you something about how the Street views the company. Intuit (Nasdaq:INTU) may have once been a growth stock darling, but those days are past, as investors and analysts appear much more concerned about the company's consumer tax business than its long-term growth potential in small business services. I continue to believe that these shares are undervalued, but investors may have to wait a bit for that value to develop.
Results In Line With Adjusted Expectations
Intuit had warned the Street about the direction of its fiscal third quarter results, so there weren't too many surprises left for the actual report. While I don't want to pretend that lower guidance isn't a bad thing, I think the numbers and performance really weren't all that bad on their own.
Revenue rose 13% as reported, with the Consumer Tax business up 14%, the Small Business Group up 17% (12% on an organic basis), and Accounting Professionals and Financial Services both up 9%. Within SBG, Financial Management Solutions saw revenue grow 24% (or 12% organic), while EMS grew 11% and payments were up 13%.
Margins also continue to improve. Gross margin rose almost a point and a half. Operating income rose 12% by GAAP and 17% on an adjusted basis, with operating margin (non-GAAP) improving more than two points and beating the average estimate by almost half a point.
SEE: Understanding The Income Statement
Are The Company's Consumer Tax Problems Structural Or Circumstantial?
For two years running, Intuit has disappointed the Street with the performance of its consumer tax business (TurboTax and the satellite operations). This time around, total units (filings) were up 3%, with TurboTax desktop down 1%, online up 6% and Free File Alliance down 9%. There seems to be some debate as to whether Intuit gained or lost share – it looks like Intuit did okay relative to H&R Block (NYSE:HRB) (not losing share and maybe gaining a little), but maybe not so well relative to the wider market.
In particular, it looks like the company is seeing a slower conversion rate of those who still manually prepare and file their own returns, as well as those who use traditional paid tax preparers. I don't find this to be altogether surprising – TurboTax has been around for quite a while now, and if you've refused to switch over by now, why would you? Unfortunately, that dynamic is inconsistent with Wall Street's insatiable appetite for growth. Even so, I think a little perspective is in order – while this business is quite profitable, it's not the majority of what Intuit does and it has been a long time since this was the primary driver of the company's future growth prospects.
Continuing To Run A Strong SMB Franchise
I'm not sure there's any one company out there with a stronger position in the small/medium-sized business (SMB) market. Perhaps Paychex (Nasdaq:PAYX) belongs in the conversation, but between QuickBooks, DemandForce, and the payroll and payment services, Intuit offers a considerable breadth of services.
It is worth asking, though, if Intuit can repeat the success of its accounting software packages in these new markets. QuickBooks appears to have more than 70% (maybe more than 80%) of its addressable market, but companies like Paychex, Square, Constant Contact (Nasdaq:CTCT), and ExactTarget (NYSE:ET) are standing in the way of similar market share positions in these follow-on markets. Intuit doesn't have to replicate that commanding share position to be successful, but it's pretty clear that investors are not sold on the growth and margin potential here.
The Bottom Line
I'm not surprised that management has decided to reorganize the company's organizational structure in the wake of another disappointing consumer tax season and a sluggish stock. Naming a new head of Consumer Tax makes sense, as does the flattening and reorganization of Small Business Group (dividing it into Financial Solutions (QuickBooks and Payments) and Management Solutions (DemandForce and EMS/Payroll)). Still, it takes more than rearranging the furniture to change the trajectory of business, so Intuit still has something left to prove.
I continue to believe that Intuit is underappreciated by the market. I expect the company to grow revenue at a long-term rate of about 6%, with free cash flow growth about a point higher. That could be a bit ambitious given the company's trailing 10-year free cash flow growth rate is about 8%, but I believe that integrating DemandForce and leveraging past investments in payments and payroll will lead to margin leverage down the road.
SEE: 5 Must-Have Metrics For Value Investors
With a 7% free cash flow growth rate, Intuit shares would seem to be worth about $70 to $71. That's meaningfully above the current price, and that leads me to believe that investors have an opportunity here. Although Intuit needs to reestablish its growth credentials with the Street and perform more consistently, I do believe these shares can outperform from here.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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