Intuit Still Looks Underrated

By Stephen D. Simpson, CFA | August 27, 2012 AAA

Even if the long-term plan is sound, confusing the Street can carry real near-term costs. Consequently, I wonder if Intuit's (Nasdaq:INTU) decision to shuffle some of its operations has cost it some valuation. Then again, the stock has been pretty strong this year and is less than 10% of its 52-week high, even though its core small/medium-sized business (SMB) market is not exactly back in full health. Whatever the case may be, I think there is still a valid long-term thesis for buying or holding Intuit shares, and I think the stock looks undervalued relative to its quality.

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Closing the Year with Some Confusion
Due in part to acquisitions and divestitures, Intuit didn't report the cleanest of quarters for its fiscal fourth quarter results. That said, guidance was relatively solid and underneath the moving parts, Intuit remains a highly profitable and growing business.

Revenue rose 14% this quarter, with the small business group seeing 19% growth. The company's financial management segment saw 9% adjusted growth, while employee management and payments were both more robust, growing 12% and 31%, respectively. Consumer tax logged a solid 16% result, while growth in the rest of the business was less impressive (albeit not surprising or alarming).

Profitability was not as impressive. Gross margin fell about one and a half points, whether you go by GAAP or adjusted accounting. Operating income performance was more mixed - while the company reported a smaller loss by GAAP, the adjusted number saw a nearly 25% decline in profits. While adjusting out some acquisition-related charges mitigates some of Intuit's profit miss, the company still missed on the operating line by about 10%.

SEE: Understanding The Income Statement

Corporate Moves Show a Priority for Growth and Margins
Intuit has never been afraid of change, and the company continues to make moves aimed at improving both growth and the profitability of that growth. The $424 million acquisition of DemandForce earlier this year makes the company more of a player in digital marketing, and gives even more cross-selling opportunities to the SMB market.

At the same time, the move gets rid of a business that looked fairly stagnant and never seemed to live up to its potential. Likewise, moving its tax refund debit card business to its partner ought to be better for margins in the long run.

Building the Brand, While Fending off Large Newcomers
Where I have doubts about Intuit is how the company's management sees the business in five to 10 years' time. There's no question that Intuit is a growing threat to Paychex (Nasdaq:PAYX), nor that it has effectively marginalized H&R Block (NYSE:HRB) in the tax business.

With the acquisition of DemandForce, though, I wonder how much competition the company is inviting (or taking on) in the likes of Google (Nasdaq:GOOG) and Amazon (Nasdaq:AMZN), among others.

Likewise, can the company exploit its SaaS niche even further and bring some of the functionality that SAP (NYSE:SAP) and Oracle (Nasdaq:ORCL) offer to enterprises down to the SMB level, particularly in areas like human resources?

The Bottom Line
I like the fact that Intuit seems to think about its addressable market in broad strokes and is unafraid to spend money in the pursuit of more of that market (like the DemandForce acquisition). Likewise, the company enjoys a pretty solid brand reputation in its core market and should be able to continue to bundle more and more functionality under the Intuit/Quicken name.

SEE: 5 Must-Have Metrics For Value Investors

Oftentimes a company with Intuit's return on capital and growth potential would carry a pretty hefty valuation. That doesn't seem to be the case here, even though these shares have outperformed so far this year. Although I do think there is a risk that the company falls into a growth trap like Paychex or Autodesk (Nasdaq:ADSK) (as different as that business may be), management seems pretty focused on not allowing that to happen. If the company can continue to improve its free cash flow conversion and post solid high single-digit revenue growth, long-term fair value ought to stand close to $70.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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