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A last-minute tax tip
Stock Spotlight: It's that dreaded time of year again and H&R Block is loving every minute of it.
April 8, 2005: 2:29 PM EDT
By Jessica Seid, CNN/Money staff writer
Tax time: Jackson Hewitt's stock had momentum shortly after its IPO but H&R Block has gained ground in 2005.
Tax time: Jackson Hewitt's stock had momentum shortly after its IPO but H&R Block has gained ground in 2005.
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NEW YORK (CNN/Money) - Benjamin Franklin once said that the only two things certain in life are death and taxes.

H&R Block (Research) is banking on the latter, literally. With April 15 just a week away, the Kansas City, Mo.-based tax preparation firm has been doing quite well. The stock is up nearly 6 percent so far this year, bucking the overall market.

Even though H&R Block has posted lackluster results in the first three quarters of its fiscal year, which ends in April, this quarter is the firm's time to shine.

That's because the bulk of tax preparation is done during this quarter and the tax business accounts for over 50 percent of the company's revenues.

Analysts expect H&R Block to earn $3.57 a share in the fourth quarter on revenue of $2.33 billion. That more than makes up for the company's losses of $4.6 million, or three cents a share, in the first nine months of its fiscal year.

But H&R Block is also a big player in mortgage banking. And that division hasn't done so well lately due to increased competition and rising interest rates.

With rates not expected to come down any time soon, will continued weakness in the home loan business lead to a pullback in H&R Block's stock? Or will Wall Street focus on the tax operation's healthy returns?

The taxman cometh

For H&R Block, there's been good news and bad news about the 2005 tax season. The good news is that tax preparation fees rose about 7 percent to $1.7 billion year-to-date through March 15. (H&R Block will issue another update on its tax business on April 18).

This tax season, H&R Block opened 1,300 new offices and kiosks at Wal-Mart and Sears stores and targeted low-income taxpayers, who tend to file early. That's helped the company's early-season growth rates.

But the bad news is that H&R Block did not actually see a big increase in customers. The number of clients visiting H&R Block offices was essentially unchanged from a year ago, up just 0.1 percent. What's more, the number of people using H&R Block's Taxcut software declined 8 percent from a year ago.

Fortunately, H&R Block appears to be benefiting from the fact that tax laws are constantly changing, making it more difficult, and costly, for the average consumer to file their returns. The average fee paid by H&R Block customers rose 6.7 percent in the first part of this year.

"The mix of clients we're serving indicates that a greater number of more complex tax returns is driving an increase in the average fee per client," H&R Block Chairman and CEO Mark Ernst said in a statement late last month. "Overall, the results thus far are on track with our expectations for the tax season."

Need for home improvement?

H&R Block is best known for taxes but the company also provides other financial products including mortgage loans and investment services. These divisions aren't performing as well as the tax preparation unit.

For example, H&R Block was fined last year by the National Association of Securities Dealers (NASD) for allowing a hedge fund customer of its financial advisory unit to market-time mutual funds in 2002, a practice regulators have cracked down on in recent years.

More worrisome to investors though is the mortgage business, which accounts for nearly a third of H&R Block's sales and has suffered lately due to aggressive pricing industrywide.

In the third quarter, H&R Block said pretax income from its mortgage business fell 28 percent from a year ago as competition in the mortgage market dented margins. That marked the third quarter in a row where the mortgage business reported a sizable drop in profits.

Fortunes are not expected to improve there anytime soon. But one analyst said the mortgage business hopefully shouldn't get much worse since the company has been lowering costs. "We assume that margins will hold relatively steady, with only modest upside," Morgan Stanley analyst Chris Gutek wrote in a recent research report.

Still, if long-term rates continue to climb and that winds up putting a dent in demand for new housing, then mortgage operations could be a bigger drag on the company's performance.

Look for an after-tax gain

H&R Block, which controlled about 21 percent of the tax preparation market last year, continues to overshadow its closest competitor, Jackson Hewitt (Research), which was spun-off from Cendant Corp. (Research) last June.

Although Jackson Hewitt had a lot of momentum right after its IPO, its stock is off about 20 percent this year as investors apparently flocked to the market leader. But H&R Block still trades at a discount to its top rival, at 12.7 times fiscal 2006 earnings estimates, compared to a P/E of 14.6 for Jackson Hewitt.

The mortgage unit's woes are a cause for concern, but with H&R Block off to such a solid start this tax season, one analyst said rising rates won't rain on the company's tax parade.

"For the most part, investors are focused on the tax business. Unless the mortgage business were to fall off a cliff, there wouldn't be much of a negative impact on the stock," said Kartik Mehta, an analyst at FTN Midwest Securities.

Overall, analysts are forecasting earnings growth of 13 percent a year for the next five years. So it looks like there is life for H&R Block after April 15.

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