Update on Portfolio Positions: H&R Block & Barratt Developments
Updates on some of the names I own. Will be spread out over a posts. H&R Block (tax prep) and Barratt Developments (U.K homebuilder) will be covered today.
I’m going to post some updates on the names I own. I post my portfolio quarterly, but it’s more for me to keep a record, so I don’t usually send out notifications (I’m sure you all get enough emails). I track the IRR since inception, current portfolio holdings, and I’ll probably rant about how individual investors shouldn’t care about YTD returns (as an individual investor, I think IRR is the key metric). I do this for fun, but at the end of the day, investing is a game and I care about the scoreboard…
You’d think this preamble would lead into me disclosing some insane IRR, but unfortunately that’s not the case… The IRR is currently ~8%, with my investment in QRTEA 0.00%↑ the main drag on returns (~80% loss – I still hold a small amount).
Originally, I planned to run through all my investments in one article, but I’m going to spread it out over a few to keep them a reasonable length. This article will cover H&R Block (tax prep services) and Barratt Developments plc (a U.K. homebuilder). Let’s get to it.
H&R Block - ~10% Position
I have a soft spot for HRB 0.00%↑ (write-up from July 2022). I got in at an average price of ~$18 during 2020, held until mid-2022 before selling half the position at ~$47 (currently up ~2.7x). I still hold the remaining half, which trades at ~$45 today (received ~$3 a share since 2020). This is one of those investments that makes me think, “maybe I’m alright at this investing game”, I then quickly remember I invested in Qurate… I am proud of this investment though, it was hiding in plain sight (everyone knows H&R Block but no one ever talks about it) and trading at such an undemanding multiple, it was very likely to work out.
At the height of the pandemic, HRB was trading at ~$4bln EV (no net-debt), earning ~$800mm in pre-pandemic normalized Ebitda (~5x EV/Ebitda), and paying out ~$200mm in annual dividends. You had to believe two things for HRB to work from the covid lows:
That customers still valued personal assistance when filing tax returns (not everyone was going to migrate over the TurboTax).
The change in pricing strategy, implemented in 2019, would stabilize the revenue base.
Bonus: you had to be comfortable owning a boring stock that operates at a loss for 3 quarters a year.
Customer value
When I first looked at HRB, the transition of share to digital solutions was the first things I researched. In general, tax filings grow ~1% a year, with ~60% prepared by professionals (HRB’s core business). The remaining 40% are self-prep, with the majority of these prepared using some type of digital tax preparation software (e.g., TurboTax).
The pre-pandemic rule of thumb was self-prep solutions were gaining ~30-50bps of share a year. This effectively meant if HRB held share in the assisted category, their volumes would be roughly flat.
I understood the hype around digital tax options and their growing popularity: upload your W-2, click through the questions, pay TurboTax using your refund, and before you know it you’ve filed your return! No cash outlay and you didn’t even have to leave your couch!
I agreed with the above, but I thought assisted volumes had more staying power than the market realized. There were two key reasons:
A lot of customers are just terrified of taxes, and they’ll happily pay for a professional to hold their hand. That peace of mind has real value.
There are some tax situations that require advice or assistance; for some filers, paying a tax pro saves them money.
The market was pricing HRB as if the tax prep business was in terminal decline (accelerated by covid). I thought the services were still valuable, and flat volumes with growth via pricing would mean a home run return.
Pricing reset
I mentioned above that if HRB held share in the assisted category, their filing volumes would be roughly flat… This hadn’t happened over the last half decade, but the hope was a new CEO (Jeffrey Jones) and a reset on pricing would make holding share possible. In FY19, HRB’s assisted revenue dropped ~5% on a ~2% reduction in volume as Mr. Jones implemented his new pricing strategy (transparent upfront pricing).
I liked the pricing reset, even if it had a short-term impact on revenue. Customers are scared and wary of anything tax related; add in uncertainty over the price for tax prep services and you get a very skeptical customer. Transparent pricing had the effect of taking a weight off customers’ shoulders; they knew what they were going to pay (~$250), their taxes would be prepared by a pro, and they could sleep better at night.
It’s fair to say the strategy has worked. The financials have been a bit messy over the last few years due to covid extending the tax season deadline (FY20 didn’t include a whole tax season), but this is a business that now generates ~$3.5bln in revenue and is growing the topline at low-to-mid-single-digits. Ebitda is flat vs 2018 (~$900mm), but remember this was a business priced at ~5x EV/Ebitda, with no debt and was returning cash to shareholders via dividends and buybacks. Management expects to grow Ebtida ~5% moving forward.
I probably wouldn’t add to HRB at current prices; I think it’s close to fair value now, but I’m happy to hold - ~$600mm cash flow, ROIC >15%, and buying back stock. It now trades for ~9x EV/Ebitda, on an ~$8bln EV. It was a little scary to buy during covid, but it’s the kind of business I sleep well at night owning.
Barratt Developments plc - ~10% Position
Barratt Developments plc ($BDEV) is the U.K.’s largest home builder (I’ve written twice about U.K. homebuilders – one on the overall industry, and another on Barratt specifically). I’ve owned Barratt for ~1 year, and I’m up ~20% including dividends. The thesis is still playing out, but I still think this is still a situation with limited downside and solid upside.
The U.K. housing market has slowed significantly as high interest rates continue to impact consumers. Barratt’s net private reservation rate per active outlet per week is ~0.4, down from ~0.6 during the same period last year (was as high as 1 during covid boom). They expect to deliver ~13.75k homes in FY24 (year ends June 30, 2024), down from ~17.2k in FY23 (~20% decline).
This was expected as the BoE has raised rates, significantly increasing the cost of housing; rate increases have a larger impact on the U.K. housing market as consumers don’t have access to 30-year fixed rate mortgages (usually fixed for 2-10 years). Looking out longer-term though, the outlook for home building in the U.K. is positive.
Under Supply
The U.K. is in desperate need of more homes, they’ve chronically underbuilt for the last couple of decades. The two charts below tell the story; new construction has barely kept up with the net population increase, let alone a reasonable replacement assumption. Other European nations have pretty much doubled their housing stock since 1970, while the U.K. has grown <50%; this has led to runaway home prices. The only way to get out of this is to build, but strict regulations (Future Home Standard) make it very difficult for smaller builders to compete.
I think there’s two likely outcomes, and they both lead to solid returns for Barratt. The first is the U.K. keeps underbuilding, volumes stay depressed, and land/home prices stay high; in this scenario builders churn out reasonable profits, but we probably don’t get a home run return.
The other is the U.K. government (both parties are starting to take this seriously), or macro factors, stimulate building and, even with a period of lower profits on increased supply (I’m skeptical this would even happen given the magnitude of underbuilding), homebuilders do well long-term on more volume. This should be possible as homebuilders have control over land costs, and there’s less competition from smaller players (top 10 U.K. home builders make up >60% of the market). Barratt also focuses on larger land sites where competition is less intense. This is the home run scenario - decade long runway with solid volumes and margins.
On the downside, Barratt is very conservatively leveraged (net cash position), so even if there’s a crash in home values, they’ll be able to get through to the other side (no solvency or liquidity issues if they need to take a land impairment charge).
Barratt currently trades at an EV of ~£4bln (net cash position ~£750mm when incl. land creditors as debt), and trades at ~10x NTM EV/Ebitda; Ebitda is currently depressed due to headwinds mentioned above, but Barratt should be ready to spit out cash when home volumes return.
The one issue I underestimated with Barratt is the liability for remediating legacy building defects (related to the Grenfell Tower Tragedy). They added ~£250mm to the provision to fix legacy issues in FY23 and now have a total liability of ~£600mm. This will be a drag on cash flow over the next few years, they estimate the next 5, but I don’t think it changes the thesis (although maybe I could have picked a better horse in U.K. homebuilding industry - i.e., one with less exposure to the Grenfell fallout).
This feels like the kind of investment that is easier for an individual to make. We might have to wait around for a while, the timing of when this turns is unknowable (macro/gov), but I think we look back and say this was a great risk adjusted bet in hindsight.