We review our investment case on Intuit (INTU) after the company released Q1 FY21 (ending October 31) results after markets closed on Thursday.
At the time of writing (12 noon EST, Friday), Intuit shares are down 3%, at $350.75. Intuit’s main competitor, Sage Group PLC (OTC:SGGEF), saw its shares closed down 13.4% in London on Friday after it released its FY20 results.
Since we initiated our coverage of Intuit with a Buy rating in September 2019, shares have gained 31.6% (including dividends).
Buy Case Recap
Our original Buy case was based on Intuit delivering a low-teens revenue growth and a stable-to-rising EBIT margin, roughly in line with management long-term targets, including:
- The Small Business & Self-Employed (“SBSE”) segment growing revenues at 10-15%+ annually, thanks to the still-low software penetration among SMBs, as well as cross-selling other products such as payments and payroll
- The Consumer segment growing revenues at 8-12% annually, from resilient U.S. tax filing numbers, Intuit market share gains and a positive price/mix
With a low-teens revenue growth and a stable-to-rising EBIT margin, we believe Intuit could achieve a low-teens EPS growth.
At the time of our initiation, relative to FY19 financials, Intuit shares were trading at a 39.2x P/E and a 2.6% Free Cash Flow (“FCF”) Yield.
Since then, Intuit’s growth and valuation have both exceeded our expectations, with EPS growing 16.4% year-on-year in FY20 and the P/E multiple expanding to 44.8x (and its FCF Yield shrinking to 1.9%).
Notwithstanding this strong performance, we believe Intuit shares still offer a 12.3% annualized return over the next 4 years, as we will explain below.
Small Business Revenues Again Grew by Double-Digits
Intuit’s Q1 FY21 P&L is shown below. Because the quarter is outside the U.S. tax season, only the SBSE segment had meaningful financials – SBSE revenues grew 12.9% year-on-year, including Online Ecosystem revenues growing 24.0%; SBSE EBIT grew 29.3%, with the margin expanding 825 bps. (The Consumer and ProConnect segments had little revenues in Q1 FY21, but performed in line with management expectations.)
SBSE’s revenue growth in Q1 FY21 was higher than preceding quarters (adjusted to exclude Paycheck Protection Program (“PPP”) revenues), but lower than the prior year; indeed SBSE revenue growth has been lower than history since the start of the COVID-19 outbreak (impacting first Q3 FY20, the quarter ending April 2020)Online Ecosystem revenue growth in Q1 FY21 was below previous quarters and also below Intuit’s long-term 30% target:
Intuit SBSE Revenue Growth Year-on-Year (Since FY18)
NB. Q4 FY20 Online Ecosystem growth included contribution from PPP revenues; Q3 FY20 PPP revenue contribution not disclosed. Source: Intuit company filings.
The slowdown in SBSE revenue growth was due to lower retention and the absence of price increases during COVID-19, as well as acquisitions, and growth is expected to trough in Q2 FY21, as Intuit’s CEO explained:
“The headwinds are in three buckets. One is, overall, as we shared at Investor Day, our retention dropped by a couple of points based on what we saw in the March, April, May timeframe. That, along with lapping a price increase and actually not taking price action deliberately, plus the impact from acquisitions in those same months, is really what impacted our growth rate for the quarter that you see here. And our view is, effective the second quarter will be probably the lowest point of the year for the Small Business Group for the same exact reasons that I just mentioned”
Sasan Goodarzi, Intuit CEO (Q1 FY21 Earnings Call)
Management expects Online Ecosystem revenue growth to return to 30% over time, both from continuing improvements in Intuit products’ value-add and from a recovery among small businesses. There are other positive datapoints in Q1 FY21, for example the 51% year-on-year growth in international Online Ecosystem revenues, driven by continuing momentum in established markets in the U.K. and Canada, as well as newer markets in France and Brazil.
FY21 Outlook Includes Low-Teens EBIT Growth
Despite macro uncertainty, management was ”growing more confident in how our business is performing in the current environment”, and was able to give a FY21 outlook, including growth of 8-10% in revenues and 11-13% in (non-GAAP) EBIT:
Intuit’s FY21 growth is expected to be driven by both its SBSE segment ( to grow at 8-10%) and its Consumer segment (to grow at 9-10%). EPS growth is expected to lag EBIT growth due to a higher tax rate (rising from 23% to 24% on a non-GAAP basis), due to rule changes on R&D tax credits as well as lower tax benefits on share-based compensation.
The guidance also includes an 8-9% revenue growth in Q2 FY21, which as stated above is expected to have the trough growth rate for the year.
Intuit’s expected FY21 revenue growth will be lower than in prior years, but EBIT margin expansion is expected to continue (at about 110 bps):
Intuit Group Revenue Growth & EBIT Margin (FY13A-21E)
NB. FY ends on 31 Jul. Source: Intuit company filings.
The margin expansion will be helped by benefits driven by the use of Artificial Intelligence (“AI”) in multiple areas of Intuit’s business:
“As we continue to evolve to more of an AI-driven expert platform, we do see opportunities for margin expansion across the P&L. And those opportunities can be in the areas of technology, where we’re increasing the velocity of development on our actual technology platform so we can deliver faster and also using products and services across the company. We also see that in customer success, where we’re scaling a common customer success platform, that drives efficiency and effectiveness serving across all products. And then, also in go-to-market, we’re able to leverage a common infrastructure so that we can more effectively target customers and manage our sales and marketing processes.”
Michelle Clatterbuck, Intuit CFO (Q1 FY21 Earnings Call)
Overall, despite the COVID-related weakness visible in FY21 financials, we believe Intuit’s long-term structural growth remains intact.
Key Competitor Sage Disappointed
Intuit’s key competitor, Sage Group PLC, released their FY20 (ending September 31) results on Friday morning, shortly after Intuit’s release, sending Sage’s shares down 13.4% in London.
Investors were disappointed by the 3 ppt operating margin reset (from 21.6%) announced by management with the results, which would reduce EBIT by more than a tenth. (Sage also guided to a 3-5% growth in recurring revenues and a decline in other revenues in FY21.) For FY20, Sage’s revenues were flat and its operating profit was down 7% on an underlying basis.
We believe Sage is being outcompeted by Intuit, and its ongoing struggles continue to represent an opportunity for Intuit.
Sage has been Neutral-rated in our coverage since September 2019, and its shares have lost 11.5% (in U.K. pounds in London) so far.
Credit Karma Now Dilutive in FY21
Intuit’s FY21 guidance excludes the pending Credit Karma acquisition (announced in February), which is now expected to be “modestly dilutive” to EPS n FY21 and potentially again in FY22.
Credit Karma has been “negatively impacted” by COVID-19 in the “last 7 months as lenders tightened access to credit”. Its revenue run-rate troughed in June and was “nearly back to pre-COVID levels” in October. This weaker performance means Intuit now expects the transaction to be “modestly dilutive” in FY21, “neutral to modestly dilutive” in FY22, though still “to be accretive over time”.
While the transaction has been under regulatory scrutiny, Intuit retains “high confidence” that it will close by CY20 year end.
At $350.75, on FY20 financials, Intuit shares are trading at a 44.8x P/E and an 1.9% FCF Yield; the Dividend Yield is 0.7% ($2.36 per share):
Intuit Earnings, Cashflows & Valuation (FY18-20)
Source: Intuit company filings.
We believe Intuit’s ability to continue growing EBIT at double-digits during COVID-19, re-confirmed by its new FY21 guidance, means it deserves a premium valuation. We now assume an exit P/E of 42x, from 40x before, consistent with multiples we have assumed for other high-quality companies, for example 42x for Estée Lauder (EL) and 45x for Mastercard (MA).
Intuit’s gross cash reached $5.8bn at Q1 FY21, more than covering the $3.6bn cash portion of the Credit Karma consideration.
On share buybacks, management once again repeated the same comments from the last two quarters, stating that, while buybacks are suspended because of the part-stock Credit Karma acquisition, $2.4bn remains on the authorised program, and “we expect to be in the market in the future”.
Free File Class Action Partly Settled
Intuit has reached a settlement with most of the claimants in the class action related to the IRS Free File program, as announced earlier in the week, by paying $40m without admitting any wrongdoing. Intuit estimated it could incur $400m in arbitration costs for claims (less after the settlement), as one law firm (Keller Lenkner) with 125,000 claimants continued to proceed with its own lawsuit.
Illustrative Return Forecasts
Apart from the change of the exit P/E from 40x to 42x, we leave the assumptions in our return forecasts unchanged:
- FY21 EPS growth of 9.0% (unchanged), coinciding with the high end of the new management guidance
- EPS growth to return to 13.5% thereafter, a conservative figure relative to the average revenue growth of 13.9% during FY18-20
- Dividend to grow in line with EPS each year, at a payout ratio of 27%
- P/E of 42x at FY24 year-end (July 2024), a 10% de-rating from present
With shares at $350.75, the exit price of $524.13 and dividends mean that we expect a total return of 53% (12.3% annualised) in just under 4 years:
Illustrative Intuit Return Forecasts
Source: Librarian Capital estimates.
Intuit released results Thursday night, and its shares are down 3%; competitor Sage’ shares closed down 13% in London after their results.
While some weakness was visible after COVID-19’s impact in the last few quarters, Intuit’s long-term structural growth remains intact.
Small Business & Self-Employed revenues grew 12.9% year-on-year, including online revenues growing 24.0% – a display of Intuit’s resilience.
Despite macro uncertainty, management was able to give FY21 guidance, including revenue growth of 8-10% and EBIT growth of 11-13%.
At $350.75, shares are expected to deliver a total return of 53% (12.3% annualized) by July 2024, in just under 4 years.
We reiterate our Buy rating.
Note: A track record of my past recommendations can be found here.
Disclosure: I am/we are long INTU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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