H&R Block issue offers attractive risk compensation for BBB investors
admin | September 25, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
H&R Block’s (HRB) 10-year debt deal in August wound up pricing close to fair value, launching in the low 300s. The curve is fairly steep relative to the existing HRB 22s and 25s and the bonds still present good opportunity for investors with appetite for low BBB credit risk. Investors venturing out into low BBB credit should be properly compensated for it, and the step language in the structure affords some additional near-term cushion against possible downgrades into non-IG categories. The bottom-line for credit is that HRB has proven more resistant to trends into competing DIY tax filling products and alternative services than many investors had projected; and lost market share has been tapering off over the past several reporting seasons, particularly with changes in the tax code.
HRB 3 ⅞ 08/15/30 @ ~305/10-year; G+307; 3.72%; $101.27
Issuer: Block Financial LLC (HRB)
Guaranteed by H&R Block Inc.
Amount outstanding: $650 million
Coupon Step Language: +25 bp per downgrade below IG; capped at +200 bp
It is difficult to find suitable comps for HRB as they are a pretty unique issuer in the IG space. WU (Baa2/BBB) is included on the graphic as they are a decent proxy given similar questions about long term obsolescence due to newer technologies, and similar volatility over the past few years. Also included below are other BBB credits from the Discretionary Consumer Services segment in the IG Index where HRB is included, such as EXPE (Baa3/BBB-/BBB-), JD (Baa1/BBB) and INFO (Ba1/BBB-/BBB).
Exhibit 1. HRB vs Consumer Services Peers
Source: Amherst Pierpont, Bloomberg/TRACE G-spread Indications
- The debt launch significantly improved HRB’s liquidity profile. The issuance itself was widely anticipated, as they have a $650 million maturity in October of this year that had not yet been funded. Other maturities include $500 million in 2022, $350 million in 2025, and the $2 bn of their loan facility outstanding through 2023, versus the $750 million facility that still remains available. HRB currently has $2.6 billion in cash on the balance sheet after drawing down their entire credit facility versus $4.0 billion in total debt outstanding. We wouldn’t rule out additional debt launches in the intermediate term, which management could use to pay down the credit facility and further shore up their liquidity profile while the demand for credit risk remains firm in the public debt markets.
- While the notes are protected against downgrades to non-IG categories via the step language, given the highly seasonal nature of the business model, the rating agencies are likely to hold off on further rating actions until the end of next year’s fiscal calendar, when HRB reports 4Q21 results at the conclusion of next year’s tax season (4/30/21). It is difficult to make that determination during HRB’s off quarters when very little of the annual cash flows are actually generated.
- HRB concluded F2020 with elevated leverage in the high 4x range as a result of the delayed tax filing season through mid-July 2020. As a result, cash flow was pushed forward to 1Q21 that would typically be a part of the fiscal year-end results. The rating agencies will be monitoring for HRB to return to its more normal run-rate of below 2x leverage in order to sustain ratings in the IG categories.
- It was difficult to garner too much from the previous two quarter’s earnings results given the unique scenario created by the tax deadline delay. Total revenue in F1Q increased +300% to $601 million, which helped offset the -22% dip in F4Q20 revenue to $1.8 bn. F1Q adjusted EPS from continuing operations was $0.55/sh versus the $0.34 consensus estimate, as HRB reported pretax earnings of $124 million versus a pretax loss of $207 million in the prior year. F4Q20 EPS from continuing operations was $2.39 vs $4.32 in the prior year period, falling well short of the consensus estimate. Total Revenue for F2020 dropped -15% from the prior year.
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