DBRS Confirms H&R Block, Inc. Issuer Rating at BBB (high), Trend Revised to Stable

DBRS has today confirmed the ratings of H&R Block, Inc. (Block or the Company) and its subsidiaries, Block Financial LLC and H&R Block Canada, Inc. including its long-term ratings of BBB (high) and short-term ratings of R-2 (high). Concurrently, the trend has been revised to Stable from Positive.

In confirming the ratings, DBRS recognizes Block’s strong franchise and leading market position, its substantial cash flow generating ability, the sound earnings generation power of the core tax preparation business, and the low financial risk profile. However, momentum in Block’s core businesses has stalled making upward ratings migration less likely in the near term. Accordingly, the trend has been revised to Stable from Positive.

The revision in the trend to Stable reflects DBRS’s opinion that revenue and earnings growth potential will be limited in fiscal year 2011. The uneven economic recovery and still weak job market will likely result in a modest decline in total tax returns filed for the 2010 tax year. As such, even with stable market share, DBRS sees Block’s total clients served as declining in the upcoming year, thereby earnings will likely remain pressured. Moreover, increased regulation and the recent IRS announcement stating that the Debt Indicator (DI) will not be available to the industry may add further pressure to earnings through increased costs and lost revenues related to refund anticipation loans (RALs). Nonetheless, DBRS sees the Company as satisfactorily-placed to manage these headwinds, given its size, scale and strong franchise.

The ratings consider Block’s still very solid earnings generation ability. Even with a 4% decline in clients served, in fiscal year 2010, Block was able to generate $3.9 billion of revenue and $479 million of net income. Further, the Tax Services segment continues to generate stable margins at 29.2%, illustrating good pricing power and the ongoing focus on cost management. Moreover, during FY 2010, EBITDA equaled total outstanding debt, which totaled $1.0 billion, at April 30, 2010. Additionally, EBITDA-to-interest expense was a very solid 11.1x. Given these solid ratios, DBRS has a level of tolerance for pressured earnings. Importantly, however, this tolerance is reduced if DBRS sees sustained weakening of the franchise or weakening of other key financial matrixes.

The ratings consider Block’s leading market position and strong franchise. During tax season 2010, H&R Block prepared 20.1 million U.S. tax returns, representing 15.6% of an IRS estimate of individual tax returns filed by April 30, 2010. DBRS notes that market share declined by 20 basis points from tax season 2009. Further, DBRS is cautiously watching the Company’s ability to leverage its strong brand name and take advantage of the growth opportunities in the digital tax preparation market. Given the limited success, to date, in achieving solid momentum in the digital tax preparation channel, DBRS views this as a challenge to the franchise.

The ratings consider the acceptable equity base given the risk profile of the balance sheet. At fiscal year end, April 30, 2010, Block’s total equity was $1.4 billion and tangible equity had increased to $233 million from $170 million a year ago. However, earnings retention is limited with the vast majority of FY2010 earnings distributed to shareholders through dividends and stock repurchases. DBRS recognizes, however, that Block has the flexibility to reduce or eliminate those distributions and retain the solid internally generated capital, should it be become necessary. Funding and liquidity continue to be well-managed with the Company continuing its practice of repaying all short-term funding facilities at the end of each tax season.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable rating methodology is Rating Finance Companies Operating in the United States, which can be found on our website under methodologies.