H&R BLOCK INC. $17 (New York symbol HRB; Conservative Growth Portfolio, Finance sector; Shares outstanding: 334.1 million; Market cap: $5.7 billion; Price-to-sales ratio: 1.4; WSSF Rating: Above Average) is the world’s largest provider of income-tax-preparation services. It operates 12,923 offices in the U.S., as well as 1,193 in Canada and 378 in Australia. Franchisees own 34% of H&R Block’s U.S. tax-preparation offices. The tax-services division accounts for 74% of the company’s revenue. The company gets 22% of its revenue by selling tax-consulting and accounting services to businesses though subsidiary RSM McGladrey Inc. The remaining 4% comes from banking services, including chequing accounts, loans and credit cards that H&R Block issues to its tax-preparation clients.

H&R Block’s earnings fell from $1.88 a share (or a total of $635.9 million) in 2005 to $1.15 a share (or $374.3 million) in 2007. (H&R Block’s fiscal year ends April 30.) The drop was mainly caused by losses at its Option One subsidiary, which specialized in subprime mortgages to H&R Block’s tax clients and other borrowers. In 2008, the company sold Option One, along with its brokerage and wealth-management subsidiary, as part of its plan to focus on its more profitable tax and accounting operations. These moves helped H&R Block’s earnings improve to $1.53 a share (or $513.1 million) in fiscal 2009.

The company’s revenue rose from $4.4 billion in 2005 to $4.9 billion in 2006, but dropped to $4.0 billion in 2007. It recovered to $4.4 billion in 2008, but fell to $4.1 billion in 2009.

H&R Block’s main tax-preparation division reported a 1.5% revenue increase in the latest fiscal year, and a 13.7% rise in pre-tax profits. The earnings gain was mainly due to the company’s purchase of a major franchise operator. This let H&R Block shed an unspecified number of jobs. Plus, it now keeps 100% of the fees from this business, instead of the 30% it usually receives from franchisees.

Tax volumes down 3.2% in 2009

H&R Block processed 21.1 million tax returns at its U.S. offices in 2009, down 3.2% from 21.8 million in the prior year. However, more people filed tax returns in 2008 to get government-stimulus cheques. The average fee per return rose 7.2%, to $187.36 from $174.70, due to the increasing complexity of the tax code. H&R Block’s international offices processed 5.1% more returns in fiscal 2009.

As a result of the recession and rising unemployment, many tax filers are opting for cheaper alternatives, including do-it yourself software. The number of U.S. tax returns processed online by H&R Block jumped by over 900,000, or 21.1%, last year. This will continue to weigh on H&R Block’s tax-preparation profits, at least in the short term.

However, the company is doing a good job of taking advantage of this trend. Through its “TaxCut” software, H&R Block has about 19% of the U.S. market. That’s well behind Intuit Inc., whose “TurboTax” program has around 80%. But other services, including online tax tips and advice, should continue to help H&R Block attract more do-it-yourself users.

Aside from online competition, H&R Block may have to deal with greater regulation in its industry. Right now, tax professionals do not have to have a license unless they represent their clients in proceedings before the Internal Revenue Service (IRS).

However, the IRS may set minimum standards for tax preparers, and require them to undergo training. The agency also plans to do a better job of monitoring their performance.

These changes will probably increase H&R Block’s costs. However, as the leading tax-preparation firm, it is in a better position to absorb these than its smaller competitors. Better standards will also improve consumer confidence in the industry as a whole.

Cost cuts, low debt fuel growth

The company is also doing a good job of increasing profits at its business-services division, whose revenue fell 4.7% in fiscal 2009. The drop was mainly caused by the weak economy, which hurt the value of the securities it manages on behalf of its clients. However, earnings rose 8.2%, thanks to cost-cutting measures, including layoffs.

H&R Block’s consumer-banking division reported a pre-tax loss of $14.5 million in fiscal 2009, compared with a profit of $11.5 million in the prior year. Although the company no longer makes mortgage loans, falling housing prices have increased the default risk of the $744.9 million worth of mortgages it still holds. As a result, loan-loss provisions jumped 52.1%, to $63.9 million from $42 million. However, revenue rose 13.3% on higher loan volumes to tax-preparation clients.

The company’s $1-billion long-term debt is a low 18% of its market cap. It also holds cash of $1.65 billion, or $4.95 a share. This should let it keep improving its tax-preparation software and online products. It also plans to spend more on marketing and advertising during the next tax season.

Low p/e for a market leader

The stock trades at just 10.2 times this year’s likely earnings of $1.66 a share. That’s cheap in light of H&R Block’s strong brand and leading market share. The $0.60 dividend yields 3.5%.

H&R Block is a buy.