Investment Thesis

Intuit (NASDAQ:INTU) is going to report Q1 numbers at the end of the month, so I wanted to take a look at the company’s financial performance to see whether it is a good time to start a position. The company’s efficiency and profitability have been on decline and low earnings do not justify such a high FW PE ratio, even in non-GAAP terms (it is much worse in GAAP terms), the company is not a good investment for a person who is looking to deploy capital on a new position, therefore, I initiate my coverage of INTU stock with a hold rating. I am waiting for a much better entry point, or if the company manages to improve earnings dramatically.

Briefly on the company

Intuit is a financial software company that provides products and services to individuals, small businesses, and accountants. It provides marketing solutions and products with its flagship marketing solutions offering Mailchimp, Payment solutions from QuickBooks, tax support services from TurboTax and ProTax, and Credit Karma that helps individuals make smarter financial decisions and propel them towards a better financial future.

What I like about the company is its focus on personal finance management that very few competitors can match. It’s got a very strong presence in the US and is one of the largest players in the sector, which provides a good competitive edge.

Financials

As of FY23, the company had around $3.7B in cash and equivalents, against $6.1B in long-term debt. That’s a decent chunk of leverage the company took on when it acquired Mailchimp. The debt is exposed to interest rate risk because it’s based on SOFR plus 0.625%-1.125%. I don’t think it is that bad anymore considering the FED is unlikely to raise interest rates by much any longer, so I think that the interest expense on debt is going to get easier to manage as time goes on. So how worrisome is this debt then? Well, the most recent interest coverage ratio stood at around 12x, meaning EBIT can cover annual interest expenses 12 times over. For reference, many analysts and credit covenants say that an interest coverage ratio of 2x or 3x is considered healthy, however, since I like to be more stringent, I think 5x is much more reasonable and safer because it allows for more flexibility on bad years when the company is not performing very well. Either way, the company is safe since its coverage ratio is well above my minimum, which means INTU is at no risk of insolvency.

The company’s current ratio is right at the range that I consider to be efficient, which is a range of 1.5-2.0. I consider this range to be efficient because it is a good balance between having the ability to pay off all the company’s short-term obligations with ease and still having enough capital to further the growth of the company.

In terms of efficiency and profitability, it seems that INTU has lost some of its luster. ROA and ROE have been trending down for the last couple of years and that is not what I would like to see from the company’s big picture. However, if we look into the numbers deeper, we can see that goodwill has increased dramatically in FY21 and FY22, which can be attributed to the company’s past acquisitions. So, the company could do a better job when taking into account the acquisitions because it has lost its efficiency as goodwill doesn’t seem to be generating enough profits to justify its value. ROE has exhibited the same downtrend because the company’s paid-in capital has increased dramatically since FY21, which means that the company issued more shares for cash, which is dilutive. Over the same period, we didn’t see a proportionate increase in the bottom line, so it seems like the company is not being very efficient with shareholder capital.

The same story can be observed in the company’s return on invested capital or ROIC. Since the company’s NOPAT hasn’t improved much over the years, the company seems to be losing its competitive advantage, which is a cause for concern.

In terms of revenues, the company has been growing at a respectable pace in my opinion. It managed to achieve 14.5% CAGR over the last decade, however, it is also trading at a Forward PE Ratio (non-GAAP) of around 35, which is rather high in my opinion for such a low-double-digit growth. It’s over 60 PE ratio if we look at GAAP figures, which is absurd, to be honest. I would have expected much higher top-line growth to justify such a PE ratio, GAAP or not.

In terms of margins (GAAP), these are quite decent in my opinion, however, if we add on share-based compensation to the mix, which was around $1.7B in FY23, we could add another 10% back to EBIT and Net margins, so these can be improved on still.

Speaking of share-based compensation, I don’t like that it has been increasing over the last few years. This will continue to dilute current shareholders, however, I can see that the management has decelerated the increase in SBC as the y/y increase was around 46%, while the year before that it was around 88%.

Overall, the company seems to be in decent shape, however, it could be much more efficient and profitable if it stops relying on SBC that much and uses its assets and shareholder capital much more efficiently.

Valuation

For revenue growth, I can’t be too optimistic here, so I went for around 12% growth in FY24, which is what the management guided in the transcript. It’s impossible to predict how the company is going to perform a year after that as even the management doesn’t know what kind of economic climate we’re going to have. Are we going to be in a deep recession? Another boom? Who knows, but the best I can do is to be conservative with my estimates and take it from there. Below are my conservative, yet reasonable assumptions for the three cases.

In the case of margins and EPS, I decided to go with the company’s non-GAAP estimates, which exclude the massive SBC expense. I went with these because the company focuses on these metrics the most, even though I’m not a fan of it. In the end, the outcome of my valuation won’t be affected (spoiler alert). Below are my EPS and margin assumptions for INTU with GAAP FY23 comparison.

As for my DCF analysis, I used the company’s current WACC as my discount rate, which is 9.5%, and I also used a 2.5% terminal growth rate because I would like the company to at least match the US long-term inflation goal.

On top of these estimates, I decided to add another 15% margin of safety as I believe the company’s balance sheet is decent, while there could be some improvements. In my opinion, 15% is enough here. With that said, Intuit’s intrinsic value and what I would be willing to pay for it is $270 a share, which means the company is trading at a massive premium.

Closing Comments

If I were to use the company’s GAAP EPS and margins, it wouldn’t be anywhere near close to being a good investment. Even with non-GAAP, I wouldn’t be looking at opening a position right now as the risk/reward is absurd in my opinion. The company is expensive in all three scenarios even without the margin of safety.

If the company managed to increase its net income dramatically over the next couple of years (as it hasn’t changed much over the last while), then I would re-assess the company’s financial position, however, it doesn’t look like there will be a lot of improvement on that end, therefore I am assigning the company a hold, as in do not commit any money right now if you are not invested in the company as that is the perspective I am coming from (as an investor who is looking for opportunities to deploy capital for the long-term gain).