I've been sharing weekly stock analysis/valuation and intend to continue doing so in the future. This week, it's Intuit, a company that is loved by many for its great product portfolio and amazing share price performance, crushing the S&P500 in the last decade.
As always, the post will be divided into a few segments:
- Understanding the business
- Understanding the historical financial performance
- Laying down some assumptions to value the company
- Valuing the company based on assumptions significantly different than mine
What is Intuit? – Understanding the business
In a nutshell, it is a software company that is specializing in financial software. This was accurate, until recently, as they've acquired MailChimp, although it is a great fit within their product offering, it is a CRM software.
The main products that they own are:
– Quickbooks (An accounting package)
– Turbotax (package for the preparation of US income tax returns)
– Mint (personal finance management tool)
– Credit Karma (Acquired during their 2021 fiscal year)
– Mailchimp (Acquired during their 2022 fiscal year)
The fiscal year of Intuit starts on August 1st and ends on July 31st. I'm mentioning this as their 2022 numbers are already out to avoid confusion about how that's possible mid-year.
Historical financial performance
The company has crushed all expectations over the last 5 years, revenue has grown from $6b in 2018 to $12,7b in 2022 (Average revenue growth of 21%).
In most companies, there was a dip in 2020/2021 due to the impact of the pandemic. However, that was not the case at all when it comes to Intuit due to the nature of their products.
For example, if there's a small business, that has 30% less revenue in a given year, it has to cut certain expenditures. However, having bookkeeping software is a must. Regardless if there are 100 or 1,000 transactions, as long as a business is running, there will be demand for Quickbooks. The demand would decrease only in two cases:
- Businesses go bankrupt, hence there's no need to have bookkeeping software anymore.
- There's another product with better quality, that's cheaper.
As for individuals, if someone earned 30% less money during the pandemic, they still need to file their tax return, hence, the demand for Turbotax remains high.
So, we have high-retention products, most of them subscription-based. The gross margin has been over 82% which is amazing.
The rest of the operating expenses have been fixed as % of revenue over time (roughly 56%) and do not fluctuate significantly. So, Intuit has been growing and the operating expenses have been growing at the same pace.
Hence, the operating margin has been stable between 26 and 29% during the last 5 years.
The free cash flow that is being generated a year is below $3b (I am not adding back the share-based compensation in the FCF calculation).
The size of their balance sheet has grown significantly, from $5b at the end of their fiscal year 2018, to $27,7b as of 2022! This is primarily due to their acquisitions as the goodwill + the other intangible assets acquired account for $19b of the difference.
Part of the acquisition was funded by debt, so at the end of 2022, their debt position (excluding leases) was around $7b. Although this is a significant increase compared to 2018 when the debt was less than $400m, this is still fairly low for a company with a market cap of $127b.
The excess cash that the company generates over time is being returned to the shareholder, partly via the dividend (0.69% dividend yield, I know, a great number) and partly via share buybacks.
Assumptions about the future & valuation
The management is guiding for revenue growth of between 14-16% for the next 12 months and analysts are expecting similar growth for the year after that.
As for the operating margin, based on the historical performance, it is quite clear that it is settled between 25% – 30%.
My assumptions:
– Revenue growth of 14% for the next year, followed by 12% up until year 5, and then slowly decrease to the risk-free rate of 3.32%. The market that they're after is not one that's significantly growing, so the organic growth cannot be there for a long period of time.
– Operating margin of 25% for the next year, increasing to 29% over time. After the two acquisitions, it takes a bit of time to identify the synergies and reduce costs, some of them being driven by duplication of roles.
– A discount rate of 8.9% (WACC-based)
Based on these assumptions, the fair value of the company is $54,3b ($192.6/share)
The current market cap is $126.85b ($450/share)
Note: I have taken into account the cash, debt, and deferred taxes on their balance sheet as well as the outstanding equity options.
What if my assumptions are significantly wrong?
Based on the assumptions above, the revenue will grow by 149% to $31,7b in 10 years and the operating margin will be 29%.
I am aware that my assumptions could be significantly wrong. So, let's take a look at how the value of the company (per share) will change based on different assumptions regarding the revenue 10 years from now and the operating margin:
| Revenue / Op. margin | 27% | 29% | 31% |
|---|---|---|---|
| 120% ($28,0b) | $159.3 | $173.5 | $187.8 |
| 149% ($31,7b) | $176.8 | $192.6 | $208.4 |
| 300% ($50,9b) | $267.3 | $291.4 | $315.4 |
| 500% ($76,4b) | $383.6 | $418.3 | $453.0 |
The table illustrates how much the company needs to grow and how high should the operating margin be so that Intuit is fairly valued today.
The management has done a great job, I really like the products and I would love to own Intuit. But at today's share price, it is over 2x what is fair value based on my assumptions.
The only decision that I'm not a big fan of is the share buyback decision. If this activity is being performed when the shares are overvalued, it destroys wealth for the remaining shareholders. Vice-versa, when the share price is undervalued, buying back shares creates value.
What are your thoughts on Intuit, its products, and its valuation?
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