Published - February 10, 2023 @ 2:45 PM (EET)

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Intuit Inc (INTU)'s share price had to slump by a whopping 39.22% over the past year, partly due to the generally declining tenor within the technology sector. But what is going on under the surface of this stock?

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The California-based company positions itself within the Packaged Software sector, or the sector of off-the-shelf software packages for consumers as well as small to medium-sized enterprises and accounting professionals. The focus of its product offering is mainly on providing SaaS (Software as a Service) products and services that help customers in accounting, tax returns, compliance and other matters related to personal finance.

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The company can be divided into four segments - Small Businesses & Self-Employed; Individuals; Credit Karma and ProConnect. The company's best-known services are undoubtedly QuickBooks accounting software and TurboTax that helps prepare and complete tax returns. In recent years, Intuit has expanded its personal finance offering to individuals through the acquisitions of Mint and Credit Karma, and also strengthened its small business services with the acquisition of email marketing platform Mailchimp.

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Intuit puts customer obsession, a hyper-focus on improving the customer experience, at the heart of its growth strategy. A term you may have heard passed by retail giant Amazon before. The starting point is observing and understanding the problems customers experience and working backwards from there to a solution. Having a customer base of more than 100 million customers, Artificial Intelligence is deployed to analyse the large amount of personal finance data and tax data it brings. In this way, it looks for solutions that can be put into practice to improve the customer experience.

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Margin to grow

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Intuit showed in the past year that the company could grow more strongly than initially expected and easily exceeded its own targets. This included a 32% year-on-year increase in revenue to $12.7 billion which translated into a 22% growth in earnings per share to $11.85. Despite these fine growth figures, the company is still only tapping into about 5% of the total potential market share (TAM) of $312 billion that this sector has to offer.

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A major asset of the company is undoubtedly the gross margin of around 80% it has on its products, which opens up a lot of opportunities in the flexibility of pricing strategies. With a return on equity (ROE) of around 12.5%, Intuit far outperforms the industry average of 2.61%. This means that the company is a lot stronger than its competition in converting equity into profit.

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By limiting capital expenditure to around 2% of total sales, the company manages to generate significant and growing free cash flow. This is used for possible acquisitions, a smaller but regularly paid quarterly dividend of $0.78 per share, paying off outstanding debts and buying back its own shares.

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The above strong numbers are also reflected in the company's Altman Z-Score. This looks at a company's key financial ratios to calculate how high the probability of bankruptcy is. The closer this score gets to 0, the higher the probability that a company is in bad financial shape and could well have to put the books down. A score higher than 3 shows that a company is financially sound and there is little reason to worry. Intuit Inc shows strong financial resilience with a score of 7.49, which may reassure investors in these turbulent economic times.

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Current valuation and outlook

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Within the segment focusing on Small Businesses & Self-Employed, the trend of strong numbers continues. Mainly Online Ecosystems continues to achieve strong revenue growth here, which was still close to 30% in the most recent quarterly figures within the US. The company is enjoying some positive factors, including continued growth in its customer base and higher pricing. Growth also continues internationally, despite macroeconomic headwinds the company is facing in the UK, France and Australia. Intuit is looking for long-term growth of 15-20% year-on-year within this segment.

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The Individuals segment is tied to the tax season. Here, every year it is looking forward to the figures of the third quarter of the fiscal year as this is where 80% of annual revenue is realised. The company expects to grow this segment's revenue by an average of 8-12% in the long run.

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The company's Mailchimp segment has so far underperformed expectations. This is mainly about the transition from a cash-flow focused company during the acquisition, to a growth company. Where the company first announced it was cutting back the marketing budget for Mailchimp, it followed up some time later with the message that the problems will take several years to get fully resolved. Currently, Mailchimp's contribution to the group's overall profit is around 10%. So this segment need not be a game-changer for Intuit's investment case, but it needs to keep moving in the right direction towards the future.

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Another segment coming from a recent acquisition, but also not quite rolling yet, is Credit Karma. In the second half of 2022, this segment's figures disappointed despite strong revenue growth within the credit card part of the business. Other branches within Credit karma, including personal loans, mortgage loans, auto insurance and car loans got wind of the decline. Intuit recently adjusted expectations for this segment, going from positive growth of between 10 and 15% to a slight contraction of 10 to 15%. Nevertheless, management remains positive and expects long-term average growth of 20 to even 25% year-on-year, a stronger growth forecast than it has in any other segment.

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The stock is currently trading around $410 and has a strong buy recommendation among 20 analysts over the past 3 months, with an average price target of $493, offering upside potential of over 20%. Analysts expect an increase in sales of about 18% compared to last quarter.

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Based on traditional measures, the share price appears overvalued. For instance, the market is pricing the stock at a forward P/E ratio of 29.09 for the coming year, where the median within the sector is only around 24. Still, we should not focus solely on the financial ratios without factoring in the positive factors in the form of the strong gross margin, strong return on equity and the good financial health the company is in. Other factors like further to be completed share buyback programme of over US$3 billion and a growing dividend may play a further role in the share's attractiveness.

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Intuit remains one of the strongest companies within the prepackaged software sector, providing key software and services to various audiences within the US, as well as internationally.  It has a smart revenue model based largely on recurring subscription revenue. The company enjoys economies of scale and can easily grow without operational costs skyrocketing as fast in the process. All eyes are now on the quarterly figures to be published on 23 February to see if growth continues and the company can meet its pre-set expectations. Despite currently already being priced high in the market, the stock remains a strong name within the sector.

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