By Scott Kessler
Intuit (INTU ) may not be the most recognized technology company by name, but the software maker's products -- including Quicken for personal finance, TurboTax for tax-preparation, and QuickBooks for small-business accounting -- are market leaders and have a very strong following. Intuit is the world's fifth-largest software company based on market capitalization.
Despite the protracted technology-spending slowdown, shares of the five-largest software companies -- Microsoft (MSFT ), Oracle (ORCL ), SAP (SAP ), Electronic Arts (ERTS ), and Intuit -- actually outperformed the S&P 500-stock index year-to-date through Sept. 26. However, only Intuit and Electronic Arts are up for the year.
We at S&P believe that Intuit's stock -- which is ranked 3 STARS (hold) -- has done better than its peers and the broader market primarily because of its impressive record of growth and margin expansion (both achieved and projected), even against a challenging economic backdrop. To find out the secrets of the company's success, I attended Intuit's Sept. 18 Analyst Day at its Mountain View (Calif.) headquarters. Here's a summary of what I learned.
Although Intuit's sales increased a healthy 18% -- to $1.36 billion (excluding discontinued operations) in fiscal year 2002, ended July -- the company has targeted an amazing 25% to 33% revenue growth this fiscal year. We at S&P expect this growth to be fueled by QuickBooks (19% sales growth in 2002), small-business services (15%), vertical business-management offerings (new), consumer-tax products (29%), and purchases by professional accountants (25%).
QuickBooks should continue to be bolstered by Intuit's pursuit of the midsize small-business market (companies with 20 to 250 employees) with new products, services, and features. Small-business services will benefit from the release of a new outsourced-payroll product (aided by Intuit's June, 2002, acquisition of CBS Payroll) that will integrate seamlessly with QuickBooks.
Intuit has also made several acquisitions as part of a so-called vertical business-management strategy it launched about a year ago. It defines vertical solutions as integrated software and services offerings that are tailored to the requirements of specific industries and enable companies to run their businesses more efficiently.
For example, Intuit Public Sector Solutions (formerly American Fundware, before being acquired in June, 2002) develops software that helps nonprofit organizations prepare and submit grant proposals. After years of working with small businesses, Intuit learned that many organizations could use and benefit from software that had industry-specific features. In fact, research group IDC estimates that this market will grow from $16 billion in 2002 to $23 billion in 2006.
At the moment, Intuit is more focused on the small-business section of this market, which is expected to increase from $4 billion in 2002 to $6 billion in 2006. It has already acquired software in this area, for sectors including construction, nonprofit groups and schools, real-estate management, and wholesale durable-goods distribution.
In addition, Intuit plans to introduce several specialized versions of TurboTax, including releases specifically for retirement planners and investors. An all-Spanish edition is also planned.
We at S&P expect overall sales growth to accelerate notably in fiscal year 2003, which seems surprising given Intuit's maturity and some of its products. However, the company has been committing significant research-and-development resources to improving its existing products and launching new ones, as well as investing sales and marketing dollars to sell them. And, as mentioned, Intuit has also been aggressively acquiring small software and services companies.
Management says its top priority is "strategic and operational rigor" -- that is, owning the right businesses and running them as adroitly as possible. Since becoming CEO in early 2000, Steve Bennett has bought and sold several businesses in the pursuit of the ideal asset mix. He has divested many of noncore businesses, including mortgage origination and servicing in August, 2002; bill presentment and payment in May, 2002; and insurance in January, 2001. We believe the last operation that might be consolidated is Quicken.com.
Like most software companies, Intuit benefits from the increased leverage that accrues from its high fixed-cost and low variable-cost business model (i.e., while it invests heavily to develop products, the costs to sell these offerings are relatively low) coupled with favorable unit-sales trends. We also expect Intuit to continue improving cost controls and efficiencies. As a result, it expects to deliver annual profit growth of 1.5 to 2 times its revenue growth over the long term. This would be an impressive achievement, and we are confident in the management team's ability to execute.
CEO Bennett has installed a good management team. Although CFO Greg Santora has announced he's retiring at yearend, we expect Bennett to hire a talented replacement, perhaps someone he worked with during his former days at General Electric (GE ). Intuit's board is impressive, diverse, and largely independent, and it has an audit committee that meets frequently.
The board has been extremely proactive in authorizing stock buybacks. These are used to offset the stock dilution, which averaged 4.7% from fiscal years 1999 through 2001 but fell to 3.2% in fiscal year 2002. Because Intuit shares have done well despite the bear market, the problems associated with a potential options repricing or issuance aren't an issue, unlike for many of its peers.
I learned quite a bit at Intuit's Analyst Day and was very encouraged by what I saw and heard. But investing in the stock involves making a decision with respect to not only a company's fundamentals but also its valuation. At a recent 34 times my fiscal year 2003 EPS estimate, the shares traded considerably higher than the p-e of the S&P 500 Software Industry index and S&P 500 as a whole. Intuit's p-e-to-growth multiple was on par with the industry but notably above the S&P 500.
My assessment of the stock's intrinsic value using discounted cash-flow analysis is $44 to $47, in line with the recent share price. Although Intuit has a lot of appeal, I'm willing to wait for a more attractive entry point before recommending that investors buy the stock.
Analyst Kessler follows Internet software and services stocks for Standard & Poor's