Comprehensive Tax Reform Could Slam H&R Block

| About: H&R Block (HRB)

As Congress kicks off its latest attempt at comprehensive tax reform, it would seem to be a prudent reminder for investors of H&R Block (NYSE:HRB) to understand that if this reform passes it could prove to be an existential threat to the company. Granted, tax reform is something that gets bandied about on an annual basis and special interests will go to war to protect sacred cows such as the mortgage interest and charitable giving tax deductions. Be that as it may, with other major policies such as Immigration reform looking bleak, and Obamacare unraveling before our eyes, tax reform may end up being the piece of legislation that is the least poisonous thus leading to a higher chance of actual passage. With H&R Block trading at close to a 52 week high, the market is treating this company as if it is a growth stock. The reality is that total tax return volume was stagnant in 2013 compared to the prior year, even as the employment picture brightened which theoretically increased the amount of individuals with a need to file a tax return. In the same vein, the company generates a significant portion of its revenue (the highest profit margin revenue) via refund anticipation loans or other short term installment loans that are directly tied to customers filing tax returns. Any type of legislation that lessens the need for those customers with simple tax returns, who are also the ones most likely to be getting force fed these highly profitable ancillary products for H&R Block, will have an outsized impact on the company.

Why Tax Reform Possibility Makes H&R Block A Bad Investment

H&R Block has seen a massive run up in its shares over the last 12 months as seen below:

HRB ChartHRB data by YCharts

Shares are up almost 100% over the last 12 months, and the company now sports a market capitalization of ~$8.1B. The company trades at ~19x its trailing earnings and ~16x its forward earnings estimates. H&R Block is hardly cheap, and many investors pile into the name because it currently pays a moderate dividend yielding 2.8%.

The company was slammed during the housing crash for its ill advised foray into the residential lending market, and saw massive losses on mortgage loans it carried. With the bulk of this disastrous move in the rear view mirror, the company is now once again being looked at a pure play tax preparer company. However, as I noted in the introduction, this industry is one that is heavily regulated with the potential to have its entire world turned upside down if sweeping tax reform is passed that simplifies the tax code.

During FY 2013, about 13% of the total revenue for H&R Block came from services unrelated to tax preparation. These ranged from refund anticipation loans, fees on the cards used to receive the loans, and consumer loans bearing interest. In a nutshell, H&R Block still managed to generate close to $400M in revenue from products that essentially gouge those who are unable to wait the 21 days it takes to get their tax refund. The company is not doing anything that is not allowed, but if tax reform is instituted and these customers who need instant cash do not need to go to an H&R Block to have their taxes prepared, the company will lose what is certainly an extremely high margin portion of its business.

Investment Outlook

12 months ago, H&R Block paid a dividend that yielded over 5.5%. After an almost 100% increase in the stock price over the last 12 months, this is not nearly as an attractive of an income investment with a much lower dividend yield. With a business showing stagnating growth in the number of total tax returns prepared, and a wide range of potential legislation that could further lessen the need for consumers to use a tax preparation company, H&R Block is an investment I would avoid entirely at this time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.