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Summary

  • Simplification of the United States Tax System would be a huge big blow to H&R Block.
  • HRB has experienced declining then sideways revenue growth due to intense competition.
  • High Multiples and a history of earnings misses make HRB risky to own.
  • Taking everything into consideration, H&R Block looks like a great long-term short sale opportunity.

H&R Block (NYSE:HRB), according to Google Finance, "provides tax preparation and banking services. The Company's Tax Services segment provides assisted income tax return preparation, digital tax solutions and other services and products related to income tax return preparation to the general public primarily in the United States and its territories, Canada and Australia. This segment also offers financial services through H&R Block Bank (HRB Bank)." Upon doing some basic research on the company, we found numerous caution signs throughout the company that make HRB a potential short sell target. In this article, we will discuss these caution signs in depth.

How We Came Across HRB

In Equities Lab, I was brainstorming through strategies that return potential short sells. In the editor, I wrote multiple conditions that a stock must meet in order to pass the strategy. A screen shot of the conditions can be seen below:

The conditions from top to bottom are saying: the EPS Estimate for the current fiscal year must have been revised downwards over the past month, the EPS estimates for the next fiscal year must have been revised downward over the past month, the stock's price to sales must rank in the top 25% of its industry, the stock's trailing 12 month sales growth must rank in the bottom 25% of its industry, and the stock's return over 251 trading days (1 year) must rank in the top 75% of its industry. The results of those conditions were 10 stocks including HRB.

Threat of Tax Reform

The major risk for H&R Block is the threat of tax reform. There is no question that the United States' income tax code is extremely complex and that is what drives people to use tax preparation services like H&R Block. This article explains how tax forms are getting more and more complicated over time. The voice to push for tax simplification is getting stronger as time goes on and the threat of tax reform becomes more likely. Any simplification to the tax system would hurt H&R Block's revenue and likely send the stock tumbling as we will see more people filing their own taxes and electing not to pay tax preparation services.

Weakening Revenue

According to Factset, sales for 2009 totaled $4.08 billion then dropped 5.12% in 2010 to $3.87 billion. From 2010 to 2011, sales took another 2.6% drop to $3.77 billion then another massive drop of 23% from 2011 to 2012. From 2012 to 2013 sales increased a slight .7% from $2.89 billion to $2.91 billion. The drop in sales then sideways growth can be attributed to the emergence of heavy competition in the tax preparation services industry. When I did my taxes about a month ago I had a decision to make on what company to use. My options were vast with H&R Block, Jackson Hewitt, Liberty Tax Service, TurboTax, TaxACT, TaxSlayer, Locally owned tax preparation services, IRS E-File (a free service), etc., etc., and etc. The bottom line is that the space is heavily saturated and H&R Block faces a vast amount of competition that sometimes offer their services at a cheaper price.

History Earnings Misses

Earnings for the 4th Quarter of 2014 has yet to be announced. It is by far the most important quarter for HRB as it represents tax season. Revenue for the 4th quarter of 2013 was $2.2 billion and analysts are expecting revenue of $2.49 billion for the 4th quarter of 2014 representing a 13.2% year-over-year increase.

Over the past 4 quarters, according to Yahoo Finance, HRB has missed its earnings estimates. I could not find Q4 or 2014 guidance that the company issued so I will be unable to comment on what we think Q4 numbers will look like. I can tell you that trailing 12 month sales growth for HRB is -1.7%.

Overpriced?

- Price-to-Sales Analysis

HRB currently trades at a price-to-sales ratio of 3.2. That ranks at the top 22% of companies in the personal services industry while their estimated 5 year growth rate of 11% ranks at the bottom 27% and sales growth over the past 5 years ranks at the bottom 14% of the personal services industry.

- Price-to-Book Analysis

HRB currently has a price-to-book of 12.3. That ranks at the top 91% of companies in the personal services industry. HRB has a dividend adjusted trailing PEG ratio of 4.7 which ranks at the top 27%. JTH Holdings (NASDAQ:TAX), a public company in the tax preparation industry, trades at a price-to-book of 4.7.

- Price-to-Earnings Analysis

HRB currently has a high PE ratio of 37.5 which ranks at the top 42% of personal services companies. It also ranks at the top 23% of stocks, excluding financial and market cap under $5 billion, while reporting well below average growth.

- Equities Lab Value Score

HRB currently has an Equities Lab Value Score of 2 out of 10. A screen shot of the value score can be seen below:

An explanation of the conditions in the score can be found in this article. Low value score stocks are generally overpriced and we have confirmed that theory with our back test. The graph below displays the back test results of stocks located in the personal services industry and a value score less than 3 can be found below:

(click to enlarge)

The green line represents the return of the strategy, while the grey line represents the return of the S&P 500 and blue line represents the Russell 2000. The green line returns -44% since 2010 while the S&P 500 has returned roughly 70%.

- Bottom Line

The bottom line is that HRB is trading at above average multiples while experiencing below average sales and earnings growth.

Summary

The threat of tax reform, weakening sales, heavy competition, and high multiples make HRB a solid long-term short sell opportunity.

The stock is up 69% since the start of 2013. Taking everything into consideration, including the technicals, we think it is a great time to short sell HRB.

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.

Source: H&R Block Offers A Great Short Sale Opportunity