H&R Block: Why It Could Be a Value Trap Despite Its Dividend

| About: H&R Block (HRB)
H&R Block (NYSE:HRB) is a good example of why cheap dividend plays aren't always cheap.
These types of plays have become more popular in the past two months, with equities offering their strongest yields in 15 years relative to bonds.
And H&R Block is among the cheapest of the high-yielders. Its P/E is now 7.8 times, way lower than any of its peers, and far below the stock's historical average.
It also scores in the top-decile of all North American stocks based on StarMine’s intrinsic value metric. North American stocks rose about 15 percent in the six months after they reached an intrinsic value score of 90 or above.
Meanwhile, Block's stock is technically oversold, based on several oscillators.
The added attraction is that HRB's dividend yield is 4.6 percent, far greater than any of its tax services peers and more than double the S&P average.
Dividend Yield:
H&R Block: 4.6%
Intuit 0%
Cintas 1.7%
Iron Mountain 2.0%
S&P 500 Average: 2.1%
Source: StarMine Professional
But when you do some extra homework on the credit side in Reuters 3000 Xtra, there are red flags that say Block is still a risky long play, and a potential value trap.
Of top dividend payers in the U.S, H&R Block has one of the highest 5-year CDS premiums relative to the sector/rating average to its triple B-rated peers.
Company Premium in BPS to peers
H&R Block 199
R R Donnelley 124
CenturyLink 89
Altria Group 44
Source: Reuters CreditViews
And it's recently taken a turn for the worse in the past month. It's CDS price spiked relative to its peer group.
H&R Block CDS:
1 Month price change: +50%
3 Month price change: +109%
Source: Reuters CreditViews
And last week, its default probability spiked, according to the Kamakura model in Reuters CreditViews.
Another potential red flag is H&R Block's Z spread. It's on the rise, which can be an indication of rising liquidity and credit concerns.
And here is part of what the credit markets appear to be concerned about:
There's been a lot of turnover at H&R Block. Over the summer, the company's CEO, CFO, its general council, and board member Thomas Bloch, all left the company.
Since that time, Alan Bennet has been appointed CEO.
And the new boss is staring down a lingering problem from the subprime mortgage heyday -- mortgage pullbacks.
In recent months, worries have increased that more mortgage issuers could forced to buy back mortgages they generated, due to breaches of warranties and legal representations.
They cover things like income documentation and property appraisals.
This is a concern for H&R Block because it started nearly $100 billion in non-prime mortgages from 2005 to 2007 through a subsidiary it has since sold.
About three-quarters of those loans were sold off to banks.
H&R Block two years ago set aside about a quarter-billion has about $188 million left in reserves for putback expenses.
So going forward, a big part of any bet on H&R Block shares is if those reserves are enough to cover its future putbacks.
When Block reported earlier this month, the company said it didn't need to boost putback reserves.
Yet it appears some in the credit markets still aren't so sure.
Fannie (OTCQB:FNMA) and Freddie (OTCQB:FMCC) have been aggressively reviewing bad loans portfolios in recent months, ratcheting up the overall putback pressure.
While there's little evidence of more putback activity for non-conforming loans like the kind the Block subsidiary made, that potential remains an overhang.
The question is, why wouldn't holders put back non-conforming loans if they can get away with it?
Block's dividend is fat and the stock is indeed cheap, but the putback issue threaens to make it cheaper still.
Disclosure: None

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