Trading Jackson Hewitt Following Lawsuit News

Apr. 4.07 | About: Jackson Hewitt (JHTXQ)

A couple of firms comment this morning on Jackson Hewitt (NYSE:JTX) after the Justice Department and the Internal Revenue Service announced civil injunction suits against five companies that operate Jackson Hewitt franchises.

- William Blair notes it is critically important to note that the suits are aimed at this one particular Jackson Hewitt franchisee, not Jackson Hewitt corporate. It is also important to note that Jackson Hewitt's franchise agreements explicitly state that franchises are independently owned and operated and that any liability arising from faulty or fraudulent tax preparation belongs exclusively to the franchisee/preparer. Mr. Sohail's 126 Jackson Hewitt offices represent approximately 1.9% of Jackson Hewitt Tax Service's more than 6,500 locations, and, according to a news source, prepared 105,000 or 2.9% of the company's total network tax returns prepared last year. All of this suggests that the risk to the corporation-legally, operationally, and financially-is fairly well contained.

The government suit and investigation could pose additional risks to the company, however, including headline and reputation risk as well as the risk of spurring class-action lawsuits directed at Jackson Hewitt Tax Service Inc. on behalf of tax clients who may now owe the government money from fraudulent refunds. The news may provide ammo for legislators looking to increase oversight of the tax preparation industry by mandating preparer training standards, etc.

Firm cautiously maintains Outperform rating and estimates. Shares of JTX declined more than 18% on Tuesday after the story broke around 1:30 CDT. While the fear and uncertainty inherent to this situation is understandable, they believe the share price decline may prove to be an overreaction to an event that appears to center around one bad apple, not the entire barrel. At Tuesday's closing price of $26.53, JTX trades at 13.7 times fiscal 2007 EPS estimate of $1.94 and 11.7 times fiscal 2008 EPS estimate of $2.27. Shares are also trading at what the firm estimates is a nearly 10% free cash flow yield based on 2008 estimated free cash flow. This strong free cash flow generation informs the company's substantial share repurchase program. The co has buying power at the current stock price to repurchase more than 19% of the diluted shares outstanding.

- Morgan Stanley is upgrading the stock to Equal Weight from Underweight saying no franchisee at Jackson Hewitt accounts for more than 2-3% of revenues, and this particular franchisee is less than 2% of revenues, accounting for about $0.03 in EPS, based on firm's estimates, for a loss of value of about 1.5%, much less than the 18% decline in valuation that occurred following the announcement. Attractive free cash flow yields of 8-9% should support the stock between $25-$30.

Firm notes they are not upgrading to an Overweight based on their longer-term cautious view on the industry and the company, which has not changed. They believe that the increased competitive intensity will slow future growth for the company.

Notablecalls:
Buy the stock here. Pay $27 if you have to. For a trade. Tight leash, though.