Trade of the Day: H&R Block (HRB)

by John Jagerson and Wade Hansen | April 16, 2014 9:21 am

Trade of the Day: H&R Block (HRB)

We watched with interest the news last week that HR Block (HRB[1]) would be selling its bank assets to Bank of Internet (BOFI[2]). (Incidentally, we still like BOFI and originally recommended it at $16 per share; it is currently trading over $80). The move is probably a good one for HR Block in the very long run but it also highlights problems that HRB has not been able to fully resolve.

The most significant of these problems is growth … there isn’t any. At first glance it may seem like 2013 was a turning point for the company and growth was coming back, but that is only if you don’t look too hard at the source of those unexpected profits. Like many firms during the last few years, increased profits came from cost cutting.

We are definitely in favor of streamlining operations and becoming more efficient, but the priority still has to be on growth. So, while 2013 looked much better, the most recent quarterly figures popped the bubble that HR Block investors were living in.

The most recent quarterly report showed revenues of $200 million versus $472 million for the same quarter last year. This seems like a terrible report (and it is) but it’s actually a little more complicated once you look beyond the surface. HR Block has a fiscal year that does not match the calendar year. These numbers were from its third quarter which actually ends on Jan. 31. Unfortunately for HRB, January is the start of tax filing season, and this January got off to a very rough start.

The IRS delayed the ability to electronically file returns in January while it was doing system tests. HR Block can’t recognize revenue for returns that were completed in January until they are actually filed. That unrecognized revenue is estimated at $276 million, which when recognized should bring them in line and a little ahead of the same quarter last year – or does it?

On the surface, this seems like a non-issue. So what if revenue and profits are recognized a quarter later than expected? If that was the only thing that changed, we would agree that it is merely a bump in the road, however, the delay also changed customer behavior. Customers in subsequent months have delayed using HRB for tax services and many others opted to use DIY software programs.

HRB has acknowledged that filings for February are down nearly 10% from the prior year. Management claims that it is selling bank assets to concentrate on its core business but, if that is true, then why is advertising spending down while customer flow is dropping? The bottom line is that HRB looks like it is setting up for another earnings disappointment and shorts could benefit.

Finally, we believe that HR Blocks’s valuation multiples (above average) do not accurately reflect the unsystemic risks of the business.

Interest rates could remain low, which hurts HRB’s usurious revenue from refund anticipation loans.

Tax-filing reform could wipe out a significant portion of HRB’s clients. The IRS has the information available to auto-file for most individuals who take the standard deduction. It may be a while before this happens, but it seems likely because it would not require reform of the tax-code itself to do it.

Software for DIY tax-filing is getting better and more popular all the time. Companies like Intuit (INTU[3]), the makers of TurboTax, have the top- and bottom-line growth rates that HRB can only dream of.

Security breaches could crush HRB’s credibility and reputation. Companies like HRB hold the most confidential information for their clients. They are certainly a target of hackers and criminals. If Target (TGT[4]), Ellie Mae (ELLI[5]), Adobe (ADBE[6]), Evernote, Apple (AAPL[7]), Facebook (FB[8]), etc. can be hacked, how likely is it that HRB will have its own data-breach – and can the company survive it?

The bottom line is that we look at a short position on HRB as a put option on security breaches, tax reform, and low interest rates.

From a technical perspective, we timed our recommendation following a massive bearish engulfing pattern on April 14 that confirmed the trendline break last Friday. The engulfing pattern was initiated when the company announced it would finally sell its bank to BOFI. This was initially greeted as a positive by analysts, which, historically speaking, has been a pretty good contrarian indicator for HRB.

HR Block Trade of the Day: H&R Block (HRB)[9]

HR Block (HRB): Chart Courtesy of MetaStock Professional

If HR Block has one saving grace, it is that management continues to return capital to shareholders through buybacks and dividends. However, the payout rate clearly points to a company that has limited reinvestment opportunities. We feel that all of these factors point to a stock that is headed lower in 2014 while investors concentrate on growth and/or value. Unfortunately for HRB, stagnation and unsystemic risks are just not as attractive as they were in 2013.

InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader[10], a trading service designed to help you make options profits by trading the news.  Get in on the next trade and get 1 free month today by clicking here[11].

Follow John Jagerson[12] and Wade Hansen[13] at Google+!

Endnotes:
  1. HRB: http://studio-5.financialcontent.com/investplace/quote?Symbol=HRB
  2. BOFI: http://studio-5.financialcontent.com/investplace/quote?Symbol=BOFI
  3. INTU: http://studio-5.financialcontent.com/investplace/quote?Symbol=INTU
  4. TGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TGT
  5. ELLI: http://studio-5.financialcontent.com/investplace/quote?Symbol=ELLI
  6. ADBE: http://studio-5.financialcontent.com/investplace/quote?Symbol=ADBE
  7. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  8. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  9. [Image]: http://investorplace.com/wp-content/uploads/2014/04/HR_Block.png
  10. SlingShot Trader: http://slingshot-trader.investorplace.com/index.html
  11. by clicking here: https://order.investorplace.com/?sid=QP7117
  12. John Jagerson: https://plus.google.com/115711248746858558308?rel=author
  13. Wade Hansen: https://plus.google.com/108450692850544646698?rel=author

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