Wednesday, January 27, 2010

Jackson Hewitt Tax Service: Don't Be Fooled Into Thinking It's In Value Territory

Subscribe in a reader

I stumbled upon Jackson Hewitt Tax Services (JTX) during one of my stock screens and had to investigate since it had an eye-popping 0.41 Price to Book (P/B) ratio. As some might know, I try to find profitable companies trading at a P/B of less than one, with the ideal scenario being that they can have all of their Goodwill and Intangibles written off and still have a P/B of less than one.

First, however, a little information on Jackson Hewitt:

Market Cap: $ 84.58 MM
Enterprise Value: $ 412.21 MM
P/E: 4.02
Forward P/E: 4.82
PEG Ratio: 0.82
P/S: 0.41
P/B: 0.41

And Yahoo! Finance description:

[The company] engages in the computerized preparation of federal, state, and local individual income tax returns in the United States. As of April 30, 2009, its network comprised 5,610 franchised offices and 974 company-owned offices. The company was founded in 1985 and is headquartered in Parsippany, New Jersey.

The Surface of Things

Just looking at the above mentioned numbers, JTX looks pretty attractive. Forward P/E and trailing P/E are both low and do not vary significantly, Price to Sales (P/S) is less than one, PEG is less than one and most importantly to me, P/B is less than one, and to boot, very low.

That all being said, even just glancing over the recent news bulletins for this company, and today's stock movement (down 16.5%), suggest that all is not necessarily well in the Jackson Hewitt household. It seems that the big market moving data piece was that JTX was not going to have enough funds to extend profitable tax return loans to customers.

This hits on two levels. The first is that it indicates a lack of cash and a lack of access to credit markets, both issues that are negative. The second, another negative, is that the business will not have access to a profitable fringe line of their business, especially during the most crowded season for individual tax work.

While negative press is something I think an investor should always be aware of, it shouldn't be the most significant factor in selecting an investment. In fact, I'm of the persuasion that oftentimes negative press can expose large amounts of value for investors to capitalize on. That being said, it's time to look under the hood and check out JTX's balance sheet.

For Want of Cash

I mentioned above that the recent negative press on JTX likely spoke to a lack of cash. This is very quickly confirmed after looking at their most recently filed 10-Q from the quarter ended October 31st, 2009, in which one discovers that they only had $60,000 at the end of the quarter. This is likely due to the net loss of $41.3 MM they reported for the quarter, but is still slightly chilling because they borrowed $85 MM under a revolving credit facility.

Now this isn't immediate grounds for dismissal since they've cut Accounts Receivable by 48% from the prior quarter, a positive sign that they're not just making sales on credit to try and boost revenues. Especially since the tax preparations business has seasonal cyclicality (centering around April 15th, the Christmas for the industry), a loss in a quarter that does not include tax season loses some of its significance.

However, after looking farther down the balance sheet, the Goodwill and Other Intangibles jump, since together these make up 85% of the company's total assets. This is somewhat understandable given that companies such as Jackson Hewitt rely on human capital (their accountants) and branding as a means of running their business. You can't really observe the value of these two items on a balance sheet, so when there's an acquisition, the bulk of the recorded assets is going to come in as goodwill.

That being said, compared to H&R Block (HRB), their biggest competitor, JTX's ratio of Goodwill and Intangibles to Total Assets looks absurdly high. H&R Block's Goodwill and Intangibles only make up 25.5% of their total assets, and they're currently sporting a P/B of 6.81. This leads me to think that JTX's low P/B is more of a warning sign than a value investing trigger.


Further examining JTX's balance sheet, if one were to write off all Goodwill and Intangibles the company would be left with a deficit of $304 MM for Shareholder's Equity. Additionally, for Shareholder's Equity to maintain a positive value (i.e. SE is greater than or equal to one), the combination of Goodwill and Intangibles can only withstand a writedown of 40%. To have a P/B of 1 or less, these same areas could only withstand up to a 24% markdown.

Given this information, I can say that I needn't do more analysis as to JTX's future prospects since these items point me to strongly reject JTX as an investment. While if you're the adventurous type JTX might be an interesting roller coaster, I find the risk-reward payoff unsuitable. In this instance, the P/B is probably a signal to look for the life boats on this Titanic.

In addition, one can almost categorically reject service industry investments such as Jackson Hewitt from my value investing perspective when their operational competitiveness is based primarily on human capital. People are the only assets that have legs, and you can bet if things go in to a bankruptcy scenario they're going to try and get out of there. Further, since this stock is going through a flux and the business model seems to be struggling, I'd bet money that JTX's most talented accountants are trying to jump ship, if they haven't already.

To look at the spreadsheet I used for my analysis, please see below
JTX Analysis

No comments:

Post a Comment