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MagicDiligence (< 20)

Stock Review: Jackson Hewitt Tax Service (JTX)



July 07, 2009 – Comments (5) | RELATED TICKERS: JHTXQ.DL , HRB , INTU

Jackson-Hewitt Tax Service (JTX) is the second largest "brick-and-mortar" tax preparation firm, trailing only H&R Block (HRB) in returns filed. The company operates primarily on a franchising model, where franchisees open locations and pay royalty and advertising fees back to the parent - although recently the company has moved towards more company-owned stores, as a large franchisee came under DOJ investigation for tax fraud in 2007, hurting the brand name. Historically, Jackson-Hewitt has focused on lower income filers, which are more likely to use physical locations instead of online software, and also are more likely to get a refund anticipation loan (RAL), which come with huge interest rates if they are not paid off quickly.

Not so long ago, Jackson-Hewitt looked like an attractively priced stock in an good industry. Tax preparation has a lot of desirable qualities. For one, it is not very capital intensive to sell franchises and collect royalties, allowing the company to grow revenues without requiring much expenditures, which in turn leaves more cash available for shareholders. Also, it is one of those "inevitable" businesses that Warren Buffett likes to talk about. Virtually every adult in the U.S. has to file a tax return, so there is almost no chance the market will just disappear or decline significantly from year to year. The stock's (then apparently) low price in early 2008 looked to be due to a one-time occurrence with a misbehaving franchisee, something that would hurt the brand for a year or so but then fade away. Unfortunately, things have snowballed downhill from there.

Today, Jackson-Hewitt sells at about 1/5th the price of early 2008, and the stock looks fairly valued. In late 2007, new management came on board, and the 2008 tax season was even worse due to the lack of an early season refund product, something that many of those low income filers relied upon. In 2009, the company offered a prepaid card option, but results continued to decline as many franchisees raised prices to get back lost returns from the '07-'08 debacles - a bad move in a weak economy. This also combined with the increasing trend of filers using online software to file returns, a market Jackson-Hewitt does not compete in. JTX saw a drop of 13% in tax return volume in 2009. Since 2007, the company has lost 20% of its business, suffered an operating margin decline from nearly 40% to about 19%, and delivered about 66% lower earnings per share. Bad momentum, indeed.

In June, the board of directors started to lay the groundwork for a turnaround or, maybe more likely, an auction of the company. Underperforming CEO Michael Yerington was replaced by H&R Block veteran Harry Buckley, and the board announced a relationship with Goldman Sachs (GS) to investigate "strategic alternatives", which in Street-talk usually means a potential sale. Some glimmers of hope exist. The company managed to negotiate an exclusive deal with Wal-Mart (WMT) to add another 1,000 locations inside of their retail stores, which should slow or reverse the rate of tax return volume declines. An online tax prep product is planned for the 2010 season, though it will be an uphill battle against Intuit's (INTU) TurboTax and Block's TaxCut. And there is always the potential of an outright sale of the company. Jackson-Hewitt's original founder, John Hewitt, took a 9% stake in JTX late last year, possibly in a bid to merge it with his Liberty Tax Service.

While these developments can give current shareholders some confidence, I can't recommend Jackson-Hewitt as a MagicDiligence Top Buy, or otherwise. RALs are an important part of JTX's business model, and banks are now shying away from them, making it a difficult proposition to continue offering them in the future. It will take time (and money) for any online product to gain traction. There is still a significant amount of debt on the balance sheet, and not much cash. A lot of franchisee agreements (almost a third) are up for renewal soon, and there are a lot of disgruntled franchisees. There are few competitive advantages to make customers want to choose Jackson-Hewitt over any of its competitors. And the stock's earnings yield is not all that low - just 10.4%, much more expensive than most MFI stocks and probably a proper valuation given the cloudy future. At this point in time, MFI investors should steer clear of Jackson-Hewitt and look for something with a little more clarity going forward.

Steve owns no position in any stocks discussed in this article.

5 Comments – Post Your Own

#1) On July 07, 2009 at 9:01 AM, Mary953 (84.30) wrote:

This comment is not directed at Jackson Hewitt alone but at all of the tax chains offering RALs.  PLEASE do not get a RAL!  You are looking at an interest rate that may be/probably will be the highest interest rate you will ever face legally.  The refund comes to you by way of the bank and tax office, both of which take their fees and interest out first.  Require that you be told the amount you would receive with a RAL and without a RAL before you consider signing up for one.  You will be in for a shock.  (I kept a copy of the contract with the fees and interest rates highlighted so that they were easy to see.  The owner didn't mind because he disliked the idea as much as I did.)

I always dreaded those first few days.  People came in, had tax returns prepared with hugh refunds.  Then they chose to get the RALs (loans)  To get a refund two days earlier, they left 75% of the refund at the bank.  The tax companies all use the same banks with the same forms and the same rates.  You will not get a better deal down the street.  Wait the two or three days and claim all of your money.  Don't give it away.

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#2) On July 08, 2009 at 6:48 PM, JoeTheRALguy (< 20) wrote:

Mary, "get a refund two days earlier..."? The average time the IRS deposits a refund into a bank account "if" you use electronic filing and "if" you have a bank account to deposit it in is 11 days. IF you don't have a bank account and don't e-file (paper), still 6-8 weeks before a check arrives. Also, FYI, the average refund loan is $3200 for which the bank charges a "one time" fee of $112...or $3.50 per $100 loaned. Thats pretty good whether the loan is 1 night, 11 nights or 11 months. In fact even if the refund is insufficient to repay the loan there are no extra late fees or interest to pay. One fee, one time, once a year. And nobody leaves "75% of the refund at the bank"...where do you get this stuff?

Yes, deducted from the refund payment would be the loan fee and the tax prep fee - meaning there are no out of pocket expenses for a taxpayer who cannot afford but wants professional tax preparation. Not everyone trusts government sponsored VITA sites to prepare their taxes for free. And not everyone has a bank account (or wants one). ... but their personal circumstances require they have quick access to cash. A RAL is a cheap alternative to cash advances on credit cards (if they have one) or payday loans ($15/$20 per $100 loaned) or even wiring money ($145 to wire $3000). With limited credit alternatives and a need for money that the government can't supply them a RAL is one of the only credit options available for them. And I don't dread those "first few days" when 100's of thousands of people are helped because they CAN get financial help finally...

With all due respect to Steve's commentary, banks are not shying away from doing RALs. Some banks are getting out, some getting in (free market). I think the comment may be mixing up banks reluctance to suppply credit in general due to the financial crisis. I can't speak to specific Jackson Hewitt directions but I can say they are focusing a lot of attention on protecting the franchisees from exposure to fraud with very sound policies which include enhanced training and education programs. Although some franchisees complain about the extra compliance measures, this is a very sound approach towards protecting them from loss.        

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#3) On July 09, 2009 at 9:34 AM, MagicDiligence (< 20) wrote:

Jackson lost HSBC as their RAL provider in 2008.  They are left with two much smaller banks that are less reliable and less able to provide adequate capital.

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#4) On July 21, 2009 at 2:45 PM, TaxGuyJH (< 20) wrote:

The switch from HSBC to SBBT and Republic came about because, as you know, HSBC is owned by HRB. An expected move on their part  to not supply a competitor. However, SBBT and HRB have done a fine job of supplying Jackson Hewitt.

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#5) On August 04, 2010 at 3:08 AM, usfregale (< 20) wrote:

As something of a correction to the comments, JTX has not used HSBC as a major supplier for RAL loan products in at least the last ten years.  HSBC through a subsidiary did provide very small amounts of non-RAL loan products to JTX during its testing of a product to assist its clients in paying balances due to the IRS.  The program was not very successful and was mutually discontinued in 2008.  The fact that HSBC is a major RAL player thus led to the confusion that HSBC had withdrawn RAL funding.

 That being said, JTX did lose 75% of its RAL funding in December 2009, when the Office of the Comptroller of the Currency issued a cease and desist order to SBBT forbiding it from facilitating RAL loans during the 2010 tax season.  This took place due to the precarius financial condition of SBBT's parent bank holding company Pacific Capital Bank (PCBC).  PCBC's financials have been weaked by their significant exposure to the California mortgage market -- all of their retail operations are located in California.  The SBBT unit was then sold by PCBC to private equity for a song and will be providing RALs for the upcoming tax season.  Republic Bank doubled its commitment to JTX in December 2009 and the company obtained an additional commitment of about 10% of its needs from River City Bank, a new RAL industry banking partner for JTX.  That means that just less than 60% of JTX's retail customers had access to a traditional RAL product during the 2010 tax season.  Additionally, the company leveraged its existing relationship with MetaBank to launch a non-traditional RAL program in markets where a traditional RAL was not available.  The company's recent annual report speaks to the success of the program.

 In summary: this is a great review with a great deal of foresight.  One important item it did not mention is that JTX negotiated out of a debt dafault in May 2009 and technically defaulted in May 2010 (though it concluded a negotiation in early May 2010, there was a technical default in the first several days of the month).  As part of its May 2010 renegotiation JTX must secure 100% RAL funding  prior to October 1, 2010 or once again be in default.  This has been made very difficult in the uncertain lending environment surrounding the potential that the IRS may eliminate the debt indicator for the 2011 tax season (possible, but unlikely, decision expected any day now), the congressional efforts to organize the new consumer lending protection agency and its possible interest in RALs, and the exit from the RAL industry of Chase (JPM) the single largest RAL lender for small non-franchised tax companies.  Chase's departure has created a gap in the industry that existing participants (Republic, SBTPG (formerly SBBT), River City, and Refund Advantage (Private) are rushing to fill.  The lenders feel that small tax preparers make a better reputational risk due to the potential of bad press from an affiliation with HRB or JTX. 

Odds are that JTX will not be able to secure full RAL funding by the deadline imposed by its lenders and either default again on October 1, 2010 or will once again renegotiate.

Finally, even if JTX is somehow able to survive default on October 1, 2010 the future remains clouded.  As mentioned in the review franchisee morale is very low and JHI's ability to make the financial concessions needed to improve it are limited for all the reasons discussed above.  Barring an exceptionally good 2011 season, (which seems unlikely given all of the issues discussed) receivership is likely.  Even an exceptional 2011 season will not solve JTX's issues -- a return to its 40% operating margins of only three years ago will at best leave the company barely able to cover its May 2011 debt payment, without giving any thought to subsequent operating capital requirements.

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