Americans just concluded the yearly drama of self-sacrifice and bureaucratic waste known as tax season. That undoubtedly has many value investors wondering if tax-preparation companies such as Liberty Tax (NASDAQ: TAX) make money?
After all there is a huge market for Liberty’s “services;” around 56% of (or 82.32 million) Americans used the services of a “tax professional” in 2014, Tax Maze; a report prepared by U.S. Senator Liz Warren’s (D-Massachusetts) stated. Warren’s staff also found that the average American spends around $200 a year on income tax preparation.
This enables the tax preparation industry to capture around 10% of the value of the average tax refund, Warren’s staff concluded. That points to a very lucrative business with a lot of potential to generate float.
The Value Argument for Liberty Tax
It also piques value investors’ interest in Liberty Tax because it operates in a non-sexy industry and offers a service that a lot of people need. Liberty also has a great “marketing tool” in the form of the IRS; which can put people in prison for not paying taxes or garnish their income.
To add icing to the cake Liberty deliberately caters to less sophisticated and less educated working class customers, who are less likely to own Turbo Tax or do their own taxes. The goofy marketing tactics such as the helpless employees dressed up as the Statue of Liberty seem to successfully attract such customers.
That enables Liberty to mostly do simple tax returns which are cheap and easy to process. This lowers labor costs, and eliminates the potential for costly mistakes. It also gives Liberty the potential for a lot of float from tax refunds and tax-refund loans.
Such refunds enable Liberty to process a high volume of returns which can increase revenues and float. That’s the secret to Liberty’s business plan, but does it work, does the company make money?
Is Liberty Tax Making Money?
The answer to these questions is not very much. Liberty reported a net income of $15.97 million and revenues of $167.22 million on January 31, 2017. It also reported a negative free cash flow of -$26.72 million on the same day.
The reason for the negative cash flow is the seasonal nature of Liberty’s business. Historically it reports one really high cash flow a year at the end of April, just after tax season. For example it reported a free cash flow of $95.02 million and a net income of $19.42 million in April 2016.
Despite the fluctuations, Liberty’s cash from operations did rise to a high of $36.05 million on January 31, 2017. It was $10.46 million a year earlier, which indicates the company is capable of steady growth in some of its cash business.
That did not translate into much float though, Liberty reported cash and short term investments of just $3.459 million and assets of $297.75 million on January 31, 2017. The major reason for the lack of float is the pay out of profits to shareholders and owners of the company’s franchises.
Is Liberty Tax a Good Investment?
That will make some people wonder if Liberty Tax is a good investment. The answer is maybe for the franchisees but not for shareholders.
Liberty investors received a dividend of 16¢ on April 10, 2017. That dividend has held steady for at least two years since 2015 according to our friends at ycharts. That dividend is low for a $14.50 a share stock, even if it is steady.
Although Liberty Tax shareholders not receive a 16.99% return on equity on January 31, which is pretty nice. Despite that I would say stay away from Liberty Tax because there are better low cost financial services companies out there that are far more diversified.
One I really like is Bank of America (NYSE: BAC) which was trading at $24.25 a share on April 25, 2017. That’s a company with $84.27 billion in revenues for $24.25 which sounds like a true value investment to me.
Stay away from Liberty Tax
My advice would be to stay away from Liberty Tax unless you are planning to buy a franchise. It just does not generate enough revenue, cash or steady float for my tastes.
It might also be a good idea to stay away from tax preparation in general because there is renewed talk of return free federal income tax in Washington. Under a return free system, most taxpayers would simply receive a bill or a refund from the IRS and not have to file a return.
Warren is the latest and most high profile politician pushing the idea right now. Were return free income tax to become reality, Liberty’s business would effectively be wiped out.
Most of the low-income people the company relies on have simple taxes so simple the IRS knows how much they make and should pay. The agency would have no trouble sending them tax bills because it has W-2 or W-4 information of their income on file.
Tax preparation is a great deal for those in the business, but a lousy deal for investors. Stay away from Liberty Tax stock if you want to make money in the market.
Disclosure: your friendly neighborhood blogger has a small long position in Bank of America.