Gauging the tax cuts' impact on Corporate America
Businesses throughout the U.S. have been particularly busy probing into one really game-changing event -- the recently passed tax bill. And a big question is: Who are the real winners and losers from the Trump administration's sweeping tax cuts?
Clearly, the Tax Cuts and Jobs Act (TCJA) will dramatically alter the top-line and bottom-line configurations of thousands of American businesses.
"Companies have already started to examine the potential positive and negative impacts to their risk exposure and bottom lines, and are changing the way they do business," said Camilla Yanushevsky of S&P Global Market Intelligence, in her assessment of what she describes as "the most sweeping tax rewrite in over 30 years." Yanushevsksy deals mostly with markets and dealmaking.
She noted that the S&P 500 fourth-quarter earnings-per-share growth rate stood at 13.69 percent as of Feb. 2, 2018, "with many pointing to corporate tax cuts as playing a major role this earnings season."
In her report on the tax law and its complex ramifications co-written by Melissa Doscher, a senior manager at S&P Global Market Intelligence, Yanushevsky examined and highlighted notable sector-, industry- and company-level "probability of default" (PD) changes as indicated by S&P's "PD Market Signal Model." This is a structural model that calculates the likelihood of a company "defaulting on its debt or entering bankruptcy over a one- to five-year horizon."
One big winner: telecommunications companies, which pay some of the highest effective tax rates. Yanushevsky noted that the weighted average effective tax rate paid by the U.S. telecom services sector stood at 34.6 percent in 2016, while the weighted average for all U.S. companies was about 27.2 percent.
Following the new tax law, telecom services saw its PD decrease 32.8 percent, from 1.27 percent on Dec. 19, 2017, to 0.85 percent of Dec. 21, 2017 -- the steepest decline among the 11 sectors in the Global Industry Classification Standard.
Yanushevsky observed that lower taxes and enhanced deductions on capital spending will enable telecom companies to increase their capital investments, including efforts to upgrade and expand their networks.
One of the biggest winners from the tax cuts is AT&T (T), which saw its PD subsequently decline 33 percent, noted Yanushevsky. In the past quarter of 2017, the corporate tax overhaul helped the telecom giant book a $19 billion profit that will result in $3 billion extra cash this year, "a sum AT&T plans to spend on bolstering its network," noted Yanushevsky.
The tax cuts and deregulation "make telecom companies especially ripe for mergers and acquisitions in 2018, she argued. "The convergence between telecom and cable and satellite is also expected as telecom operators seek opportunities to add content offerings amid stagnating revenues," Yanushevsky pointed out.
Also affected is the household appliance industry, a subset of the consumer discretionary sector, which saw the largest drop in PD of 47.8 percent, according to Yanushevsky.
Real estate and the utilities were also affected but in the opposite direction. These two sectors saw "the largest market-perceived escalations in credit risk," according to the Yanushevsky study. The real estate sector saw its PD increase 21.6 percent from 0.04 percent on Dec. 19, 2017, to 0.05 percent on Dec. 21, 2017, while the utilities sector saw its PD rise 20.2 percent from 0.15 percent, to 0.18 percent.
On the subsector level, specialized REITs and residential REITs got the largest escalations in credit risk, with PD increases of 69.2 percent and 64.7 percent, respectively. The upticks in real estate and utilities could be the result of dampened enthusiasm for those sectors during the last months of 2017, said Yanushevsky.
What about the impact of the tax cut on the company level? The Yanushevsky study showed that roughly 55 percent noted a decline in their one-year PD, and 12 percent saw no change. But companies with both high and low last-12-months effective tax rates saw a reduction in credit risk.
To sum up, "our PD Market Signal model showed that TCJA did impact the short-term market-perceived credit quality of firms," the report concluded. But while the tax law's longer-term implications remain uncertain, said Yanushevsky, "we saw in 1986 how the widely praised Reagan tax cuts led to an implosion in the real estate market and the onset of the savings-and-loan crisis."
More recently, "we saw how the TCJA fueled an epic stock rally and stellar earnings forecasts," said Yanushevsky. "Likewise, the TCJA will most likely have its own winners and losers. Companies as well as individuals should be especially alert as the longer term impacts play out."
To be sure, more details and headlines are yet to come as more studies dig into the tax cuts and their impact on businesses, companies and individuals.