It has been a long time coming, but a corporate tax overhaul may finally be here. In late September, President Donald Trump gave a rough outline of the changes he would like to see implemented. The details are a little sketchy, and Congress still must hash it out and formally craft legislation. But broadly, these are the details of the president's corporate tax cuts:
- The corporate tax rate will be lowered from the current 35% to a more internationally competitive 20%.
- Many corporate deductions would be eliminated.
- There would be a one-time repatriation tax on untaxed overseas assets; in other words, assets held overseas will be taxed as if they had been brought home. The precise tax rate wasn't specified; the number is rumored to be about 10%.
Again, this is a rough outline, and Congress undoubtedly will do what Congress does and muddle it up. But the bill that eventually makes it to President Trump's desk probably will look like the outline you see above.
And while there will be winners and losers, they won't necessarily be who you think.
Despite partisan cries to the contrary, it's really not a gift to "big business." America's largest multinationals already employ armies of tax lawyers, lobby for specific deductions and keep most of their foreign income offshore. Big boys like Apple (AAPL (opens in new tab)) and Alphabet (GOOGL (opens in new tab)) don't pay anything close to the standard 35% rate. It's small- and midsize businesses that can't afford Apple's or Alphabet's attorneys that get stuck paying the full rate and thus stand to potentially benefit the most.
This is not to say that the large multinationals won't benefit, of course. While the repatriation tax smells like a cash grab by the government, it's great news for shareholders. Money that effectively has been dormant overseas likely will be brought home, and a fair bit of it is likely to get paid out as dividends and share buybacks.
Today, I'm going to highlight five companies that stand to benefit from Trump's tax cuts. Each would benefit in slightly different ways, but all will potentially enjoy windfalls. Shareholders, take note!
Data and stock prices are as of Oct. 2, 2017, unless otherwise indicated. Click on symbol links in each slide for current share prices and more.
I've already mentioned consumer giant Apple (AAPL (opens in new tab), $153.81), so I'll start there.
On a going-forward basis, Apple isn't a particularly big winner, as its effective tax rate is currently 25.8%. That's less than 6 percentage points higher than Trump's proposed corporate rate and the result of very smart tax planning on the part of Apple's tax attorneys. (For your amusement, Apple and Alphabet both used an offshore tax scheme called a "double Irish with a Dutch sandwich." That was an actual thing.)
In Apple's case, the benefit will come from the repatriation of its gargantuan offshore cash hoard, estimated at $246 billion, or 94% of its $262 billion in total cash and investments.
"Apple has managed to be very generous with its shareholders despite the fact that the vast majority of its cash has been overseas and thus effectively unavailable," said Chase Robertson, managing partner of Robertson Wealth Management, a Houston Registered Investment Advisor with $2.5 billion in assets under management. "If we get the reform along the lines of what the president outlined, you're going to see a lot of that cash get repatriated.
"We believe there is ample room for additional buybacks and special dividends, both of which would be beneficial to Apple shareholders at current prices."
If tax cuts are passed, don't be surprised if Apple issues the largest dividend in history this time next year.
Energy Transfer Equity
Master limited partnerships are one of the most complicated investments to own from a tax perspective. I've owned several MLPs for years, and I'm an investment professional … yet I have little confidence that I've ever filed my taxes for those investments 100% correctly. Were I to get audited, I'm nearly certain the IRS accountant would be as confused as me.
It's just that bad.
Partly due to sheer complexity – which is off-putting to many investors and banks – midstream pipeline giant Kinder Morgan (KMI (opens in new tab)) converted from an MLP to a corporation a few years ago, and other MLPs have followed suit. A lower corporate tax rate would only accelerate this trend.
"If corporate tax rates were to be lowered, we believe some large-cap MLPs might choose to take advantage of the lower rate to simplify their structures and reorganize as corporations, or possibly add a C corp tracking vehicle in order to attract a broader universe of investors," said John Musgrave, co-chief investment officer and portfolio manager of Cushing Asset Management.
The larger and more complex the MLP, the more benefit reorganization would provide. So, one potential beneficiary would be Energy Transfer Equity (ETE (opens in new tab), $17.20) and its largest daughter MLP, Energy Transfer Partners (ETP (opens in new tab)).
Were ETE to consolidate its empire into a single C corporation, it would likely enjoy a lower cost of capital and far greater acceptance by fund managers that have thus far shied away from the stock for governance reasons.
KKR & Co.
Along the same lines, many private equity companies and other alternative asset managers such as KKR & Co. (KKR (opens in new tab), $20.23) are organized as partnerships and LLCs to enjoy carried interest from their portfolio investments and to avoid a layer of taxation at the company level. It has its perks, of course, but it also makes the companies exceptionally hard to analyze and ends up scaring away a lot of potential investors.
This is where Trump's tax plan gets interesting.
Trump has said repeatedly that he would like to eliminate the special rates currently levied on carried interest and instead tax it as ordinary income – and while that's not yet explicitly stated in his tax plan, White House Economic Director Gary Cohn says it's a loophole he still hopes to address as "we continue to evolve on the framework." But it's not clear if this would apply only to hedge funds that trade stocks or if it would apply to longer-term investors that take an active role in the business. It's also unclear whether Trump's proposed lower tax rates for "pass-through" entities would apply in this case.
I believe it ultimately will prove to be cheaper (and vastly simpler) for these companies to be organized as corporations, so that's the direction they'll go. This likely would cause a lot of investors who previously would have been sitting on the sidelines to give asset managers such as KKR a second look.
Companies that get the vast majority of their revenues from U.S. sales (and that don't operate in industries enjoying special subsidies or other tax breaks) stand to gain the most from Trump's tax proposals in the years ahead.
A perfect example would be home improvement retailer Home Depot (HD (opens in new tab), $164.02). Home Depot has a thriving business in Canada and Mexico, but 87% of its stores are located in the United States. And as such, the company gets absolutely hosed on taxes, paying an effective rate of 36.3%.
Some of that is due to state and local taxes, to be sure. But the fact remains that Home Depot doesn't have the same opportunities to avoid taxes that a more internationally diversified company might, so it ends up paying a much higher rate. Thus, the Trump tax plan would be very good news indeed for Home Depot shareholders.
As a similar example, consider used car seller CarMax (KMX (opens in new tab), $76.59). CarMax is about as American as you can get, as fully 100% of its sales take place in the good ol' US of A.
But as a result, the company gets punished come tax time, paying an effective tax rate of more than 37%. The finest tax attorneys in America would have a hard time legally lowering CarMax's tax bill given current laws. It has very little in the way of special deductions, and nowhere to hide from the taxman.
So, CarMax would be a very natural beneficiary of Trump's tax cuts, as they would lower the company's tax bill by around 17 percentage points.
On a side note, if Trump is successful in getting personal income tax rates lowered too, middle- and working-class Americans might have a little extra cash on hand to buy one of CarMax's pre-owned vehicles.
As of this writing, Charles Lewis Sizemore was long AAPL, ETE and KKR.
Charles Lewis Sizemore, CFA is the Chief Investment Officer of Sizemore Capital Management LLC, a registered investment advisor based in Dallas, Texas, where he specializes in dividend-focused portfolios and in building alternative allocations with minimal correlation to the stock market.
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