In an attempt to boost employment and stimulate economic growth in the United States, President Donald Trump proposed changes in tax rates for both individuals and corporates.
At present, the U.S. corporations have to pay up to 35%, one of the highest in the world, on repatriated foreign incomes. However, it gives tax credit for the amount of tax paid in overseas country.
The tax holiday plan proposes to lower the current corporate tax rate of 35% to 15%. This is expected to favorably impact the post-tax earnings of companies. The Trump administration is also proposing a move away from the current worldwide tax system to a territorial system, allowing companies to send offshore profits back to the United Stateswithout incurring extra taxes.
Another major reform proposed is the repatriation of trillions of dollars held as cash reserve overseas by the companies with global operations for one-time tax (reportedly 10%).
Impact of the Proposal
In 2004, the Bush administration attempted a similar repatriation tax holiday for bringing in overseas cash reserves for one-time tax of 5.25%. A number of companies repatriated an amount exceeding $300 billion.
The tax reforms are anticipated to create new jobs and aid economic growth through expanded investment as more cash will be available to companies. These cash can be utilized by the companies for dividends and share repurchases, merger & acquisition (M&A), capital expenditures and to pay the outstanding debts.
Going forward, reduction in debt will help in improving balance sheets. Meanwhile, if the cash is used toward employment or infrastructure spending, we can expect higher productivity and income in the economy.
4 Biggest Gainer on Trump’s Tax-cut Promise
Let’s discuss the impact of tax reform on the some technology giants:
Apple Inc. AAPL
The effective tax rate for Apple in 2016, 2015 and 2014 were 25.6%, 26.4% and 26.1%, respectively. Consequently, a revision of tax rate to 15% will bring a huge positive change in post-tax earnings.
Moreover, after 10% tax, it will save more than $48 billion per ITEP's estimates, if the total overseas cash is repatriated. Apple had more than $230 billion in overseas cash as of May 2017, per The Telegraph report. A repatriation will help the company to pay off the debt ($89 .9 billion as of Jul 1, 2017) quickly, spend some of the money on acquisitions and may initiate a buyback.
Most of Apple’s manufacturing is done in Shenzhen, China, where the company’s contract manufacturing partner Foxconn is based. The outsourcing maximizes Apple’s profits, primarily due to cheap labor, which is significantly lower when compared withthe minimum standards in the United States.
Apple currently carries a Zacks Rank #3 (Hold) and has a long-term expected EPS growth rate 11.9%.
Microsoft Corporation MSFT
Microsoft is the second-biggest cash pile overseas with around $122 billion, according to Bloomberg’s report. The effective tax rate for Microsoft in 2017, 2016 and 2015 were 8%, 15% and 34%, respectively. Hence, a tax rate cut will save billions of dollars for Microsoft.
Moreover, the total cash reserve of the company has changed minimally in the past one year. So, the repatriation reform may initiate a buyback. Further, after 10% tax, it will save approximately $28 billion in cash reserve, if the total overseas cash is repatriated. This increase in cash can also be utilized in acquiring new companies.
Microsoft currently carries a Zacks Rank #3 and has a long-term expected EPS growth rate 8.7%.
Cisco Systems, Inc. CSCO
Cisco recently completed the acquisition of Sunnyvale-based start-up, Springpath, for $320 million in cash. It also completed the acquisition of AppDynamics (for $3.7 billion in 2017). According to channel checks, the analyst noted that Cisco is likely to acquire NetApp (market capital of $11.04 billion). Per Bloomberg’s report, Cisco had $65 billion of cash reserves in overseas countries as of Jun 13, 2017.
A repatriation will help the company to pay off the debt ($25.7 billion as of Jul 29, 2017) quickly and provide it with the flexibility to fund growth by investing in R&D (research and development). Moreover, it while also abide by its usual policies of returning cash to shareholders through stock buybacks and dividends. The effective tax rate has been between 19% and 22% (2015-2017), which suggests a marginal impact due to tax rate cut.
Cisco currently carries a Zacks Rank #3 and has a long-term expected EPS growth rate 6.2%.
Alphabet Inc. GOOGL
The effective tax rate for Alphabet in 2016, 2015 and 2014 were 19.3%, 16.8% and 21.1%, respectively. Consequently, a revision of tax rate to 15% will not bring a huge positive change in post-tax earnings. As of June mid, Alphabet had around $55 billion in cash reserve, up almost 23% from the last year. Hence, Alphabet is anticipated to be positively impacted by these reforms, through stock repurchases and dividends payout.
Alphabet currently carries a Zacks Rank #3 and has a long-term expected EPS growth rate 16.5%.
Bottom Line
The tax reform isn't going to be easy and is still in the proposal period. Until then, we believe that stocks with strong fundamentals, huge cash overseas reserves along with high tax paying capabilities are likely winners under the plan.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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