Industry Sectors Getting the Best Earnings Bump from the Tax Cuts

The new tax law aims to create a lot of winners in corporate America by fattening bottom lines. Reducing the corporate tax rate to 21% from 35% by itself is a huge plus. And for multinationals bringing back overseas profits, the law is a double blessing—they pay even lower rates on foreign-stored money than the new law’s reduced level.

A study from UBS estimates that, thanks to the new tax law, the Standard & Poor’s 500 companies will see their earnings per share increase by an extra 7.2% in 2018. Credit Suisse puts the amount of money saved for S&P 500 members at $75 billion to $100 billion this year. For context, research firm Calcbench places S&P 500 pre-tax earnings for 2016 at $1.3 trillion.

But some businesses will make out better than others from the tax changes, says UBS, the Swiss-based global bank. The leader: telecom, at 17.4% higher earnings per share this year. And the laggard: pharmaceuticals, whose tax-related EPS increase is a mere 2.3%. It all depends on how high or low an industry’s previous tax rate was. High payers will get the biggest EPS reward, low payers won’t.

For investors, this means that the biggest beneficiaries of the tax revamp are also the ones most likely to buy back shares and raise dividends. The extra earnings also will let these companies make strategic moves that could boost their stock and EPS in the longer term, such as increasing capital spending and paying down debt, which reduces interest outlays and makes for better credit ratings.

Pharma, on the other hand, already had a low effective federal tax rate, around 23%, before the tax law’s enactment, according to UBS.. With an old effective rate almost at the level of the new official corporate rate, it’s easy to see why drug companies don’t get much of a jump from the 2018 tax schedule.

Why has pharma’s effective rate been so low? The drug industry makes use of a lot of longstanding tax breaks for such things as research and development, and also has parked an enormous amount of profits overseas, where taxes have tended to be lower. The top five US pharma companies hold $250 billion abroad, the Citizens for Tax Justice estimates. 

While drug outfits in 2018 can bring back overseas money and avoid high US rates, they pay the price on the bottom line, for now. Every company with overseas cash, and pharma is the likely champ in this category, must make a mandatory one-time tax payment on those holdings, whether they bring them back or not. Yes, the repatriation levy—just 15.5% tax on liquid assets and 8% on other earnings—is less than even the new 21% corporate rate. But it’s a charge against earnings in the short term.

To be sure, pharma will be able to take advantage of the new tax law, just not in ways that will boost its EPS, at least right away. Expect drug firms to use a lot of that freed-up offshore cash for acquisitions, said David Chan, a managing director as asset manager Jennison Partners. But how will a spate of M&A play out for the companies’ future profitability? That’s the risk. Not all mergers are home runs.

Here are snapshots of the sectors that should receive the best EPS boosts:

Telecom. At the head of the pack, the expected 17.4% EPS surge this year for telecommunications stems from the simple reason that many of these corporations already pay at or near the old top corporate rate. “When you pay more than a 30% effective rate, like they do, you can expect to benefit a lot,” said JJ Kinahan, chief marketing strategist at TD Ameritrade. A big reason is that the telecom companies tend to have few overseas holdings, so they don’t get the advantage of low rates in places like Ireland (12.5%). Verizon, for instance, paid the full 35% rate last year, according to MarketWatch.

This industry faces some real challenges, so the earnings hike will be welcome. Many have operations in cable and broadcast TV, which are under siege. AT&T, which also has been paying Uncle Sam in the mid-30s, does have a stable wireless business, but is seeing losses in its DirectTV satellite service—losing 146,000 subscribers in last year’s fourth quarter, by research firm MoffettNathanson’s reckoning. The new tax code will increase AT&T’s 2018 EPS by 18%.

Retail. The same heavy domestic focus prevails among merchants. So, the sector should receive an additional 15.7% in EPS this year, UBS calculates. Take Home Depot, with just 300 stores abroad (in Canada and Mexico), and 2,000 in the US. Small wonder: The big-box retailer doles out 36% to the tax man. That’s why Home Depot is slated for a 15% tax-fueled EPS jump in 2018.

Here again, there are industry problems that weightier profits will help ease. The relentless assault of online shopping has challenged once-mighty mall stalwarts. In 2017, at least 50 retailers declared bankruptcy, the most in six years. Department store chain J.C. Penney will not get any manna from the new tax law because it continues to run red ink—there are no profits to tax.

The picture is brighter elsewhere in the retail realm. A mini-turnaround in brick-and-mortar stores means that more retailers are doing well enough to partake of the new tax code’s bounty. In 2017, traditional retail sales advanced 4.2%, the most in three years as merchants adjusted to the digital age. Look at electronics outlet Best Buy, which five years ago seemed doomed as customers used it to eyeball the physical products before buying at Amazon. Best Buy launched a robust online operation, lowered prices, and upgraded its floor selling experience. Result: Best Buy, nicely profitable once more, will gain 15% additionally in EPS due to the tax cut.

Banks. Aside from a few mega-banks, this industry has little presence overseas. Giant Citigroup, with an extensive foreign footprint and massive amounts of cash stashed offshore, paid $22 billion in repatriation taxes, making it book a loss for last year’s final quarter. Hence, Citi, with its profits trimmed, will enjoy a mere 6% tax-related increase in its EPS this year.

Industry-wide, however, the profit expansion is much richer from tax cuts: 12.9%, UBS says. That’s buoyed by the home-bound likes of US Bancorp (14%), M&T (19%), and KeyCorp (15%).

And the lower corporate rates will give banks a leg up, along with all other tax-paying companies. Banks overall are reveling in strong earnings growth and higher interest rates, which allow them to charge borrowers more.

How pleasant for them and their earnings that the IRS will be taking less of a bite going forward.