What will S&P 500 firms do with their tax cut billions?
"The majority of the benefits of tax reform will flow to the bottom line."
U.S. corporations expect to keep a few hundred billion dollars more in profits this year, thanks to the lower tax rates passed by Congress and signed by President Trump in December. What will they do with the money?
Economists at Morgan Stanley checked with more than 400 of the Fortune 500, and here's what they're promising to do. For every dollar of lower taxes:
– 43 cents will go to share buybacks and dividends, enriching stockholders such as top executives, hedge funds, foundations, retirement funds, and the minority of Americans who own shares, and raising hopes these recipients will spend more, stimulating the economy.
– 19 cents will fund mergers and acquisitions, enriching investment bankers and other dealmakers while dislocating the employees of acquired firms.
– 17 cents will be invested in capital spending, research and development and equipment upgrades: the basic business spending that some tax cut proponents assumed — or expected us to believe — were the tax cuts' goal.
– 13 cents will fund higher wages and benefits, mostly in onetime worker bonuses.
– 8 cents will be used to pay back corporate debt.
Stocks rose so much in expectation of the tax cuts that investors seem to believe the entire tax benefit will go to the bottom line and to investors, with none put back in the business, concluded a team of Morgan Stanley stock analysts led by equity strategist Adam Virgadamo. That's a lot of optimism.
Earlier this month I quoted the bond analysts at Standard & Poor's worrying the tax cuts could be harmful for Apple, Facebook, Microsoft, and other tech companies: Freed to dump their foreign cash hoards off their books, these companies could waste billions buying their own stock and chasing expensive mergers, and end up weaker for future competition and product development.
Indeed, some corporate executives in their year-end investor conference calls have admitted they don't expect tax cuts will fuel new demand for what they sell, anytime soon.
"Tax reform is just tremendous," and will "unleash innovation and economic growth," gushed Boeing CEO Dennis A. Muilenburg. But asked directly whether tax cuts would boost aircraft demand, his chief financial officer, Gregory A. Smith, said, "No," adding, "I don't see a changing pattern of buying patterns." Boeing's R&D and capital expenditures will remain at long-term levels.
Similarly, "I don't think there's necessarily a direct correlation" between tax cuts and an increase in ad spending that would boost Comcast revenues, Comcast NBC Universal chief Stephen R. Burke said, when Wells Fargo & Co. analyst Marci L. Ryvicker asked whether lower taxes would spur demand for advertising.
Comcast had said it expects nearly $13 billion in tax reform savings. And then on Tuesday, the company, reflecting Morgan Stanley's No. 2 point above, announced its first big merger plan in several years, an offer to pay $31 billion for Europe's Sky TV.
Investors reacted by dropping Comcast shares 7 percent that day. It would be a lot more efficient for Comcast to spend some of those billions buying back its own shares, which trade at a lower price-earnings ratio, suggested telecom analyst Amy Yong in a report to Macquarie Research clients.
Morgan Stanley also published summaries of what executives have so far told investors they will do with their tax windfalls. Highlights include:
Automatic Data Processing: "The majority of the benefits of tax reform will flow to the bottom line " through "things like share buybacks and dividends."
Chevron: The oil giant plans to use savings to dig up more oil in Texas and the Gulf of Mexico, and upgrade its processing and chemical plants.
Chipotle Mexican Grill: Expects to pocket tax savings of up to $50 million, with one-third going to "special bonuses to our crew, managers and support staff," plus benefits, and training, with the rest going to "enhance existing restaurants."
CVS: Will spend "at least half" its expected $1.2 billion in tax reform cash benefits on "debt reduction in 2018."
JPMorgan, Chase & Co.: Will use ongoing profits, tax benefits, and gains from reduced financial regulation, to expand the bank at a time when other big banks have been shutting branches and laying off staff. That will include 400 new branches, 4,000 new employees (the bank already employs 250,000, including 10,000 in Delaware), and higher wages and better benefits for hourly employees,
Merck: "Tax reform does not fundamentally change our capital allocation priorities," which include spending $8 billion in the U.S. and $4 billion in other countries over the next five years "to add capacity" especially in oncology, vaccines, and animal health, while remaining "committed to our dividend." Merck also promised to give more profits back to shareholders, if the company doesn't do a bunch of mergers.
Microsoft: "Almost all our free cash flow" already goes to shareholder dividends and share buybacks. CEO Satya Nadella added he's glad that, thanks to tax reform, he won't have to borrow money to send investors more cash.
Mondelez, the snack food maker that closed the often-fragrant Kraft bakery at Roosevelt Boulevard and Byberry Road in 2015, told investors that "most of our earnings [are now] generated outside of the U.S." in lower-tax countries. So not much tax-cut benefit here.
PayPal: Will "absolutely" boost payments to shareholders; will be "much more aggressive, perhaps" in acquisitions; and will "take a large chunk" of cash reserves and use the money to buy back shares.
Pulte Corp.: Lower tax rates don't much affect demand for the homes Pulte builds, so tax reform won't affect the company's plans much, at least in 2018.
Quest Diagnostics: Of $180 million in new tax savings this year, $75 million will go to "high-touch concierge service" for favored Quest patients, better testing, improved customer service; including up to $20 million in $500 employee bonuses "as a way of saying thanks." The rest will "grow earnings per share."
Starbucks: Will collect $350 million in extra 2018 profits from lower taxes. Up to half of that will go to higher barista and worker wages, benefits and software, combined; the rest, to investors.
Visa: Like PNC and a few other companies, will boost corporate contributions to the 401(k) retirement plan, this year. Will also spend a lot more on stock buybacks.
Among smaller companies, "retail, hospitality and banking" firms will enjoy some of the biggest benefits from lower taxes, Isdaner & Co. CPAs of Bala Cynwyd told clients in a summary of the tax cuts last week.
Expectations of lower taxes and higher profits for public and private firms have helped boost the sale prices (equity plus debt) of smaller companies with sales of $10 million to $250 million to more than eight times earnings (before interest, taxes, depreciation/amortization), up from six times in 2013, says Andrew T. Greenberg, a Philadelphia investment banker who leads GT Data of Conshohocken, which polls 200 local investment-banking firms on sales every quarter.
These high prices and high expectations "are obviously not sustainable" — tax reform will actually boost taxes this year on highly indebted firms, for example — yet the prices buyers are willing to pay for private companies keep rising, in hopes of future gains, "longer than any of us suspected," Greenberg concluded.