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Equity Strategy Focus Point
Death and tax reform
Quantitative Analysis
29 January 2017 Corrected
Unauthorized redistribution of this report is prohibited. This report is intended for amanda.ens@baml.com
Deep dive on corporate tax reform
OK, maybe it’s not as inevitable as death and taxes, but some form of corporate tax
reform seems likely. It is a stated priority of President Trump and has widespread
Congressional support. We here focus on four components that could have big equity
implications. We assess the impacts at a market, sector, and industry level, and plan to
update and augment this work as more details come to light.
Potential near-term boost to EPS, long-term impact varies
Our 2018 S&P 500 EPS estimate of $137 already implies healthy two-year growth of +16%.
Tax reform in its entirety could add as much as $5-6 to near-term EPS, as benefits are frontloaded.
The sustained impact depends: under a 20% tax rate, the Blueprint would be
modestly accretive; under a 15% rate, this annual benefit could triple; but a 25% tax rate that
would appease the deficit hawks could shave $3.50 off of earnings each year. We also
estimate a one-time $8-9 charge to GAAP EPS associated with the repatriation tax (Table 1).
Cutting corporate tax rate could add $8 to EPS
Our starting point is the US statutory corporate tax rate. If it were lowered from 35% to
20% and the US moved to a territorial tax system (no longer taxing foreign profits), it
would boost S&P 500 EPS by an estimated 12% ($17 to 2018 EPS). We assume
companies would be able to retain half of the benefit ($8) and the remainder would be
passed on to customers or competed away. For instance, a lasting impact to Utilities'
profits is unlikely, as the benefit would be passed on via regulated pricing.
Repatriation: Buybacks could boost EPS by 3%
Both Trump and the Blueprint support a mandatory (as opposed to 2004's optional) tax
of overseas earnings of US firms’ subsidiaries at reduced rates. Non-Financials in the S&P
hold at least $1.2tn in overseas cash (mostly Tech and Health Care). If half was used for
buybacks, this could add 3% ($4) to S&P 500 EPS. A redux of 2004 where companies
used 80% of cash for buybacks may be less likely, in our view. For if repatriation is
accompanied by an end to interest expense deductions, companies may choose to pay
down debt over buybacks.
Border adjustment tax (BAT) hits EPS by $5-6
While Trump has described the BAT as being “too complicated,” White House press
secretary Spicer’s recent comments call into question his stance. This is a key
component of the Blueprint and would generate significant revenue. First-order impacts
could be significant, with border adjustments detracting $5-6 from 2018 EPS — nearly
80% of the drag comes from the consumer sectors. The second order impacts — product
pricing, pricing within the supply chain, exchange rates, foreign policy reactions, etc. —
while harder to quantify, are important to consider.
End to interest deductibility could detract 4% from EPS
We estimate that over time, the removal of the interest expense deduction would
detract about 4% from S&P 500 EPS. An increase in the cost of debt by an incremental
25% could have longer term ramifications for capital structures and funding..
Tax reform winners and losers
We include stock screens for potential beneficiaries and victims of tax cuts, repatriation
and interest deductibility changes, as well as industries most helped/hurt most by a BAT.
Note that the very fact that there are companies and industries that have the potential
to be very negatively impacted could call into question the likelihood of passage.
BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. As a
result, investors should be aware that the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision.
Refer to important disclosures on page 26 to 27. 11706251
Timestamp: 29 January 2017 12:01AM EST
Equity and Quant Strategy
United States
Savita Subramanian
Equity & Quant Strategist
MLPF&S
+1 646 855 3878
savita.subramanian@baml.com
Dan Suzuki, CFA
Equity & Quant Strategist
MLPF&S
+1 646 855 2827
dan.suzuki@baml.com
Marc Pouey
Equity & Quant Strategist
MLPF&S
+1 646 855 1142
marc.pouey@baml.com
Alex Makedon
Equity & Quant Strategist
MLPF&S
+1 646 855 5982
alex.makedon@baml.com
Jill Carey Hall, CFA
Equity & Quant Strategist
MLPF&S
+1 646 855 3327
jill.carey@baml.com
Jimmy Bonilla
Equity & Quant Strategist
MLPF&S
+1 646 556 4179
jimmy.bonilla@baml.com
Table 1: Estimated impact of tax reform on S&P 500
2018 EPS
Tax policy 15% 20% 25%
Tax rate change 10.50 8.00 5.00
End int. deduct. – init. impact* -0.50 to -1.00 -0.50 to -1.50 -0.50 to -2.00
Border adjustments -4.00 -5.50 -6.50
Repatriation buybacks 4.00 4.00 4.00
Total init. Impact 9.50 to 10.00 5.00 to 6.00 0.50 to 2.00
End int. deduct. – recur. impact -3.50 -5.00 -6.00
Recurring impact 7.00 1.50 -3.50
One-time repat. tax -8.50 -8.50 -8.50
Source: BofAML US Equity & Quant Strategy, FactSet, Compustat, S&P
*Assumes end to interest deductibility only applies to new debt, where we estimate
70-90% of debt is long-term.
Note: For this exhibit, we assume that 100% of the cash is repatriated and 50%
of it is spent on buybacks. For different buyback assumptions, please see the
section on repatriation.
Contents
The costs and benefits of tax reform 3
Cutting the corporate tax rate 4
Repatriation 6
Border adjustment tax analysis 12
Closing loopholes 15
No interest tax shield 17
Tax reform screens 19
Related BofAML research on US tax reform 22
Methodology 24
2 Equity Strategy Focus Point | 29 January 2017
The costs and benefits of tax reform
2017 could be a watershed year from a tax reform perspective. Trump has continuously
stated that tax reform is a priority, and there is evidence of widespread support in
Congress. Tax reform could be enacted through reconciliation without the risk of being
filibustered, suggesting the timing could be imminent. Corporate tax reform could have
a significant impact on S&P 500 earnings, corporate behavior and capital markets. Much
has been written on the timing, funding and process by which corporate tax reform
could be enacted. In this report, we use House Speaker Paul Ryan’s Blueprint proposal as
a starting point in quantifying the impact of corporate tax reform on the S&P 500, with
some scenario analysis to account for differences included in the final bill (such as
Trump’s proposals). Our analysis is focused specifically on the impact of corporate tax
reform, however we recognize that there are many other factors that can impact the
sensitivity analysis (e.g. changes to household income tax rates, infrastructure spending,
etc.).
We estimate that the Blueprint proposal would initially boost S&P 500 EPS by $5-6,
assuming the end of interest expense deductions only applies to new debt, or is phased
in over time. But the devil is in the details. Over time, the loss of the interest tax shield
would be a significant drag on earnings as existing debt is refinanced. Additionally, the
corporate tax rate is critical in determining whether or not the tax reform policies end
up being accretive to earnings on a sustained basis. We estimate that at the 20% tax
rate, the Blueprint would be modestly accretive, the benefit would triple under Trump’s
proposed 15% tax rate, but at a higher 25% tax rate that would appease the deficit
hawks in Congress, the benefit would turn to a negative over time (Table 2). We also
estimate a one-time $8-9 charge to GAAP EPS that would be associated with the
discounted repatriation tax.
Table 2: Estimated impact of tax reform on S&P 500 2018 EPS
Tax policy 15% 20% 25%
Tax rate change 10.50 8.00 5.00
Ending interest deductibility – initial impact* -0.50 to -1.00 -0.50 to -1.50 -0.50 to -2.00
Border adjustments -4.00 -5.50 -6.50
Share count reduction from buybacks (50%) 4.00 4.00 4.00
Total initial impact 9.50 to 10.00 5.00 to 6.00 0.50 to 2.00
Ending interest deductibility – recurring impact -3.50 -5.00 -6.00
Recurring impact 7.00 1.50 -3.50
One-time repatriation tax (8.75%), GAAP
charge -8.50 -8.50 -8.50
Source: BofAML US Equity & Quant Strategy, FactSet, Compustat, S&P
*Assumes end to interest deductibility only applies to new debt, where we estimate 70-90% of debt is long-term.
Note: For this exhibit, we assume that 100% of the cash is repatriated and 50% of it is spent on buybacks. For different buyback
assumptions, please see the section on repatriation.
In the following pages, we focus on the following topics that have large implications for
US equity investors, but it is important to consider corporate tax reform holistically
rather than drawing major implications from each measure in isolation:
• Reducing the US corporate tax rate
• Repatriation - mandatory tax on overseas profits
• Border adjustment tax
• Removal of interest expense deduction
The government revenue associated with each of these is included in the table below.
Equity Strategy Focus Point | 29 January 2017 3
Table 3: Estimated 10-year* revenue impact from tax plans, $bn
Based on estimates from both the Tax Policy Center and Tax Foundation
House Plan Trump Plan
Corporate Tax Reform -890 to -1200 -1940 to -2630
Lower corporate tax rate (20% under House, 15% under Trump) -1800 to -1850 -2120 to -2350
Full capex expensing, interest expense no longer deductible (mandatory under
House, choice between two under Trump)** -450 to -1040 -320 to -590
Deemed repatriation of overseas earnings 140 to 190 150-200
Move to territorial tax system -90 to -160 n/a
Border adjustment 1070 to 1180 n/a
Changes to individual income/payroll taxes -980 to -2020 -2190 to -3730
Repeal estate/gift taxes -190 to -240 -170 to -240
Total (static) estimate -2420 to -3100 -4370 to -6150
*Tax Foundation assumes impact over 2016-2025 and Tax Policy Center assumes impact over 2016-2026
**Under House plan, Tax Foundation separately breaks out estimates for full capex expensing (-$2236) and disallowing interest deduction
on new loans (+$1194).
Note: estimates rounded to nearest ten billion, with range to incorporate estimates from both sources. Other elements to corporate tax
reform not itemized above include eliminating the AMT, repealing certain corporate tax deductions, etc.
Source: Urban-Brookings Tax Policy Center, Tax Foundation, BofA Merrill Lynch US Equity & US Quant Strategy (calculation of ranges)
From a sector and industry perspective there are haves and have-nots based on each
policy, but in aggregate most sectors have some puts and some takes based on tax
reform. The table below shows some relevant aggregate statistics by sector that inform
our subsequent analysis.
Table 4: Estimated overseas cash vs. last 12 month effective tax rate vs. COGS net exports by sector
Sector
Est. cash
overseas ($bn)
Overseas cash
% mkt cap
Effective tax
rate LTM
Net % imported vs
exported COGS
Discretionary 75 2.9% 28% -14%
Staples 68 3.2% 29% -13%
Energy 39 2.6% 21% -3%
Health Care 187 7.0% 23% -4%
Industrials 127 6.0% 26% 1%
Technology 647 14.9% 20% -9%
Materials 24 4.0% 23% 3%
Telecom 1 0.2% 29% 0%
Utilities 2 0.3% 28% 0%
S&P 500 ex. Financials & Real Estate 1,170 5.7% 25% -6%
Source: BofAML US Equity & Quant Strategy, FactSet, Bloomberg
Cutting the corporate tax rate
The best starting point for analyzing corporate tax reform is the US statutory corporate
tax rate, as this rate is critical in determining the impact of other proposed changes
(border adjustments, interest deductibility, etc.). If the tax rate were lowered from 35%
to 20% and the US moved to a territorial tax system (no longer taxing foreign profits),
all else equal, we estimate an initial boost to S&P 500 EPS of 12% ($17 to 2018 EPS).
However, over time, some of this benefit could be passed on to customers via lower
prices — for instance, it is unlikely that there will be any major long-lasting impact from
tax reform for Utilities sector profits, as any benefit/cost would likely be passed through
to customers when incorporated into each company's regulated pricing. The benefit
would also be offset by some of the other changes discussed in subsequent sections.
We assume that S&P 500 companies would be able to retain half of the benefit, or
roughly $8 of 2018E EPS. Below, we show the estimated EPS impacts on each sector
based on a tax rate of 20%.
4 Equity Strategy Focus Point | 29 January 2017
Chart 1: Sector EPS estimated impact from 20% rate
0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%
Financials
Discretionary
Telecom
Staples
Industrials
Health Care
Energy
Materials
Info Tech
Real Estate
2%
4%
8%
10%
10%
14%
12%
12%
16%
18%
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
While the effective tax rate of the S&P 500 is generally about 28% (currently closer to
25% due to the recent commodity recession), we estimate that the tax rate for the S&P
500’s domestic operations is much higher at roughly 33% — although this includes
state and local taxes. If all companies with tax rates above the proposed new tax rate of
20% were to drop to 20%, and no companies provisioned for US taxes on foreign
profits, we estimate the domestic effective tax rate for the S&P 500 would fall in line
with its foreign tax rate of roughly 19%. This would represent a 9ppt decrease in the
current S&P 500 tax rate and a 12% increase in EPS. We show the sensitivity to S&P
500 EPS to different assumed tax rates in the chart below, but we reiterate that these
estimates exaggerate the actual impact on profits, as a significant portion of these
benefits would likely be passed on to consumers via lower prices. We assume that in
aggregate, roughly half of the gains from the lower tax rate would be retained (i.e. half
of the amounts shown in the sensitivity analysis in Chart 2).
Table 5: Impact of 20% domestic corporate tax rate
Sector Current tax rate New tax rate Change
Discretionary 30% 19% -12ppt
Staples 29% 20% -9ppt
Energy 41% 32% -9ppt
Financials 33% 21% -11ppt
Health Care 25% 16% -9ppt
Industrials 32% 23% -9ppt
Info Tech 18% 14% -4ppt
Materials 28% 23% -5ppt
Real Estate 9% 7% -2ppt
Telecom 29% 20% -9ppt
Utilities 32% 20% -12ppt
S&P 500 28% 19% -9ppt
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
* Current tax rates may differ from other sources, as this analysis is based on companies’ 5-yr median
fiscal year domestic and foreign tax data from annual filings.
Chart 2: Benefit to 2018 S&P 500 EPS from lower tax rates
20%
15%
10%
5%
0%
$10.50 $8.00
15% 20% 25%
New Corporate Tax Rate
Estimated impact on 2018 EPS
$5.00
Source: BofAML US Equity & Quant Strategy
Note: Our base case assumes that half of the benefit would be passed on to customers, competed
away or offset by other changes to the tax code. Thus, we would expect the uplift to our EPS forecast
to be roughly half the calculated benefit from simply lowering the corporate tax rate.
The market is beginning to price in the benefits of tax cuts , but we may still be in the
early days – note that potential beneficiaries of fiscal stimulus (i.e. infrastructure
spending) have seen an 18% multiple re-rating but de minimis fundamental support,
whereas potential beneficiaries of lower corporate tax rates have seen performance
driven nearly equivalently by multiples and earnings.
Equity Strategy Focus Point | 29 January 2017 5
Chart 3: Decomposition of performance of 1) S&P 500 stocks exposed to fiscal stimulus* and 2) top
50 S&P 500 stocks with the highest L12M effective tax rates, vs. rest of S&P 500 (1/31/16-1/23/17)
25%
20%
15%
10%
5%
20%
2%
18%
15%
7%
19%
11%
8% 8%
15%
6%
9%
0%
Stimulus Beneficiaries
S&P 500 ex-Stimulus
Beneficiaries
High Effective Tax Rate
List
Chg in PE Chg in EPS Performance
S&P 500 ex-High Eff Tax
Rate List
*Stocks identified by BofAML analysts as stimulus beneficiaries in 150 stocks with exposure to the Fiscal Stimulus theme 21 Aug. 2016
Source: FactSet, BofA Merrill Lynch US Equity & US Quant Strategy
Potential beneficiaries: See Table 19 at the end of this report for a screen of
domestically-oriented companies with high effective tax rates which could
potentially benefit from a lower corporate tax rate.
Repatriation
Repatriation likely under both Blueprint and Trump plans
Mandatory tax on overseas profits of 8.75% under Blueprint, 10% under Trump
The US currently operates under a tax system in which the domestic earnings of US
corporates are taxed at the federal US corporate rate (35%) and any overseas earnings
that are repatriated are taxed at this rate less a credit for foreign taxes paid on those
same earnings. Many multinationals’ foreign earnings thus remain parked offshore,
allowing corporations to avoid the tax hit associated with bringing them back to the US.
Both Trump and the House (under Ryan) have proposed a mandatory tax of overseas
earnings of US firms’ foreign subsidiaries at reduced rates, such that this cash can be
brought back and put to work in the US. This differs from the 2004 repatriation tax
holiday, which was optional.
Under the Blueprint, accumulated overseas earnings will be subject to a transition tax of
8.75% 1 (for those held in cash/cash equivalents) or 3.5% (for all other holdings), with
companies able to pay the tax liability over an eight-year period. This would be part of
broader tax reform, where a proposed territorial tax system would exempt companies’
foreign income from US taxes and prevent future buildup of overseas profits as
companies would be free to bring them home. Trump’s plan calls for a one-time deemed
repatriation of overseas corporate profits at a 10% tax rate.
Table 6: Blueprint vs. Trump tax plans for taxing offshore earnings of US firms’ foreign subsidiaries
Plan
Tax rate on accumulated overseas earnings
Blueprint
8.75% for cash/cash equivalents, 3.5% of all other holdings
Trump tax plan 10%
Source: donaldjtrump.com, abetterway.speaker.gov
The Tax Policy Center estimates that a repatriation tax holiday would generate
approximately $150bn in tax receipts under Trump’s plan (over 10 years) and $140bn
1
Note: The effective tax rates of 8.75% and 3.5% under the Blueprint are based on an allowable deduction of 75% (for
deferred earnings held in cash/liquid assets) or 90% (for the non-cash portion), with the remainder taxed at the US
corporate tax rate, i.e. 35%(1-75%) = 8.75% and 35%(1-90%) = 3.5%. This methodology was proposed by Dave Camp’s
(former chairman of the House Committee on Ways and Means) Tax Reform Act of 2014.
6 Equity Strategy Focus Point | 29 January 2017
under the Blueprint (over eight years). The Tax Foundation similarly estimates that a
repatriation act could drive spending amounting to $185-200bn in revenues through
2025, which could help fund infrastructure/defense spending.
S&P 500 companies could bring back over $1tn – mostly in Tech & Health Care
Our FX team has written that US corporates in aggregate (including Financials) hold
~$2tn in cash overseas, and their work suggests that nearly half is concentrated within
20 companies. Similarly, as we discuss below, half of the repatriated cash following the
2004 Homeland Investment Act came from just 15 companies, predominantly in Pharma
and Tech. Our own analysis of the S&P 500 (based on filings and estimates from our
analysts) suggests that non-Financials in the S&P hold approximately $1.2tn overseas,
nearly three-quarters of which is in Tech and Health Care (Chart 4).
Chart 4: Estimated overseas cash as a % of mkt. cap by sector for the S&P 500 (excludes Financials
and Real Estate)
Overseas cash as a % of market cap
16%
14%
12%
10%
8%
6%
4%
2%
0%
Tech
Health Care
Industrials
S&P 500 ex. Fins. &
Real Estate*
Materials
Staples
Cons. Disc.
Energy
Utilities
Telecom
Note: Overseas cash based on company disclosures where available, BofAML analyst estimates, and BofAML US Equity & Quant Strategy
estimates using overseas sales as a guide where the former two were not available. For some companies, analyst estimates are for total
accumulated overseas profits (which may not all be in cash). *S&P ex. Fins. & Real Estate cash is as a % of total S&P 500 market cap
Source: Bloomberg, FactSet, BofA Merrill Lynch US Equity & US Quant Strategy, BofA Merrill Lynch Global Research
Repatriation in context: a look back at 2004
The last repatriation holiday in the US was the Homeland Investment Act (HIA) of 2004
(part of the American Jobs Creation Act), which allowed for a one-time repatriation of
foreign earnings by US multinationals at a reduced effective tax rate of 5.25% (vs. the
statutory 35% rate), based on an allowable exemption of 85% of foreign earnings from
US taxes (35% x [1-85%] = 5.25%). This deduction could be claimed in the tax year
beginning before or after the passage date in Oct. 2004. Approximately $300bn was
repatriated, according to the Bureau of Economic Analysis (BEA)’s U.S. International
Transactions Accounts Data, vs. an average of $60bn over the prior five years. The IRS
estimates 2 that 843 US companies took advantage of the act.
Despite HIA’s intent; most repatriated cash was spent on buybacks/dividends
Despite the U.S. Treasury Department’s guidelines that repatriated earnings should be
spent on capital investment, R&D, M&A, and other pro-growth uses such as hiring, this
was not ultimately the result: the National Bureau of Economic Research (NBER)
estimates 3 that $0.92 of every $1.00 brought back was used to return cash to
shareholders ($0.79 for buybacks and $0.15 for dividends) 4 , and that repatriation
ultimately did not lead to a pick-up in capex, employment or R&D. In fact, a 2011 report
by US Senate Permanent Subcommittee on Investigations 5 found that the top 15
2
Redmiles, Melissa: “The One Time Received Dividend Deduction”, https://www.irs.gov/pub/irssoi/08codivdeductbul.pdf
3
Dhammika Dharmapala, C. Fritz Foley, and Kristin J. Forbes: “Watch What I Do, Not What I Say: The Unintended
Consequences of the Homeland Investment Act”, NBER Working Paper No. 15023, June 2009,
http://www.nber.org/papers/w15023.pdf.
4 The $0.79 for buybacks and $0.15 for dividends does not sum to the $0.92 cash return figure due to the
NBER’s calculation methodology.
5
United States Senate Permanent Subcommittee on Investigations: “Repatriating Offshore Funds: 2004 Tax Windfall
for Select Multinationals”, Majority Staff Report, October 11, 2011
Equity Strategy Focus Point | 29 January 2017 7
repatriating companies—which accounted for 52% of the total repatriated amount—
actually reduced their US workforce and decreased their R&D spending following the
repatriation act. The authors of the NBER study point out that cash is fungible, and
firms were able to bypass the guidelines on how repatriated cash should be used.
Table 7 shows the top 15 repatriating companies following the HIA, and IRS estimates
for the proportion of repatriated cash by industry are in Table 8.
Table 7: Top 15 repatriating companies based on the 2004 HIA
Company
Repatriated Amount ($bn)
Pfizer 35.5
Merck 15.9
Hewlett Packard 14.5
Johnson & Johnson 10.7
IBM 9.5
Schering-Plough 9.4
Bristol Myers 9.0
Eli Lilly 8.0
DuPont 7.7
Pepsi Co, Inc. 7.4
Intel 6.2
Coca-Cola 6.1
Altria 6.0
Procter & Gamble 5.8
Oracle 3.1
Source: Data provided by corporations in response to U.S. Senate Permanent Subcommittee on
Investigations survey
Table 8: Corporations Repatriating Dividends Under IRC Section 965,
Selected Items, by Selected Major and Minor Industry of the Parent
Corporation, Tax Years 2004-2006
Industry
% of Repatriated Cash Dividends
Pharmaceutical and medicine manufacturing 29%
Computer and electronic equipment manufacturing 19%
Other manufacturing 8%
Food manufacturing 6%
Other chemical manufacturing 5%
Information (including software publishers) 4%
Finance, insurance, real estate, rental and leasing 4%
Transportation equipment manufacturing 3%
Management of companies and enterprises 3%
All other industries 2%
Paper manufacturing 2%
Machinery manufacturing 2%
Electrical equipt, appliance & component manufacturing 2%
Other services 2%
Basic chemical manufacturing 2%
Fabricated metal product manufacturing 1%
Retail trade 1%
Wholesale trade, nonduarable goods 1%
Wholesale trade, durable goods 1%
Profiessional, scientific and technical services 1%
Transportation and warehousing 0%
Plastics and rubber products manufacturing 0%
Primary metal manufacturing 0%
Note: all figures are IRS estimates
Source: IRS (https://www.irs.gov/pub/irs-soi/08codivdeductbul.pdf)
Our data for the S&P 500 similarly suggests that share repurchases saw the biggest
pick-up in terms of cash use from when the HIA was passed in October 2004 through
the end of 2006. Buybacks jumped over 200% over this period, where they went from
12% of operating cash flows to 33% of operating cash flow by the end of 2006.
Chart 5: Capex, dividends, buybacks and M&A for the S&P 500 ex-Financials: increase from
10/31/2004-12/31/2006 and % of Operating Cash Flow during both dates
60%
250%
% of Operating cash Flow
50%
40%
30%
20%
10%
0%
200%
150%
100%
50%
0%
Capex Dividends Net Buybacks Acquisitions
% of OCF - 10/31/2004 (LHS) % of OCF - 12/31/2006 (LHS) % increase (RHS)
% increase 10/31/04-12/31/06
Source: FactSet, BofA Merrill Lynch US Equity & US Quant Strategy
(https://www.hsgac.senate.gov/subcommittees/investigations/media/new-data-show-corporateoffshore-funds-not-trapped-abroad-nearly-half-of-so-called-offshore-funds-already-in-the-united-states)
8 Equity Strategy Focus Point | 29 January 2017
No alpha from repatriation and multiples actually compressed
Our analysis of the top 15 repatriating companies (from Table 7) suggests that while
these companies initially outperformed both the S&P 500 and equal-weighted S&P 500
from November 2004-April 2005 (by 6ppt and 5ppt, respectively), they subsequently
underperformed during the remainder of 2005 and early 2006 (Chart 6). From the end of
September 2004 through year-end 2006, these stocks were up 27% on average, in-line
with the overall S&P 500, and below the equal-weighted benchmark’s 36% return. And
multiples for these stocks compressed over the majority of this period, both on an
absolute basis and relative to the benchmark (Chart 7).
Chart 6: Cumulative relative performance (equal-weighted) vs. S&P 500
and EW S&P 500 of Top 15 repatriating companies, 9/30/04-12/31/06
Chart 7: Fwd. P/E of Top 15 repatriating companies – absolute and
relative to the S&P 500 median fwd. P/E, 9/30/04-12/31/06
106.0
104.0
102.0
100.0
98.0
96.0
94.0
92.0
90.0
88.0
86.0
Sep/04
Oct/04
Nov/04
Dec/04
Jan/05
Feb/05
Mar/05
Apr/05
May/05
Jun/05
Jul/05
Aug/05
Sep/05
Oct/05
Nov/05
Dec/05
Jan/06
Feb/06
Mar/06
Apr/06
May/06
Jun/06
Jul/06
Aug/06
Sep/06
Oct/06
Nov/06
Dec/06
23.0
22.0
21.0
20.0
19.0
18.0
17.0
16.0
Sep/04
Nov/04
Jan/05
Mar/05
May/05
Jul/05
Sep/05
Nov/05
Jan/06
Mar/06
May/06
Jul/06
Sep/06
Nov/06
Top 15 Fwd P/E (LHS)
1.50
1.40
1.30
1.20
1.10
1.00
0.90
Top 15 vs. S&P 500 Top 15 vs. EW S&P 500
Top 15 Rel Fwd P/E vs. Median S&P 500 Fwd P/E (RHS)
Source: U.S. Senate Permanent Subcommittee on Investigations survey (for Top 15 repatriating
stocks), FactSet, Bloomberg, BofA Merrill Lynch US Equity & US Quant Strategy
Source: U.S. Senate Permanent Subcommittee on Investigations survey (for Top 15 repatriating
stocks), FactSet, BofA Merrill Lynch US Equity & US Quant Strategy
Post-repatriation cash use: will this time be different?
Valuations, investor preference, growth & leverage ratios suggest less buybacks
While any potential restrictions on the use of repatriated earnings are still unknown, we
suspect that a pick-up in buybacks is likely, but that a lower proportion will be used for
buybacks today than during the last repatriation holiday. Valuations were generally more
attractive in 2004-2005 on most metrics (Table 9), and we’ve found that buybacks tend
to be more rewarded when stocks are cheap (Chart 8). Additionally, the largest buybacks
have not generated alpha for the last several years, as investors have increasingly
agitated for companies to use their excess cash on pro-growth investments (namely
capex.) According to BofAML’s latest Global Fund Manager Survey, 60% of investors
want companies to increase capex spending, vs. 17% who want companies to return
cash to shareholders (Exhibit 1). This compares to a majority of investors desiring
companies to return cash to shareholders when the HIA was passed in late 2004.
Companies may also feel less pressure to bolster per share metrics by reducing share
count if top line is recovering and organic growth is finally materializing. And from a
capital structure perspective, if leverage loses its tax benefit, given that leverage ratios
are already high (see below) companies may be less likely to reduce their equity capital
base, as that would marginally increase their weighted average cost of capital.
Special dividends, pay-down of debt may be other likely uses
Companies may also return the cash to shareholders by issuing a one-time special
dividend: income remains in-demand, given that both interest rates and dividend payout
ratios remain historically low. And if a repatriation tax holiday comes within the context
of broader tax reform that includes an end to the deductibility of interest expense,
companies may choose to pay down debt over other uses of cash, in an attempt to skew
their balance sheets less toward debt and more toward equity (see the section on no
Equity Strategy Focus Point | 29 January 2017 9
interest tax shield later in this report). Deleveraging balance sheets may also be spurred
by a continued environmwnt of rising interest. Leverage for S&P non-Financials has
steadily been ticking up over the last few years, and, if we exclude the cash-rich
Technology sector, leverage is approaching all-time highs (Chart 9).
Table 9: S&P 500 valuations: October 2004 vs. today
Metric 10/31/2004 Today (12/31/16)
Fwd P/E 15.6 16.9
Trailing P/E 16.7 22.0
Median Fwd P/E 16.2 17.3
P/B 2.8 2.9
EV/EBITDA 11.6 11.7
P/S 1.5 2.0
EV/Sales 2.2 2.3
Source: FactSet, S&P, BofA Merrill Lynch US Equity & US Quant Strategy
Chart 8: Average Annual Return of Russell 1000 Top Quintiles by factor
(1986-present)
16%
14%
12%
10%
8%
10.0%
11.7%
13.5%
Benchmark High Share Repurchase INEXPENSIVE
Companies with High
Share Repurchase
Note: valuation factor used to determine inexpensive companies is FCF/P
Source: FactSet,, BofA Merrill Lynch US Equity & US Quant Strategy
Exhibit 1: BofAML Global Fund Manager Survey (January 2017): What
would you most like to see companies do with cash flow?
Chart 9: Net Debt/EBITDA for the S&P 500 ex Financials (and excluding
Energy and Tech)
3.5
3.0
2.5
2.0
1.5
Source: BofA Merrill Lynch Global Fund Manager Survey (17 January 2017)
1.0
86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
S&P 500 ex Financials
S&P 500 ex Fins. & Energy
Avg.
S&P 500 ex Fins. & Tech
Source: FactSet, BofA Merrill Lynch US Equity & US Quant Strategy
Potential EPS impacts
$8-9 (6-7%) hit to GAAP EPS from the mandatory tax on accumulated overseas
profit
We estimate that a tax of accumulated overseas profits of $1.2tn would result in a cash
tax impact of $100-120bn (which may be allowed to be paid over 8-10 years), and a
one-time hit to GAAP EPS of $8-9 (a lower $65-80bn, given that a several large
multinationals such as AAPL already provision for US taxes on a portion of their
overseas profit, resulting in effective US tax rates well above the US statutory rate). Our
analysis assumes Trump’s/the Blueprint’s proposed rates of 8.75%/10%, and that all
overseas profits are hit with this one-time tax, as suggested by their plans. See Table
10.
Note that our estimate of ~$1.2tn of cumulative profits overseas is based on estimates
from us, our fundamental analysts, and company filings, where in many cases only
overseas cash but not other indefinitely invested earnings are disclosed/estimated.
Thus, the tax on these earnings could be slightly higher, though the Blueprint would tax
earnings not held in cash at a lower 3.5% rate. (We conservatively assume our estimated
$1.2tn is all cash and use the higher 8.75% rate under the Blueprint and 10% under
Trump’s plan in our below analysis).
10 Equity Strategy Focus Point | 29 January 2017
Table 10: Tax impact from taxation of accumulated overseas profits at 10%/8.75% rates (assuming
mandatory tax i.e. all overseas profits are taxed)
Cash tax impact ($bn) One-time tax hit to GAAP earnings
Sector Trump (10%) Blueprint (8.75%) Trump (10%) Blueprint (8.75%)
Consumer Discretionary 7.5 6.5 7.5 6.5
Consumer Staples 6.8 5.9 6.8 5.9
Energy 3.9 3.4 3.9 3.4
Health Care 18.7 16.4 18.7 16.4
Industrials 12.7 11.1 12.7 11.1
Information Technology 64.7 56.6 26.0 22.7
Materials 2.4 2.1 2.4 2.1
Telecommunication Services 0.1 0.1 0.1 0.1
Utilities 0.2 0.2 0.2 0.2
S&P 500 ex. Financials & Real Estate 117.0 102.4 78.3 68.5
S&P 500 GAAP EPS impact ($9) ($8)
Source: FactSet, Bloomberg, BofAML Global Research estimates, BofA Merrill Lynch US Equity & US Quant Strategy
We estimate share buybacks add $4 (or as high as $6) to EPS (GAAP & non-GAAP)
If the full $1.2tn that we estimate for overseas cash for the S&P 500 ex. Financials &
Real Estate is brought back (given the tax is mandatory and will be paid either way) and
50% is used on buybacks (~3% of S&P 500 market cap), this could add ~$4 to S&P 500
EPS. And if 80% (~4% of market cap) were used on buybacks, similar to NBER’s
estimate of what occurred following the 2004 tax holiday, this could add $6 to EPS.
(The difference between the Trump and Blueprint tax rates is small, leading to only
cents in index EPS.) If one assumed companies only brought half of their offshore cash
home immediately, even though the full amount was taxed, these benefits would be cut
in half.
Note that buyback programs may span several years, which could spread out some of
the EPS benefit below. But if one assumes a buyback is fully executed in Year 1, this
provides a one-time boost to EPS growth and a recurring benefit to future EPS given a
permanently lower share count.
Table 11: Impact to S&P 500 EPS based on various buyback scenarios
% used for buybacks: 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Trump (10% tax) 1% 1% 2% 2% 3% 3% 4% 4% 5% 6%
Blueprint (8.75% tax) 1% 1% 2% 2% 3% 3% 4% 5% 5% 6%
Benefit to 2017 EPS: $1 $1 $2 $3 $4 $4 $5 $6 $7 $7
Benefit to 2018 EPS: $1 $1 $2 $3 $4 $5 $5 $6 $7 $8
Assumes 100% of overseas cash is brought back (given tax is mandatory)
Source: FactSet, Bloomberg, BofA Merrill Lynch Global Research estimates, BofA Merrill Lynch US Equity & US Quant Strategy
Below we calculate the potential impact to sectors’ EPS under various buyback
scenarios. Differences are small under the Trump vs. Blueprint tax rates.
Table 12: Impact to sector EPS from various buyback scenarios under
Trump (10% tax rate)
% used for buybacks:
10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Cons. Disc. 0% 1% 1% 1% 1% 2% 2% 2% 3% 3%
Staples 0% 1% 1% 1% 2% 2% 2% 3% 3% 3%
Energy 0% 0% 1% 1% 1% 1% 2% 2% 2% 2%
Health Care 1% 1% 2% 3% 3% 4% 5% 5% 6% 7%
Industrials 1% 1% 2% 2% 3% 4% 4% 5% 5% 6%
Tech 1% 3% 4% 6% 7% 9% 11% 13% 14% 16%
Materials 0% 1% 1% 2% 2% 2% 3% 3% 4% 4%
Telecom 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Utilities 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Assumes 100% of overseas cash is brought back (given tax is mandatory)
Source: FactSet, Bloomberg, BofA Merrill Lynch Global Research estimates, BofA Merrill Lynch US
Equity & US Quant Strategy
Table 13: Impact to sector EPS from various buyback scenarios under
Blueprint (8.75% tax rate)
% used for buybacks:
10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Cons. Disc. 0% 1% 1% 1% 1% 2% 2% 2% 3% 3%
Staples 0% 1% 1% 1% 2% 2% 2% 3% 3% 3%
Energy 0% 0% 1% 1% 1% 1% 2% 2% 2% 3%
Health Care 1% 1% 2% 3% 3% 4% 5% 5% 6% 7%
Industrials 1% 1% 2% 2% 3% 4% 4% 5% 5% 6%
Tech 1% 3% 4% 6% 8% 9% 11% 13% 15% 16%
Materials 0% 1% 1% 2% 2% 2% 3% 3% 4% 4%
Telecom 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Utilities 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Assumes 100% of overseas cash is brought back (given tax is mandatory)
Source: FactSet, Bloomberg, BofA Merrill Lynch Global Research estimates, BofA Merrill Lynch US
Equity & US Quant Strategy
Equity Strategy Focus Point | 29 January 2017 11
Cross-asset implications of repatriation
Repatriation should spur USD-buying – up to 40% may be non-USD denominated
While few companies disclose the currency composition of their offshore cash, our FX
team estimates that 60-75% is already in USD while 25-40% is non-dollar-denominated.
(If we extrapolate based on the S&P 500’s geographic revenue exposure, the largest
proportion could be in Europe, followed by emerging Asia.) This may result in upward
pressure on the USD (which they estimate could amount to $250-$400bn if half of all
offshore cash, which they estimate at ~$2tn, was repatriated). Their analysis of the
EUR-USD during the last repatriation holiday suggests an “announcement effect” is
likely, as the dollar strengthened ahead of the bulk of the actual repatriation flows.
Repatriation could put upward pressure on bank funding costs
Our rates team’s analysis of some of the largest multinationals with offshore cash
suggests ~70% of cash is invested in securities with maturities greater than one year,
with the remaining 30% having shorter maturities. See table below. They believe
repatriation could put upward pressure on bank funding costs as firms reduce their
holdings in these short-term investments. According to Crane Data on offshore money
fund holdings, our rates team cites that $161bn of offshore funds are held in commercial
paper and CDs, of which the majority are from financial institutions with Japan, France and
Canada the largest issuers.
Table 14: Offshore holdings and investment allocation for select firms
(see footnote) per BofAML Rates team (as published 12/9/2016)
Allocation*
Cash & MMF 8%
CP & CD 5%
Tsy & Agy 35%
Corporate 36%
Non-US Sov 4%
Other 12%
Maturity of securities holdings**
<1y 28%
1-5y 59%
5-10y 7%
>10y 6%
*Allocation = weighted avg of holdings across all company investments for AAPL, MSFT, CSCO, ORCL,
GOOG, MRK, INTC and PFE. **Maturities = weighted avg. of holdings from MSFT, CSCO, GOOG, INTC.
Source: BofAML Global Research, company 10Q’s
Exhibit 2: Offshore money fund USD asset holdings ($bn) as of 9/30/16
Source: Crane data, BofA Merrill Lynch Global Research
Potential beneficiaries: See Table 20 for a screen of companies with high (>10%)
overseas cash to market capitalization ratios which could potentially benefit from
repatriation.
Border adjustment tax analysis
A new tax policy outlined in the Blueprint proposal that has been getting a lot of
attention recently is the border adjustment tax, or the application of border adjustments
to a company’s imports and exports. While Trump has described the proposal as being
“too complicated,” it is a key component of the Blueprint plan and should not be
ignored. Additionally, White House press secretary Sean Spicer’s recent reference to
“…the plan taking shape right now, using comprehensive tax reform as a means to tax
imports from countries…” could be a sign that Trump is not as against the proposal his
other comments would indicate.
12 Equity Strategy Focus Point | 29 January 2017
This policy would effectively result in the tax authorities recognizing all sales that take
place in the US (regardless of where they are produced) and all the domestic costs
incurred to produce goods and services for customers (regardless of where the sale
takes place). As a result, net importers (such as many retailers) would suffer, as they
would have to pay taxes on their domestic sales without being able to deduct a
significant portion of their costs of production. Conversely, net exporters (companies
with much of their production in the US but sales outside of the US) would stand to
benefit from not having to pay taxes on their foreign sales while being able to deduct a
significant proportion of production costs (Exhibit 3). Purely domestic companies would
be unaffected.
Exhibit 3: Illustration of border adjustment treatment of US corporate taxation
US
Sold in the US:
Recognize sales
Made in the US:
Deduct costs
Sold overseas:
Ignore sales
Non-US
Sold overseas:
Ignore sales
Made in the US:
Deduct costs
Sold in the US:
Recognize sales
Made overseas:
Made overseas: Can’t deduct costs
Can’t deduct costs
Source: BofA Merrill Lynch US Equity & US Quant Strategy
Even if border adjustments are enacted, there is significant uncertainty around
implementation details. For this analysis, we focus on the first order impact of border
adjustments, but we recognize there would be significant second order impacts on the
pricing of products, pricing within the supply chain, foreign exchange rates as well as
foreign policy reactions. (We discuss many of these second order impacts later in this
report.) For the current exercise, we also ignored the cost of services as the
implementation of these rules would be more complicated. See the Methodology
section for more details.
We estimate that at a 20% tax rate, border adjustments would detract $5-6 from 2018
EPS, with nearly 80% of the drag coming from the Consumer Discretionary and
Consumer Staples sectors (roughly evenly split). This impact includes a 50% haircut to
account for offsets from alternate sourcing, currency rates and pricing power. On one
hand, we may be drastically underestimating the impact because we have not included
the second order impacts on the supply chain. For example, many retailers source the
bulk of their goods from domestic suppliers, who source their goods from overseas
suppliers. So while the original retailer may not feel the direct tax hit from importing
goods, the supplier that took the tax hit would likely pass along a significant portion of
this via a higher cost. On the other hand, the supplier or the retailer could look for
alternate domestic sources for those products, but it would largely depend on whether
the cost differential of production between the US and overseas exceeded the border
adjustment tax. Some key components in determining the cost differential are the
foreign exchange rates (more on this below) and labor costs. In the end, the net impact
of the border adjustment taxes will be driven by a complex interplay between corporate
tax rates, pricing power, foreign exchange moves, foreign versus domestic availability
and cost differentials.
Equity Strategy Focus Point | 29 January 2017 13
Chart 10: Sector EPS impact from border
adjustment tax (15% rate)
Staples -23%
Discretionary -21%
Energy
-8%
Health Care
-4%
Info Tech
-3%
Utilities
0%
Telecom
0%
Financials
0%
Real Estate
0%
Industrials
1%
Materials
3%
-30% -20% -10% 0% 10%
15% tax rate
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
Chart 11: Sector EPS impact from border
adjustment tax (20% rate)
Staples -31%
Discretionary -28%
Energy
-10%
Health Care
-5%
Info Tech
-4%
Utilities
0%
Telecom
0%
Financials
0%
Real Estate
0%
Industrials
1%
Materials
4%
-40% -30% -20% -10% 0% 10%
20% tax rate
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
Chart 12: Sector EPS impact from border
adjustment tax (25% rate)
Staples -38%
Discretionary -35%
Energy
-13%
Health Care
-6%
Info Tech
-5%
Utilities
0%
Telecom
0%
Financials
0%
Real Estate
0%
Industrials
2%
Materials
5%
-50% -40% -30% -20% -10% 0% 10%
25% tax rate
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
Offsetting BAT with a little math and some price increases
A company could fully offset the border adjustment tax by raising prices such that the
after-tax increase in sales would exceed the drag from the lost deduction of costs. All
else equal, the break-even price increase would be equivalent to the cost of goods sold
as a % of sales multiplied by net % imported and the tax to after-tax ratio, which at a
20% rate is 0.25 (20%/80%).
As an example, a company with a 25% gross margin that imports 30% of its goods
would need to increase its prices by of 5-6% to offset the border adjustment tax, all
else equal.
Offsetting BAT with FX
Some of the increase in the after-tax cost of imported goods can also be offset by a
strengthening dollar. For example, companies producing goods in Mexico, which stand to
see a 25% increase in the cost of imported goods, should see the cost increase partially
offset by the 13% devaluation of the Mexican Peso against the US dollar since the
election. The net cost increase is a more digestible 9%, especially when you also
consider that the Peso has devalued nearly 30% since its 2013 peak. While it may offer
little consolation to corporates, the US Dollar Index is up over 25% since mid-2014, so
the border adjustment tax would presumably act as a reversal of the lowered cost of
overseas production over that period.
Border adjustment sensitivity analysis
The table below illustrates how the change in the tax rate and the application of the
border adjustment tax would impact the domestic earnings of a hypothetical company
with sensitivity to different tax rates and net export assumptions. We assumed the
company has a 40% gross margin, operating expenses are 20% of sales and an initial
tax rate of 35%. As you would expect, the biggest benefit would accrue to companies
with significant net exports at a high domestic tax rate (bigger tax shield) and the most
negative impact to significant net imports at a high domestic tax rate (higher taxes on
higher taxable income).
14 Equity Strategy Focus Point | 29 January 2017
Table 15: Sensitivity of a company’s domestic earnings
Net exports (% of COGS)
Tax rate -100% -50% 0% 50% 100%*
15% -38% -4% 31% 65% 100%
18% -54% -13% 27% 67% 108%
20% -69% -23% 23% 69% 115%
23% -85% -33% 19% 71% 123%
25% -100% -42% 15% 73% 131%
28% -115% -52% 12% 75% 138%
30% -131% -62% 8% 77% 146%
33% -146% -71% 4% 79% 154%
35% -162% -81% 0% 81% 162%
Source: BofAML US Equity & Quant Strategy
*We note that it is unlikely that a company can be a 100% net exporter and have any domestic earnings to begin with.
Note: We assume a company with a 40% gross margin, operating expenses are 20% of sales and an initial tax rate of 35%
Industry screen: Below we highlight industries which could potentially
benefit most / be hurt most by the BAT.
Chart 13: Industry EPS impact from border
adjustment tax (15% rate)
-100% -50% 0% 50%
Industrial Conglomerates
Life Sciences Tools & Svcs
Chemicals
Household Products
Machinery
Health Care Technology
Electrical Equipment
Media
IT Svcs
Energy Equipment & Svcs
Biotechnology
-1%
Semiconductors & Sem Equip
-2%
Software
-2%
Pharmaceuticals
-2%
Trading Cos & Distributors
-3%
Health Care Equipment &…
-4%
Metals & Mining
-5%
Building Products
-5%
Electronic Equip Instr &…
-6%
Construction Materials
-6%
Oil Gas & Consumable Fuels
-9%
Communications Equipment
-9%
Tech Hardware
-9%
Health Care Providers & Svcs
-11%
Household Durables
-12%
Auto Components
-20%
Leisure Products -30%
Specialty Retail -33%
Distributors -38%
Textiles Apparel & Luxury Goods -39%
Internet & Direct Mktg Retail -41%
Automobiles -41%
Multiline Retail -49%
Food & Staples Retailing -74%
5%
4%
4%
3%
3%
2%
2%
2%
1%
1%
Chart 14: Industry EPS impact from border
adjustment tax (20% rate)
-150% -100% -50% 0% 50%
Industrial Conglomerates
Chemicals
Life Sciences Tools & Svcs
Household Products
Machinery
Health Care Technology
Electrical Equipment
Media
IT Svcs
Energy Equipment & Svcs
Biotechnology
-1%
Semiconductors & Sem Equip
-2%
Software
-3%
Pharmaceuticals
-3%
Trading Cos & Distributors
-3%
Health Care Equipment &…
-5%
Metals & Mining
-7%
Building Products
-7%
Electronic Equip Instr &…
-8%
Construction Materials
-9%
Oil Gas & Consumable Fuels
-12%
Tech Hardware
-12%
Communications Equipment
-12%
Health Care Providers & Svcs
-14%
Household Durables
-16%
Auto Components
-21%
Leisure Products
-40%
Specialty Retail
-45%
Distributors
-51%
Textiles Apparel & Luxury Goods
-52%
Internet & Direct Mktg Retail -54%
Automobiles -55%
Multiline Retail -65%
Food & Staples Retailing -99%
7%
5%
5%
4%
4%
3%
3%
2%
2%
1%
Chart 15: Industry EPS impact from border
adjustment tax (25% rate)
Industrial Conglomerates
Chemicals
Life Sciences Tools & Svcs
Machinery
Household Products
Health Care Technology
Electrical Equipment
Media
IT Svcs
Energy Equipment & Svcs
Biotechnology
Semiconductors & Sem Equip
Software
Pharmaceuticals
Trading Cos & Distributors
Health Care Equipment &…
Electronic Equip Instr &…
Metals & Mining
Building Products
Construction Materials
Tech Hardware
Oil Gas & Consumable Fuels
Communications Equipment
Health Care Providers & Svcs
Household Durables
Auto Components
Leisure Products
Specialty Retail
Distributors
Textiles Apparel & Luxury Goods
Internet & Direct Mktg Retail
Automobiles
Multiline Retail
Food & Staples Retailing
-200% -150% -100% -50% 0% 50%
-2%
-3%
-3%
-4%
-4%
-6%
-8%
-9%
-9%
-11%
-14%
-15%
-15%
-18%
-20%
-21%
-50%
-56%
-64%
-65%
-68%
-69%
-81%
-124%
8%
6%
6%
5%
5%
4%
4%
3%
2%
2%
15% tax rate
20% tax rate
25% tax rate
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
Closing loopholes
Both Trump and the Blueprint proposal suggest getting rid of special-interest
deductions and credits that distort capital allocation decisions. The table below lists the
25 biggest US corporate tax breaks. The #1 and #3 “tax breaks” are the deferral of
foreign income and certain foreign financial income, but these would become irrelevant
if the US moves to a territorial tax system, as is being proposed by the Blueprint plan.
Exempting corporations from paying US taxes on foreign income would put the US in
Equity Strategy Focus Point | 29 January 2017 15
line with the rest of the world on this issue. Similarly, the accelerated depreciation of
machinery & equipment would become irrelevant due to the move toward taxation
based on business cash flow and the immediate write-off of capital expenditures. Once
the depreciation from legacy investments has run off, then depreciation should become
irrelevant for tax purposes. We also highlight the deduction for US production activities
(section 199) due to it being specifically highlighted by the Blueprint proposal as no
longer being necessary under the new tax policies. Both the Blueprint and Trump have
noted that they would likely maintain the Research & Development related tax credits.
Table 16: Top 25 US corporate tax breaks (2016)
Government tax expense
Category/Industry
2016
($mn)
Deferral of income from controlled foreign corporations International affairs 102,100
Accelerated depreciation of machinery & equipment Commerce 28,570
Deferred taxes for financial firms on certain income earned overseas International affairs 15,320
Deduction for US production activities Commerce 12,080
Credit for increasing research activities General science, space, and technology 9,580
Exclusion of interest on public purpose State & local bonds General purpose fiscal assistance 8,400
Credit for low-income housing investments Housing 8,200
Expensing of research & experimentation expenditures General science, space, and technology 6,350
Deferral of gains from like-kind exchanges Commerce 5,720
Inventory property sales source rules exception International affairs 4,270
Graduated corporation income tax rate Commerce 3,300
Exemption of credit union income Financial institutions and insurance 2,310
Special ESOP rules Income security 1,910
Deductibility of charitable contributions, other than education & health Training, employment, and social services 1,720
Tax credit for orphan drug research Health 1,700
Exclusion & deferral of policyholder income earned on life insurance & annuity contracts Financial institutions and insurance 1,470
New markets tax credit Community and regional development 1,260
Energy production credit Energy 1,050
Exclusion of interest on hospital construction bonds Health 1,010
Energy investment credit Energy 890
Work opportunity tax credit Training, employment, and social services 830
Deductibility of charitable contributions (education) Education 820
Tax exemption of insurance income earned by tax-exempt organizations Financial institutions and insurance 690
Exclusion of interest on bonds for private nonprofit educational facilities Education 660
Special Blue Cross/Blue Shield tax benefits Health 630
Source: BofAML US Equity & Quant Strategy, US Department of Treasury
Immediate capex expensing should provide some initial cash tax benefits
The shift to the immediate expensing of capital expenditures should provide a
significant near-term reduction in cash taxes as companies benefit from the ongoing
reduction of taxable income from the depreciation of legacy assets combined with the
full expensing of new investments. As the depreciation of legacy assets rolls off, the tax
benefit would become more modest. Keep in mind that, for tax reporting, many
companies already take advantage of the accelerated depreciation schedules discussed
above. The ongoing benefit of capex expensing derives from the deferral in the timing
of tax payments.
Chart 16: S&P 500 capital expenditure to depreciation & amortization ratio
1.6
1.5
1.4
1.3
1.2
1.1
1.0
'86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '12 '13 '14 '15 '16
Capex/D&A
Avg.
Source: BofAML US Equity & Quant Strategy, S&P, Compustat
16 Equity Strategy Focus Point | 29 January 2017
No interest tax shield
Another key offset to the lower corporate tax rate is the proposed ending of the
deduction of net interest expense. We assume that this rule would apply to new debt
and that existing debt would be grandfathered. This tax shield removal would increase
the cost of debt by an incremental 25% (not to mention the 100bp+ rise in long-term
interest rates seen since the summer of 2016). In the table below, we illustrate the
impact on S&P 500 corporate profits. We estimate that over time, the removal of the
interest rate deduction would detract about 4%, or $4-5 from S&P 500 2018 EPS,
although the initial impact would be less significant given 70-90% of the debt is long
term.
Table 17: Estimated EPS impact from the removal of interest tax shield
S&P 500 Non-Financials
Net Debt ($mn) 2,899
Net Debt/EBITDA 1.74
New tax rate 20%
After-tax interest rate [interest rate w/ no tax shield * (1 - new tax rate)] 4.2%
Interest rate w/ no tax shield [interest expense / net debt] 5.2%
Change in cost of debt [(interest rate w/ no tax shield / after-tax interest rate) -1] 25%
Potential profit impact (%) [(interest rate w/) no tax shield - after-tax interest rate) * (net debt / net income)] 4%
Potential impact on 2018 EPS $4-5
Source: BofAML US Equity & US Quant Strategy, S&P, FactSet
Many investors assume that interest deductions would likely apply only to new debt, and
if this were the case, the drag would be gradual for the overall S&P 500 as debt matures
and is refinanced. Companies have shifted the composition of their debt toward longer
maturities and fixed rates. We estimate an average S&P 500 debt maturity of over eight
years, with just one-third maturing within the next three years. The grandfathering of
existing debt is a reasonable assumption, but not a sure thing, in our view. There is a
possibility that legislators apply it to all debt on the grounds that most companies are
expected to be net beneficiaries of comprehensive tax reform.
There is also a possibility that this policy is phased in over a number of years, with
certain portions of the existing debt losing their interest deductibility over time.
Chart 17: Russell 1000 debt by type and
maturity - 2007
ST
Floating,
23.3%
LT
Floating,
19.7%
ST
Fixed,
2.8%
Source: FactSet, BofAML US Equity & US Quant Strategy
LT
Fixed,
54.2%
Chart 18: Russell 1000 debt by type and
maturity - October 2016
ST
Floating,
15.3%
LT
Floating,
14.0%
ST
Fixed,
4.1%
LT
Fixed,
66.6%
Source: FactSet, BofAML US Equity & US Quant Strategy
Table 18: Russell 1000 estimated weighted
average debt maturity (ex-Financials & REITs)
Sector Estimated Wtd Avg Maturity (years)
Cons. Disc. 7.0
Cons. Staples 8.1
Energy 8.4
Health Care 8.0
Industrials 8.0
Materials 7.4
Technology 7.4
Telecom 10.8
Utilities 12.0
Total 8.3
Source: FactSet, BofAML US Equity & US Quant Strategy
The most negatively impacted companies would clearly be the ones with the most
leverage, in addition to those with depressed earnings (Metals & Mining, Energy, etc.).
While the Utilities sector has a lot of leverage, there would likely be a pass through to
customers in determining their allowed rate increase.
Equity Strategy Focus Point | 29 January 2017 17
Chart 19: Sector EPS impact from ending
interest deductibility (15% rate; ex- fin, utes)
Energy -6.2%
Telecom -5.9%
Materials
Discretionary
Industrials
Real Estate
Staples
Health Care
Info Tech
-8% -6% -4% -2% 0%
-3.5%
-3.1%
-2.7%
-2.8%
-2.2%
-1.7%
-0.9%
Chart 20: Sector EPS impact from ending
interest deductibility (20% rate; ex- fin, utes)
Energy
Telecom
Materials
Discretionary
Industrials
Real Estate
Staples
Health Care
Info Tech
-12%-10%-8% -6% -4% -2% 0%
-8.2%
-7.9%
-4.7%
-4.1%
-3.5%
-3.4%
-2.9%
-2.3%
-1.1%
Chart 21: Sector EPS impact from ending
interest deductibility (25% rate; ex- fin, utes)
Energy
Telecom
Materials
Discretionary
Industrials
Real Estate
Staples
Health Care
Info Tech
-15% -10% -5% 0%
-10.2%
-9.6%
-5.7%
-5.1%
-4.3%
-3.8%
-3.6%
-2.7%
-1.3%
15% tax rate
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
20% tax rate
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
25% tax rate
Source: BofAML US Equity & Quant Strategy, FactSet, S&P
How will levered companies react?
Companies will likely grow comfortable with a smaller amount of debt, retain more
earnings, use less cash for dividends and share buybacks, and potentially draw down
cash if they have it. If a tax holiday is also granted, that might offset the loss of benefit.
Companies that regularly issue long-term debt may choose to reduce that burden to
offset the tax change, and find those funds elsewhere. We find it unlikely that the
change would result in a surge in equity issuance, unless the change applies to existing
debt, which is unlikely in our view. While this change should be taken as a line item in a
wholistic bill, there are victims and beneficiaries here. Corporations that have high
leverage ratios, low retained earnings, high interest expense to earnings ratios, no cash
overseas offset from repatriation, and those that have recurring long-term debt needs
may be most at risk.
Other implications
While some argue that companies will try to raise outsized amounts of investment grade
capital ahead of the deadline to lock in funding with the tax benefit before the loophole
is closed, there is a reasonable chance that a provision is included in the legislation that
would treat such debt as new debt. In our Investment Grade Strategist Hans Mikkelsen’s
view, demand for IG credit could be materially reduced over time. The tax change could
also dampen Leverage Buyout (LBO) activity, according to our High Yield strategist
Michael Contopoulos, where these funds are already struggling to generate high returns
– note that LBO funds are currently sitting on close to $1tn in cash looking for a home,
according to Preqin’s third quarter update.
Who could be hurt: See Table 21 for a screen of stocks with high net interest
expense as a percentage of net income which could potentially be hurt most by an
end to the deductibility of interest expense.
18 Equity Strategy Focus Point | 29 January 2017
Tax reform screens
Lower US corporate tax rate: potential beneficiaries
Below we provide a screen of domestically-oriented S&P 500 companies (<10% foreign
sales exposure) with a high (>35%) median 5-year effective tax rate which could
potentially benefit most from a lower US corporate tax rate.
Table 19: S&P 500 companies with high (>35%) median 5-year effective tax rates and low (<10%) foreign sales
Ticker Company Name Sector Industry
Foreign Sales
%
5-Year Median Effective Tax
Rate %
CHTR Charter Communications, Inc. Class A Consumer Discretionary Media 0% 445.3
DVN Devon Energy Corporation Energy Oil Gas & Consumable Fuels 8% 58.3
REGN Regeneron Pharmaceuticals, Inc. Health Care Biotechnology 0% 44.3
COG Cabot Oil & Gas Corporation Energy Oil Gas & Consumable Fuels 0% 43.5
EOG EOG Resources, Inc. Energy Oil Gas & Consumable Fuels 5% 42.3
RRC Range Resources Corporation Energy Oil Gas & Consumable Fuels 0% 41.9
CNC Centene Corporation Health Care Health Care Providers & Services 0% 41.4
ABC AmerisourceBergen Corporation Health Care Health Care Providers & Services 0% 40.2
CNP CenterPoint Energy, Inc. Utilities Multi-Utilities 0% 39.7
AWK American Water Works Company, Inc. Utilities Water Utilities 0% 39.4
SWN Southwestern Energy Company Energy Oil Gas & Consumable Fuels 0% 39.3
CVS CVS Health Corporation Consumer Staples Food & Staples Retailing 0% 39.3
WFM Whole Foods Market, Inc. Consumer Staples Food & Staples Retailing 3% 38.7
CMG Chipotle Mexican Grill, Inc. Consumer Discretionary Hotels Restaurants & Leisure 1% 38.5
JWN Nordstrom, Inc. Consumer Discretionary Multiline Retail 0% 38.5
AN AutoNation, Inc. Consumer Discretionary Specialty Retail 0% 38.5
TROW T. Rowe Price Group Financials Capital Markets 0% 38.4
KMX CarMax, Inc. Consumer Discretionary Specialty Retail 0% 38.2
PEG Public Service Enterprise Group Inc Utilities Multi-Utilities 0% 38.2
JBHT J.B. Hunt Transport Services, Inc. Industrials Road & Rail 0% 38.1
ULTA Ulta Salon, Cosmetics & Fragrance, Inc. Consumer Discretionary Specialty Retail 0% 38.1
CHK Chesapeake Energy Corporation Energy Oil Gas & Consumable Fuels 0% 38.0
AEE Ameren Corporation Utilities Multi-Utilities 0% 37.9
ALK Alaska Air Group, Inc. Industrials Airlines 0% 37.9
CTL CenturyLink, Inc. Telecommunication Services Diversified Telecommunication Services 0% 37.8
UNP Union Pacific Corporation Industrials Road & Rail 0% 37.7
ROST Ross Stores, Inc. Consumer Discretionary Specialty Retail 0% 37.7
LOW Lowe's Companies, Inc. Consumer Discretionary Specialty Retail 8% 37.6
BBY Best Buy Co., Inc. Consumer Discretionary Specialty Retail 8% 37.5
AAP Advance Auto Parts, Inc. Consumer Discretionary Specialty Retail 0% 37.5
LUV Southwest Airlines Co. Industrials Airlines 0% 37.4
SYF Synchrony Financial Financials Consumer Finance 0% 37.2
DLTR Dollar Tree, Inc. Consumer Discretionary Multiline Retail 8% 37.2
SCHW Charles Schwab Corporation Financials Capital Markets 0% 37.2
NAVI Navient Corp Financials Consumer Finance 0% 37.2
CAH Cardinal Health, Inc. Health Care Health Care Providers & Services 4% 37.1
CXO Concho Resources Inc. Energy Oil Gas & Consumable Fuels 0% 37.1
DFS Discover Financial Services Financials Consumer Finance 0% 37.1
DGX Quest Diagnostics Incorporated Health Care Health Care Providers & Services 2% 37.1
CSRA CSRA, Inc. Information Technology IT Services 0% 37.1
DG Dollar General Corporation Consumer Discretionary Multiline Retail 0% 37.0
XEC Cimarex Energy Co. Energy Oil Gas & Consumable Fuels 0% 37.0
WEC WEC Energy Group Inc Utilities Multi-Utilities 0% 36.9
CSX CSX Corporation Industrials Road & Rail 0% 36.9
CTAS Cintas Corporation Industrials Commercial Services & Supplies 9% 36.9
ORLY O'Reilly Automotive, Inc. Consumer Discretionary Specialty Retail 0% 36.7
KSS Kohl's Corporation Consumer Discretionary Multiline Retail 0% 36.7
BBBY Bed Bath & Beyond Inc. Consumer Discretionary Specialty Retail 0% 36.6
TSCO Tractor Supply Company Consumer Discretionary Specialty Retail 0% 36.6
HUM Humana Inc. Health Care Health Care Providers & Services 0% 36.5
TSO Tesoro Corporation Energy Oil Gas & Consumable Fuels 0% 36.5
ESRX Express Scripts Holding Company Health Care Health Care Providers & Services 0% 36.4
HD Home Depot, Inc. Consumer Discretionary Specialty Retail 9% 36.4
CME CME Group Inc. Class A Financials Capital Markets 0% 36.4
UNH UnitedHealth Group Incorporated Health Care Health Care Providers & Services 4% 36.4
PAYX Paychex, Inc. Information Technology IT Services 1% 36.3
NSC Norfolk Southern Corporation Industrials Road & Rail 0% 36.2
M Macy's Inc Consumer Discretionary Multiline Retail 0% 36.2
RAI Reynolds American Inc. Consumer Staples Tobacco 5% 36.1
CMCSA Comcast Corporation Class A Consumer Discretionary Media 8% 35.8
AZO AutoZone, Inc. Consumer Discretionary Specialty Retail 6% 35.7
UHS Universal Health Services, Inc. Class B Health Care Health Care Providers & Services 0% 35.5
AET Aetna Inc. Health Care Health Care Providers & Services 2% 35.5
DVA DaVita Inc. Health Care Health Care Providers & Services 0% 35.4
Equity Strategy Focus Point | 29 January 2017 19
Table 19: S&P 500 companies with high (>35%) median 5-year effective tax rates and low (<10%) foreign sales
Ticker Company Name Sector Industry
Foreign Sales
%
5-Year Median Effective Tax
Rate %
FE FirstEnergy Corp. Utilities Electric Utilities 0% 35.3
ZION Zions Bancorporation Financials Banks 0% 35.2
MO Altria Group, Inc. Consumer Staples Tobacco 0% 35.1
EXC Exelon Corporation Utilities Electric Utilities 0% 35.1
RSG Republic Services, Inc. Industrials Commercial Services & Supplies 0% 35.0
Note: This screen is not a recommended list either individually or as a group of stocks. Investors should consider the fundamentals of the companies and their own individual circumstances/objective before making any
investment decisions.
Source: FactSet, BofA Merrill Lynch US Equity & US Quant Strategy
Repatriation: potential beneficiaries
Below we provide a screen of S&P 500 companies (excluding Financials and Real Estate)
with high (>10%) overseas cash as a percent of market cap, which could potentially
benefit most from repatriation.
Table 20: S&P 500 (ex. Financials & Real Estate) companies with the highest overseas cash* as a % of their market cap (>10%)
Ticker Company Sector Industry Overseas Cash ($mn) Overseas Cash as a % of Mkt Cap
WU Western Union Company Information Technology IT Services 6,100 62%
FSLR First Solar, Inc. Information Technology Semiconductors & Semiconductor 1,500 59%
NWS News Corporation Class B Consumer Discretionary Media 813 54%
ORCL Oracle Corporation Information Technology Software 48,200 40%
CSCO Cisco Systems, Inc. Information Technology Communications Equipment 59,800 39%
NTAP NetApp, Inc. Information Technology Technology Hardware, Storage & 4,000 39%
QCOM QUALCOMM Incorporated Information Technology Semiconductors & Semiconductor 29,600 36%
AAPL Apple Inc. Information Technology Technology Hardware, Storage & 216,000 34%
JNPR Juniper Networks, Inc. Information Technology Communications Equipment 3,167 30%
SYMC Symantec Corporation Information Technology Software 4,900 29%
PVH PVH Corp. Consumer Discretionary Textiles, Apparel & Luxury Goo 2,100 28%
AMGN Amgen Inc. Health Care Biotechnology 29,000 26%
GE General Electric Company Industrials Industrial Conglomerates 64,680 24%
MSFT Microsoft Corporation Information Technology Software 108,900 22%
TDC Teradata Corporation Information Technology IT Services 819 22%
CTSH Cognizant Technology Solutions Corp. Class A Information Technology IT Services 7,495 22%
RL Ralph Lauren Corporation Class A Consumer Discretionary Textiles, Apparel & Luxury Goo 1,085 21%
CA CA, Inc. Information Technology Software 2,137 21%
WAT Waters Corporation Health Care Life Sciences Tools & Services 2,346 20%
LRCX Lam Research Corporation Information Technology Semiconductors & Semiconductor 3,500 19%
NWSA News Corporation Class A Consumer Discretionary Media 813 18%
GOOG Alphabet Inc. Class C Information Technology Internet Software & Services 42,900 18%
MCHP Microchip Technology Incorporated Information Technology Semiconductors & Semiconductor 2,559 17%
GOOGL Alphabet Inc. Class A Information Technology Internet Software & Services 42,900 17%
GILD Gilead Sciences, Inc. Health Care Biotechnology 15,700 17%
VRSN VeriSign, Inc. Information Technology Internet Software & Services 1,200 16%
PBI Pitney Bowes Inc. Industrials Commercial Services & Supplies 470 16%
XLNX Xilinx, Inc. Information Technology Semiconductors & Semiconductor 2,240 15%
ADI Analog Devices, Inc. Information Technology Semiconductors & Semiconductor 3,374 15%
A Agilent Technologies, Inc. Health Care Life Sciences Tools & Services 2,181 14%
NOV National Oilwell Varco, Inc. Energy Energy Equipment & Services 2,034 14%
CTXS Citrix Systems, Inc. Information Technology Software 1,970 13%
KLAC KLA-Tencor Corporation Information Technology Semiconductors & Semiconductor 1,730 13%
GPS Gap, Inc. Consumer Discretionary Specialty Retail 685 13%
WDC Western Digital Corporation Information Technology Technology Hardware, Storage & 2,800 13%
GT Goodyear Tire & Rubber Company Consumer Discretionary Auto Components 1,042 13%
ADSK Autodesk, Inc. Information Technology Software 2,059 13%
PCLN Priceline Group Inc Consumer Discretionary Internet & Direct Marketing Re 9,800 13%
JNJ Johnson & Johnson Health Care Pharmaceuticals 38,200 13%
MRK Merck & Co., Inc. Health Care Pharmaceuticals 20,995 12%
GLW Corning Inc Information Technology Electronic Equip., Instruments 3,085 12%
MJN Mead Johnson Nutrition Company Consumer Staples Food Products 1,577 11%
LLY Eli Lilly and Company Health Care Pharmaceuticals 8,100 11%
KO Coca-Cola Company Consumer Staples Beverages 17,900 11%
MOS Mosaic Company Materials Chemicals 1,276 11%
AMAT Applied Materials, Inc. Information Technology Semiconductors & Semiconductor 4,000 11%
PH Parker-Hannifin Corporation Industrials Machinery 2,065 11%
*For some companies, total overseas cash may represent total accumulated overseas profits. Overseas cash based on BofAML analyst estimates or Bloomberg data from company disclosures.
Note: This screen is not a recommended list either individually or as a group of stocks. Investors should consider the fundamentals of the companies and their own individual circumstances/objective before making any
investment decisions.
Source: FactSet, Bloomberg, BofA Merrill Lynch Global research estimates, BofA Merrill Lynch US Equity & US Quant Strategy
20 Equity Strategy Focus Point | 29 January 2017
End of interest deductibility: who could be hurt?
Below we provide a screen of the top 50 S&P 500 companies (excluding Financials, Real
Estate and Utilities) by high net interest expense as a percentage of net income, which
could potentially be hurt by an end to the deductibility of interest expense.
Table 21: S&P 500 (ex. Financials, Real Estate & Utilities) with high net interest expense as a % of net income
Ticker Company Sector Industry Net Interest Expense (% of L12M Net Income)
CHTR Charter Communications, Inc. Class A Consumer Discretionary Media 1387%
DVN Devon Energy Corporation Energy Oil, Gas & Consumable Fuels 467%
CXO Concho Resources Inc. Energy Oil, Gas & Consumable Fuels 357%
MU Micron Technology, Inc. Information Technology Semiconductors & Semiconductor 316%
FCX Freeport-McMoRan, Inc. Materials Metals & Mining 280%
OKE ONEOK, Inc. Energy Oil, Gas & Consumable Fuels 135%
KMI Kinder Morgan Inc Class P Energy Oil, Gas & Consumable Fuels 120%
LVLT Level 3 Communications, Inc. Telecommunication Services Diversified Telecommunication 96%
WYNN Wynn Resorts, Limited Consumer Discretionary Hotels Restaurants & Leisure 95%
CTL CenturyLink, Inc. Telecommunication Services Diversified Telecommunication 94%
CF CF Industries Holdings, Inc. Materials Chemicals 92%
NFX Newfield Exploration Company Energy Oil, Gas & Consumable Fuels 82%
RIG Transocean Ltd. Energy Energy Equipment & Services 81%
NFLX Netflix, Inc. Consumer Discretionary Internet & Direct Marketing Re 80%
SE Spectra Energy Corp Energy Oil, Gas & Consumable Fuels 78%
TDG TransDigm Group Incorporated Industrials Aerospace & Defense 77%
HCA HCA Holdings, Inc. Health Care Health Care Providers & Servic 63%
MPC Marathon Petroleum Corporation Energy Oil, Gas & Consumable Fuels 56%
CAT Caterpillar Inc. Industrials Machinery 56%
EVHC Envision Healthcare Corp. Health Care Health Care Providers & Servic 55%
URI United Rentals, Inc. Industrials Trading Companies & Distributo 54%
DVA DaVita Inc. Health Care Health Care Providers & Servic 52%
TGNA TEGNA, Inc. Consumer Discretionary Media 52%
DE Deere & Company Industrials Machinery 50%
MAS Masco Corporation Industrials Building Products 49%
ENDP Endo International Plc Health Care Pharmaceuticals 48%
COTY Coty Inc. Class A Consumer Staples Personal Products 47%
IP International Paper Company Materials Containers & Packaging 47%
R Ryder System, Inc. Industrials Road & Rail 46%
DLTR Dollar Tree, Inc. Consumer Discretionary Multiline Retail 46%
NEM Newmont Mining Corporation Materials Metals & Mining 46%
FOX Twenty-First Century Fox, Inc. Class B Consumer Discretionary Media 46%
GT Goodyear Tire & Rubber Company Consumer Discretionary Auto Components 45%
RSG Republic Services, Inc. Industrials Commercial Services & Supplies 45%
SEE Sealed Air Corporation Materials Containers & Packaging 45%
PBI Pitney Bowes Inc. Industrials Commercial Services & Supplies 45%
AN AutoNation, Inc. Consumer Discretionary Specialty Retail 44%
KSS Kohl's Corporation Consumer Discretionary Multiline Retail 44%
F Ford Motor Company Consumer Discretionary Automobiles 43%
VIAB Viacom Inc. Class B Consumer Discretionary Media 42%
MNK Mallinckrodt Plc Health Care Pharmaceuticals 41%
ADS Alliance Data Systems Corporation Information Technology IT Services 41%
WRK WestRock Co. Materials Containers & Packaging 40%
VRTX Vertex Pharmaceuticals Incorporated Health Care Biotechnology 39%
BLL Ball Corporation Materials Containers & Packaging 37%
GE General Electric Company Industrials Industrial Conglomerates 37%
M Macy's Inc Consumer Discretionary Multiline Retail 37%
CVX Chevron Corporation Energy Oil, Gas & Consumable Fuels 37%
SLB Schlumberger NV Energy Energy Equipment & Services 37%
TSO Tesoro Corporation Energy Oil, Gas & Consumable Fuels 36%
Note: This screen is not a recommended list either individually or as a group of stocks. Investors should consider the fundamentals of the companies and their own individual circumstances/objective before making any
investment decisions.
Source: FactSet, BofaA Merrill Lynch US Equity & US Quant Strategy
Equity Strategy Focus Point | 29 January 2017 21
Related BofAML research on US tax reform
Below we provide links to reports from our BofAML Global Research colleagues that
address this topic.
Economics:
Global Watch: Will border adjustment lead to border battles? 18 January 2017
US Economic Weekly: Cutting taxes could be taxing 02 December 2016
Credit strategy:
Situation Room: Corporate tax reform=less debt 28 November 2016
The HY Wire: ‘A Better Way’: tax proposals could affect HY issuance 09 December 2016
FX:
FX Watch: Ten thoughts on Border Adjustments 18 January 2017
FX Viewpoint: Homeland Investment redux? 17 October 2016
Autos:
Automotive Industry: The Trump trade – implications for the automotive value chain 18
January 2017
Consumer/Retail:
Retailing - Hardlines: A taxing set of proposals for Hardline Retailers 14 December 2016
Specialty Retail and Department Stores: Border adjustment seems unlikely but would
decimate retail earnings 14 December 2016
US Consumer Staples: Policy changes: what to watch for 18 January 2017
Cosmetics, Household & Personal Care: 2017 – The Year Ahead: a few diamonds in the
rough 10 January 2017
Consumer Staples: 2017 - the year ahead: sector rotation puts fundamentals in focus 13
December 2016
Tobacco: Tobacco Year Ahead 2017; see domestic players having more upside potential
this yr 04 January 2017
Homebuilders and Building Products: State of the union 12 December 2016
Financials / Real Estate:
2017 Banks Year Ahead: T-R-U-M-P: Find out what it means for “E” (20% potential
upside) 10 January 2017
US Banks Chart of the Week: Muni exposure will mute benefit from lower corporate
taxes 11 December 2016
Insurance: Tax changes could have mixed implications 18 January 2017
Brokers, Asset Managers & Exchanges: 2017 Year Ahead: An attractive outlook, with 12-
20%+ upside, with catalysts 12 January 2017
U.S. REITs: Regulatory changes are coming: A REIT analyst guidebook 17 January 2017
Health Care:
Managed Care: MCO rally has just begun; beneficiaries of the non-Health Care upside
from Trump 02 December 2016
Biotechnology: On the road to recovery 04 January 2017
Healthcare: 2017 – the year ahead: the only constant is change 15 December 2016
22 Equity Strategy Focus Point | 29 January 2017
Energy:
Refiners: What’s going on with Refining in 2017: potential benefits in a Trump
administration 05 January 2017
Industrials / Materials:
Industrials/Multi-Industry: DEM#217: The Year Ahead; Resetting for higher US growth
and inflation 09 January 2017
Engineering & Construction: 2017 view: energy backlog more 2H story, own
infrastructure & federal 12 January 2017
Transportation - Railroads: 2017 Rail Year Ahead: Macro factors favor group; 1H comps
set stage for growth 12 January 2017
Business, Education & Professional Services: 2017 year ahead: INFO top pick in
Business Services 12 January 2017
Basic Materials & Industrials 2017 Year Ahead: Buy America and inflation, but watch the
US dollar and interest rates 12 December 2016
Global Chemicals: Potential tax reform could be more meaningful than infrastructure
spending 15 December 2016
Tech:
Apple Inc.: Deep Dive - Benefit from lower U.S. tax rate, but border tax could be onerous
13 January 2017
Server & Enterprise Software: Tax reform +ve for INTU, CRM; Cash repatriation +ve for
ORCL, MSFT, VMW 12 December 2016
Semiconductor Capital Equipment: Tax sensitivity analysis. Repatriation a bigger deal
than taxes for Semicaps, EDA 02 December 2016
Telecom Equipment: New administration appears likely to drive spending on
infrastructure & cyber security 18 January 2017
Internet/e-Commerce: Top 2017 US Internet Sector Drivers – Trump Act One 17 January
2017
Telecom:
Wireline & Wireless Telecom Services: For AT&T, Verizon and CenturyLink, the telco tax
trade could be ‘Huge’ 19 December 2016
Wireline & Wireless Telecom Services: 2017 Year Ahead – Fiscal forces, regulation, and
video migration to mobile 10 January 2017
Media:
Media & Entertainment: 2017 year ahead - living the stream 11 January 2017
Cable/Satellite: 2017 year ahead – reform, relief and resilience 11 January 2017
Utilities:
Utilities: 2017 Year Ahead: Washington DC will likely cast a long shadow on utilities 06
January 2017
Equity Strategy Focus Point | 29 January 2017 23
Methodology
Repatriation impact
We estimated cumulative overseas profits for the S&P 500 excluding Financials and
Real Estate via three sources: 1) Bloomberg data on cash held overseas (if
disclosed/available), 2) BofAML analyst estimates on cumulative overseas profits or
cash, and 3) our own estimate if neither (1) or (2) are available, based on (Total cash x
[% of foreign sales +10%]) for companies with at least 5% foreign sales.
We apply the effective tax rates proposed by Trump (10%) and the Blueprint (8.75%) to
our estimated $1.2tn in overseas cash to determine taxes due for the S&P 500 ex.
Financials & Real Estate. We estimate that 100% is brought back given that the tax is
mandatory. To compute the one-time tax impact to GAAP EPS, we divide the cumulative
tax impact by the S&P 500 divisor, after first excluding the impact from several large
multinationals (e.g. AAPL) which already provision a portion of their overseas profits for
US taxes and have effective US tax rates well above 35%.
Note that for companies for which our analysts provided estimates, we asked them to
provide cumulative overseas profits if possible, but in most cases this number reflects
overseas cash. Thus, taxes paid could be slightly higher than we estimate given that
both the Blueprint and Trump’s plans suggest a mandatory tax on all accumulated
overseas profits, some of which may be permanently reinvested; here, the Blueprint
suggests a lower 3.5% tax for retained earnings not held in cash/equivalents, suggesting
that any additional taxes payable that we are not capturing are likely to be small.
To calculate the % EPS impact from buybacks, we subtract the amount of taxes payable
from total cash brought back for the S&P 500 ex. Financials & Real Estate (and for each
sector) and divide this by the market cap for the S&P 500 (and for each sector.) We
multiply this % impact for the overall index by our 2018E EPS of $137 to determine the
potential EPS impact, applying various buyback scenarios (10-100%). We use 50% as a
base case scenario, which is lower than the 80% brought back during the 2004 tax
holiday, to be conservative.
Border adjustments impact on EPS
We estimate the costs of goods imported and exported for each company using the
latest company filings, conversations with analysts, industry research, management
commentary and the Input-Output accounts data published by the U.S. Department of
Commerce. For more information about the Input-Output accounts data, please refer to
the Bureau of Economic Analysis website at http://www.bea.gov/industry/io_annual.htm.
When using the estimates based on Input-Output accounts, we adjust them to account
for the varying foreign exposures of different S&P 500 industries. For companies that
source products through importers (e.g. retailers), we only included the costs of goods
estimated to be directly imported by each company, as taxes pertaining to those
imported goods should be paid by the importers themselves.
We estimate the earnings impact of border adjustments based on the additional taxes
that companies would pay on the costs of imported goods sold in the US (nondeductible)
and any reduction in taxes related to the production costs for exported
goods (deductible). To calculate this, we multiple the net value of imported COGS by the
assumed tax rate. Note that the net impact can be either positive or negative depending
on whether the company is a net importer or exporter. We assume a 50% haircut to the
impact to account for from alternate sourcing, currency rates and pricing power.
Lower corporate tax rate impact on EPS
We estimate the normalized effective domestic tax rate of a company based on
conversations with the analysts or the median 5-year domestic income tax rate. If a
company had a negative tax rate for a particular year, we exclude the tax rate of that
24 Equity Strategy Focus Point | 29 January 2017
year from the median calculation. For companies with normalized tax rates of more than
75%, we assume 35%.
The impact of a lower corporate tax rate on company earnings is directly proportional to
the difference between the current domestic tax rate and the proposed tax rate. The
impact is calculated by taking the difference between the current tax rate and the
proposed tax rate, and dividing it by (1-current tax rate).
To calculate the impact of a lower corporate tax rate on the S&P 500 earnings, we can
divide the change in the effective tax rate by (1 – the current effective tax rate).
Interest deductibility impact
We estimate the cost associated with the removal of the net interest expense deduction
from taxable income by multiplying the net interest expense by the tax rate.
Equity Strategy Focus Point | 29 January 2017 25
Disclosures
Important Disclosures
BofA Merrill Lynch Research Personnel (including the analyst(s) responsible for this report) receive compensation based upon, among other factors, the overall profitability of Bank of America
Corporation, including profits derived from investment banking. The analyst(s) responsible for this report may also receive compensation based upon, among other factors, the overall
profitability of the Bank’s sales and trading businesses relating to the class of securities or financial instruments for which such analyst is responsible.
Other Important Disclosures
Prices are indicative and for information purposes only. Except as otherwise stated in the report, for the purpose of any recommendation in relation to: (i) an equity security, the price
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26 Equity Strategy Focus Point | 29 January 2017
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Equity Strategy Focus Point | 29 January 2017 27