All Things Are on the Table
While tax reform is a subject that puts most people to sleep, it’s the fuel that’s been powering the market’s rally since Election Day.
Even with President Trump’s vow to unveil a “phenomenal” tax plan, it’s starting to look like Congress might not get around to passing a tax-reform package until late this year.
Despite a unified GOP government, there’s still competition between the branches, including two separate tax proposals—the House Republican “Blueprint” and Trump’s campaign tax plan.
To reconcile their differences, there will be extensive negotiations between policymakers, not to mention intensive lobbying from businesses, before a growth-oriented tax bill is finally passed.
Although the market is still running on fumes, the typical ugliness of the legislative process has not been lost on Wall Street’s sell-side analysts, who have yet to incorporate potential tax changes into their earnings estimates.
For instance, strategists at Goldman Sachs believe that the market could end up giving back some of its recent gains once investors awaken to the reality that tax reform could provide a “small, later tailwind” to earnings growth than previously expected.
While corporate tax cuts are generally good for business, there are some sectors where their potential effect is more ambiguous, especially if lawmakers decide to offset lower tax rates by eliminating certain key deductions.
At Investing Daily’s Utility Forecaster, we’ve reviewed both tax plans, as well as utility executives’ response.
Their take? Well, it depends.
First, it’s important to note that regulated utilities would generally pass along any benefits realized from tax cuts to their ratepayers. So the benefit from lower tax rates would be indirect.
If consumers were to pay lower utility rates as a result of tax cuts, then it would give utilities more room to continue growing rate base through infrastructure upgrades and buildouts, which would give a slight boost to earnings growth.
Trump vs. Ryan
But in general, as far as utilities are concerned, the Trump plan would be a modest winner, insofar as its effect would be neutral, at worst, and moderately accretive to earnings, at best.
By contrast, House Speaker Paul Ryan’s plan is largely a loser for utilities. The consensus among the four utility super-giants—NextEra Energy Inc. (NYSE: NEE), Duke Energy Corp. (NYSE: DUK), Dominion Resources Inc. (NYSE: D), and Southern Company (NYSE: SO)—is that the Blueprint would be earnings neutral, at best, to 5% dilutive, at worst.
From the utility sector’s standpoint, the key distinction between the two plans is that Trump’s proposal would give companies the flexibility to choose which tax regime suits their business best, while the House plan is more akin to “one size fits all.”
The main wrinkle is over whether companies will be allowed to continue deducting interest paid on debt, a key issue for the capital-intensive utility sector.
Trump’s plan would allow companies to choose between immediately expensing business investments and continuing to deduct interest payments on bonds, whereas the House is hoping to offset the former by eliminating the latter.
In assessing the House plan, Southern’s CEO Tom Fanning observed, “ … this notion of eliminating interest deductibility is a grand experiment … [that could] radically change how America finances long-term capital.”
“And if we’re trying to stimulate long-term capital,” he continued, “I’m not sure that’s the right way to go.”
At Utility Forecaster, our own take is constructive. The two plans aren’t all that far apart on their particulars, and their overall intent is the same: to stimulate business investment and the overall economy.
Additionally, we would expect policymakers to give essential-service providers such as utilities a sympathetic ear when it comes to granting sector-specific exceptions.
Furthermore, there will be considerable lobbying firepower trained on key members of Congress. As the chart below shows, the Edison Electric Institute, which is the association of investor-owned utilities, is no slouch when it comes to playing political moneyball in order to get the results the sector wants.
For their part, utility executives are already using their powers of persuasion on lawmakers. Three of the four utility super-giants explicitly acknowledged that they’re already engaging with policymakers to ensure that their sector gets appropriate treatment. We think their efforts will ultimately prove successful.
As one Duke senior executive put it, ” … all things are on the table.”
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