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Tobacco giant Altria and bank JP Morgan Chase feature among the beneficiaries of US tax reform, according to Stuart Cox, who runs the Jupiter Global Managed fund.
After months of negotiations, the Tax Cuts and Jobs Act was finally passed in December, marking US president Donald Trump’s first major policy victory. The act reduces the headline corporation tax rate from 35% to 21%, as well as establishing a one-off repatriation tax of 8% on profits from overseas subsidiaries and 15.5% on cash that US multi-nationals have accumulated overseas.
Cox was keen to highlight another rule that offers 100% tax deductibility on capital investments that are made by companies in the US over the next five years. For example, investments in property, plants and equipment. The change will prove particularly beneficial for multi-nationals which were already considering investing in their US operations, said the fund manager.
The reforms also reduce personal tax rates and aim to simplify the US tax code as a whole. This has resulted in the closing of loopholes which previously allowed companies to pay less tax in the US. With this in mind, Cox said it was important to look beyond the headline corporate tax rate reduction, as some companies previously took advantage of these loopholes to lower their tax bills.
‘The devil will be in the micro level details,’ he added.
Nevertheless, there will be clear beneficiaries from the reforms and Cox suggested the repercussions would be multi-faceted. Firstly, lower tax payments for companies with a significant presence in the US should result in higher dividend payments and share buybacks.
British American Tobacco (BATS), which generates around 40% of its revenues in the US, is a good example. It estimates that the tax changes will provide a 6% uplift to its earnings per share (EPS) this year.
For fellow tobacco stock Altria (MO), which is based in the US, the impact will be far greater. According to Cox’s estimates, the US tax changes could spark a double-digit increase in EPS.
‘What is really interesting and differentiates stock picking going forward would be whether management teams of companies use the tax changes to give them more optionality to make decisions to further enhance shareholder returns,’ Cox said.
By this, he means whether management teams use the extra cashflow to reinvest in the business. This could be via research and development (R&D) or acquisitions.
In Altria’s case, the tax changes come at a crucial point. Philip Morris International’s (PMINEUR) IQOS ‘heat-not-burn’ product is awaiting approval from the US Food and Drug Administration (FDA) following successful roll-outs in Japan, Italy and Switzerland.
Altria will have the sole distribution rights to market the IQOS product in the US, which is the second biggest market for cigarettes in the world after China. If the FDA application is successful it has the potential to provide a massive boost to Altria's earnings, coinciding with the positive tailwind of lower tax payments.
‘They are going to benefit from extra cashflow and reduced tax on investments, which will help them to launch the product,’ Cox added.
The fund manager suspects Altria may also look to put cash to work via smaller acquisitions in the US.
Pharmaceutical giant Pfizer (PFE.N) is another company that has the potential to invest in the US after it repatriates money held overseas, according to Cox.
‘Pfizer has lots of overseas cash that it has not transferred back to the US yet because of the high tax rates. If you lower the tax rate, it creates opportunities for them to invest in the US pharma and biotech market,’ he explained.
Cox also highlighted JP Morgan Chase (JPM.N) as having the potential to grow its market share following the tax changes. The bank plans to invest its extra cashflow into its wealth management and consumer credit card divisions – a development the fund manager welcomes because these two areas have historically generated high returns for the bank.
It is a different story for US aerospace and defence company Lockheed Martin (LMT.N). Cox suspects the tax cuts will have less of an impact on its underlying business because its revenues are reasonably predictable, with orders coming in from governments around the world. In this case, the fund manager expects the tax savings will be returned to shareholders via dividends or share buybacks, rather than being reinvested into the business.
‘What is more interesting is where companies can reinvest the money and use more enhancing options than dividends or buybacks,’ Cox added.