Earnings Forecasts From Tax Law May Be Too Rosy: Morgan Stanley

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By Steve Burkholder

U.S. capital markets predict a substantial boost to net income among S&P 500 companies from the recent tax overhaul, though such a collective view by analysts might be too optimistic, Morgan Stanley & Co. LLC researchers said.

What seems to be a too-rosy earnings picture from the 2017 tax law stems from analysts not fully factoring in apparent plans by companies to reinvest tax savings from the law and the costs of such reinvestment, according to a Feb. 23 Morgan Stanley report.

The analysts’ view—and the report’s prediction of a potential 7.6 percent boost to 2018 consensus earnings among Standard & Poor’s 500 Index companies—assumes that all of the law’s tax benefits will flow through to the bottom line.

Reinvestment Effects

The investment bank’s review of earnings-call transcripts of more than 400 companies in the S&P 500 showed “reinvestment will likely prevent full flow-through” of the tax benefits from the law.

“Consensus numbers have efficiently adjusted for new tax rates, but have implicitly failed to account for higher expenses from reinvesting of the tax savings,” the Morgan Stanley analysts said.

“How much of the tax cuts flow through to the bottom line is a critical question for earnings,” the report said. That amount has implications for markets and the business cycle.

The Morgan Stanley analysts said their study of the comments of the companies in recent earnings calls “tells us reinvestment in the business could be substantial.”

Sectors to Watch

They said sectors to watch include consumer staples, financial, health care, and industrial.

The baseline change in tax rates among large capitalization companies has fallen to about 21 percent from about 27 percent before the law was enacted on Dec. 22, according to the report. Large cap companies are those with a market capitalization of more than $10 billion.

“Some companies gave firm guidance on the potential impact of the tax benefit and how much would be reinvested,” Morgan Stanley said. “However, our read was the majority of companies either 1) have not completed their planning, 2) were unwilling to share how much they planned to reinvest, or 3) were waiting to see what others will do.”

Starbucks Corp. said in an earnings call that the majority of its tax savings “will go to the bottom line, with more than 50 percent but less than 60 percent accruing to earnings.”

“The vast majority of the 40 percent remaining will be invested in our US partners via wages and benefits above our plans with the balance funding accelerated digital investment,” the coffee company said.

Professor’s Take

Fabio Gaertner, an assistant professor of accounting at the University of Wisconsin-Madison, told Bloomberg Tax Feb. 23 that the Morgan Stanley analysis “seems reasonable.” He suggested that the companies ”seem to be optimistic” about the ultimate effect of the tax law’s benefits.

There “seems to be quite a bit of uncertainty” among companies about “what they’re going to do with the savings,” said Gaertner, a specialist in tax accounting.

To contact the reporter on this story: Steve Burkholder in Norwalk, Conn. at sburkholder@bloombergtax.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bloombergtax.com

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