The New Corporate Diet: Fatter Profits, Skinnier Tax Bills

By Theo Francis and Richard Rubin 

The largest U.S. companies found a new formula for success in the first quarter: Larger pretax profits and smaller tax bills.

More than half of the combined net income reported by 200 large public companies in the first quarter stemmed from a decline in the companies' effective tax rates, a Wall Street Journal analysis of quarterly financial data from Calcbench found.

At a third of the companies, tax expenses fell in dollar terms even as pretax income rose, boosted by strong revenue growth and the expanding economy.

Chip giant Intel Corp.'s pretax profits rose $1.2 billion over first quarter 2017 -- but tax expenses fell by $294 million. Defense contractor Lockheed Martin Corp. said pretax profits rose $325 million in the March quarter while tax costs fell $43 million.

The tax savings are helping to drive profits to new highs among companies in the S&P 500 index. Overall, first-quarter after-tax earnings for index companies are on track to rise 25.3% over the same period in 2017, according to Thomson Reuters. That would mark the seventh straight quarter of per-share profit growth and the strongest gains in more than seven years.

A cut in the U.S. corporate tax rate to 21% from 35% was the centerpiece of the federal overhaul that was passed in December, and lawmakers and tax analysts expected the largest immediate benefits would go to companies with few foreign operations and few tax breaks to lose such as retailers.

Underscoring that expectation: Pretax earnings for the S&P 500 are forecast to rise about half as fast as after-tax earnings, at 12.1%, Thomson Reuters said.

"It's clearly not just the economy" driving corporate profits, said Joseph LaVorgna, chief economist for the Americas at Natixis, a corporate and investment bank. "Change in tax policy is part of it."

Investors had anticipated big tax savings and pushed major U.S. stock indexes to record highs earlier this year. In recent weeks, gains have been more muted even as companies from Goldman Sachs Group Inc. to Apple Inc. have reported strong results.

S&P 500 revenues are expected to rise 8.3% from a year earlier, tied with the fourth quarter for the fastest clip since late 2011 and the seventh straight quarter of growth, Thomson Reuters data show. The figures reflect reported results -- as adjusted by stock analysts -- for about two-thirds of companies in the index, and analyst estimates for the rest.

Energy, technology and financial firms have led per-share earnings growth with gains of 30% or greater, followed by companies in the materials and industrial sectors, both above 25%. Real estate has lagged behind, at 2.7% per-share earnings growth, as have consumer staples, at 13% growth.

Broader data suggest that the tax overhaul has had at best a modest impact on the economy as a whole. Gross domestic product expanded at 2.3% in the first quarter, a slower pace than at the end of 2017, as household spending cooled. But business investment was strong and the tax benefits are showing up in the quarterly results of the biggest U.S. corporations.

At CSX Corp., tax expenses for the first quarter were roughly flat, despite a 57% increase in pretax earnings, "illustrating the favorable impacts of tax reform," the railroad's chief financial officer, Frank Lonegro, said in a mid-April conference call with analysts. The company expects taxes to total about 25% of pretax income this year, down from 38% last year.

In addition to a reduced income-tax rate at home, multinational companies will benefit because they generally can now bring current and future foreign profits back for U.S. investment, dividends or share buybacks without paying an additional U.S. tax.

As a result, large companies are grappling with what to do with their tax windfalls. Apple on Tuesday boosted its dividend and said it would repurchase $100 billion of its own shares from investors, the latest in a flood of companies returning cash to investors.

Apple's tax costs a year ago were $3.7 billion, including an assumption that the company would pay U.S. taxes on some of its foreign income. This year, those costs declined by $1.3 billion even as pretax income went up by $1.5 billion. That deep a cut may be temporary, because the new foreign minimum tax likely won't apply to Apple until after its next fiscal year starts later in 2018.

Many companies are returning their tax savings to their investors. The amount spent on share buybacks in the first quarter rose by more than 50% over the fourth quarter of 2017, and by two-thirds over the first quarter of 2017, according to S&P Dow Jones Indices. Companies have also set plans to invest in expansion and new technology, and paid one-time bonuses to employees.

For 28 S&P 500 companies, lower taxes were enough to account for the difference between reporting earnings growth and an earnings decline. Those included chemical maker Monsanto Co., asset manager T. Rowe Price Group Inc. and laboratory chain Quest Diagnostics Inc.

A T. Rowe Price spokesman said the company also recorded an increase to net revenues and near-record asset inflows. "The tax savings are also helping us accelerate investments in our strategic priorities and increase the return of capital to our stockholders," he said.

Monsanto noted that, while its lower effective tax rate was primarily a result of the tax overhaul, it also reflected other, unspecified tax effects. Quest didn't respond to a request for comment.

"More than ever, it matters to look at more than just the bottom line," said Jack Ciesielski, an accounting analyst and publisher of Analyst's Accounting Observer. "The lower tax rate could be masking deteriorating fundamentals."

Write to Theo Francis at [e-mail] and Richard Rubin at [e-mail]

(END) Dow Jones Newswires

May 03, 2018 08:14 ET (12:14 GMT)

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