What a week it’s been! It’s strange to think the inauguration was only last Friday. Depending on your political stripes those seven days were either fantastic or scary (or anywhere in between for that matter). Two things I’ve resisted doing on the blog is talking politics and posting articles that encourage short term trading, but I think President Trump’s plans with respect to business taxes can be broached without crossing those lines. I mean just on what we’ve seen and heard so far it’s setting up to be the most pro-business administration of all time.
Now if you wander over to the campaign pledge site you’ll get an overview of the plan; and that is to cut the corporate tax rate from 35% down to 15%. Given Republicans in Congress have also touted this (I think their version called for a cut from 35% to 25%), and given how much noise has been made about it, I think it’s safe to say the business rate is coming down.
A lot of the financial media coverage of this has predictably focused on shorter opportunities. In that respect I’d say look at restaurant stocks and retailers that generate all, or nearly all, of their revenues and profits in the United States and have little to no debt (e.g. Chipotle Mexican Grill). That said there are definitely longer-term implications here, with three very strong blue-chips standing out for me in particular.
The Hershey Company
By now you’ll know I’m a big fan of The Hershey Company (NYSE: HSY) having done a couple of dedicated articles as well as mentioning it in countless others. A lot of folks attribute Hershey’s lack of geographical diversity as a negative but look at it this way; Hershey has a 30% market share in the largest single market on Earth (okay, technically second if we’re counting the European Union as one). Looking at the specific numbers we’re talking something like 90% of revenues and nearly 100% of the company’s profits being generated in the US.
Now there’s a sure fire way to ensure that as a company you’re getting the full tax-bill. One is what we just covered (i.e. you do most of your business in the U.S.) and the other is that you’re insanely profitable and don’t generally offset taxes by way of impairments or major capex breaks. Given what Hershey is – a stodgy candy company defending a monster market share in one of the wealthiest markets on Earth – then it fits the bill perfectly.
If you’ve ever wanted to own a chocolate stock/comapany you’ve no doubt already looked up the available options: Mondelez International, Swiss chocolatier Lindt & Sprüngli and Hershey. Aside from Herhey there’s one thing they all have in common: much lower effective rates of tax. The difference isn’t negligible either; we’re talking like 10 points every year here. According to management at Mondelez the company’s normalized tax rate is “in the mid-20s”. Lind’s effective tax rate is around 26%. Despite that inbuilt disadvantage Hershey’s profit quality metrics are still best-in-class. A business tax cut will make Hershey’s already ridiculous profitability metrics stand out even more. Okay the value isn’t so great right now, but with the prospective of increased it’s probably a fair deal if you’ve got a long-term outlook.
J.M. Smucker (NYSE: SJM) isn’t a company I’ve featured yet on the site, although I did write about it on Seeking Alpha a couple of months back. Smucker is in the same boat as your usual consumer defensive food stocks. It has a bunch of great brands that give it high quality profits, plus there’s a tremendous dividend growth history stretching back to 1960s. If you ever need a profit machine to keep on your watchlist then let it be this. Just check out the net profit margins it generates from flogging peanut butter and jam over the past decade or so.
There’s also a couple of added features that make Smucker stand out that little bit extra. One is that it’s still relatively small with a $16 billion market-cap. The second is that the value is actually quite attractive now, which is definitely something you can’t say about its peers. If you’re American that likes defensive stocks which pay out dividends that tend to grow every year then you should seriously be looking at this one right now. At just under 17x earnings it’s already great long-term value, and a Trump tax-cut just makes it look even better than it already does.
Dr Pepper Snapple Group
Like Hershey, Dr Pepper Snapple Group (NYSE: DPS) is a stock I’ve featured a couple of times already on The Compound Investor. I’m sure I don’t need to run over the deal here as you’ll all be aware of Dr Pepper’s flagship product and generally superb business economics. Also like Hershey they’re basically tied to the United States. I guess a major difference is that unlikely Hershey the actual brands are already established overseas (I’m pretty sure everyone knows Dr Pepper and Schweppes right across the globe), it’s just the licenses are held by other companies. That might make a difference should the company ever want to expand overseas, but in the here-and-now Dr Pepper Snapple Group is pretty much an entirely U.S. based corporation.
The upshot of all this is that like Hershey and Smucker the company pays huge amounts in business taxes on its profits. Going back to 2006 its corporate tax rate has averaged 36.5%. For Coca-Cola that average tax rate was over 10 points lower at 23% and for PepsiCo it was 26%.
Now if you run the maths on that then we’re looking at huge numbers, relatively speaking, in additional bottom line profits. Imagine what that’s going to look like going forward. We’re talking hundreds of millions, even billions, of dollars worth of cash that’s primarily going to end up enriching stockholders. Given that the likes of Hershey, Smucker and Dr Pepper are the kinds of stocks you wouldn’t mind holding for decades, across any political environment (heck they’ve already been though all kinds of different ones), I think that makes them the best way to play a Trump/Republican tax cut from a long-term investing perspective.