Called to Account: The tax bill is making the fourth-quarter earnings season a muddle
The U.S. tax bill signed into law in December has made the fourth-quarter earnings season a muddle, as companies take wildly different approaches to their disclosures of its impact.
The Securities and Exchange Commission issued guidance on how companies should reflect the impact of lower corporate tax rates in the quarter ending Dec. 31, and the changes to the value of deferred tax assets or liabilities, directing them to report charges or benefits based on a “reasonable estimate” that can be adjusted later.
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All of the companies that have reported earnings so far have included tax-law-related disclosures, and many have posted multibillion-dollar charges or benefits. But companies are not being consistent in how they are presenting the impact on GAAP earnings, or those that comply with Generally Accepted Accounting Principles, the industry standard.
“Some companies present [a] detailed breakdown in the non-GAAP section, others bundle all the tax-related adjustments into a single line that includes [the] impact of tax reform, other discretionary tax adjustments and [the] tax impact of other non-GAAP items,” said Olga Usvyatsky, vice president of research at Audit Analytics.
‘The tax act was completed shortly before the holidays and it caught people by surprise. There are not a lot of proven models out there yet and the tax bill is extraordinarily complex. Even within one industry, it depends on how a company is structured, how much debt it has, where it operates, so that’s also driving the inconsistency.’
Many companies that have seen a positive impact are including the benefit in reported earnings, and some with negative impacts are reporting it as an adjustment to GAAP, while emphasizing non-GAAP results. And it’s not clear that, in most cases, the impact does not carry over to free cash flow and is preliminary, meaning any cash expense will come later in 2018 and estimates are likely to change.
Stephen Quinlivan, a partner at the law firm Stinson Leonard Street LLP, said companies taking charges have tended to describe those as noncash, while those recording benefits do not. But he said some confusion was to be expected, given the tight time frame between passage of the bill and the start of the reporting season.
“The tax act was completed shortly before the holidays, and it caught people by surprise,” he said. “There are not a lot of proven models out there yet, and the tax bill is extraordinarily complex. Even within one industry, it depends on how a company is structured, how much debt it has, where it operates, so that’s also driving the inconsistency.”
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The picture should become clearer when companies start to make their mandatory quarterly filings with the SEC at the end of February with the help of their auditors.
“Hopefully there will be more time for people to spend thoughtfully putting pen to paper and better models out there,” he said. “And, hopefully, auditors will help drive consistency and make sure that companies hit all the rungs.”
Stock movement reflects confusion
For investors, the different approaches companies are taking are adding a layer of confusion to earnings and to determining whether companies have met, missed or beaten analysts’ consensus estimates.
“Companies just don’t know, or are not really willing to put pen to paper regarding what they think,” said Aram Balian, director of data operations at Estimize, which crowdsources earnings estimates. “It definitely makes it a little murkier.”
Chevron Corp. CVX, -5.57% , for example, on Friday reported a big jump in earnings, to $ 3.1 billion, or $ 1.64 a share, from $ 415 million, or 22 cents a share, in the same period a year ago. Revenue rose to $ 37.6 billion from $ 31.5 billion, beating the FactSet consensus of $ 37.4 billion.
The company said its earnings included a $ 2.02 billion noncash benefit related to the tax bill, a gain of $ 1.44 billion on asset sales and impairments and noncash charges of $ 840 million. But it did not provide details of the impact on earnings per share in the earnings release.
Some investors clearly thought Chevron’s earnings per share of $ 1.64 had beaten the FactSet consensus of $ 1.23. As the chart illustrates, after Chevron’s earnings were released at 8:30 a.m. Eastern time, the stock initially rallied, as much as 1.6% in premarket trade, before turning lower.
To find the EPS number “excluding special items” that investors use to compare with Wall Street expectations, investors had to go to the “2017 4Q Earnings Conference Call Presentation” on the company’s website and scroll down to the appendix on the 19th page, to see that it was 72 cents, which missed expectations, as the company explained to MarketWatch in an email.
Meanwhile, Chevron rival Exxon Mobil Corp. XOM, -5.10% reported earnings per share of $ 1.97, up from 41 cents, thanks to a big tax benefit. But it also provided an adjusted EPS number of 88 cents that excluded the one-time tax benefit and charges, so investors could see that EPS missed the FactSet consensus of $ 1.03. Exxon’s stock rose initially, but only as much as 0.5%, before turning lower.
Then there are other aspects to the bill that may confound investors.
AT&T Inc. T, -2.78% , for example, booked a one-time noncash net income gain of $ 20.4 billion for the markdown of its deferred tax liabilities — taxes it would owe in the future — to the new 21% rate from 35%. But that’s not its only benefit. The company also expects that the lower rates will give it about $ 3 billion extra in cash in 2018, which it said it plans to spend on enhancing its network.
AT&T didn’t have to wait for the new year to see more cash in hand as a result of the tax reform. The company’s adjusted EPS of 78 cents included a positive impact of 13 cents from one of the very few retroactive provisions of the new law effective back to Sept. 27. That provision allows full expensing and, therefore, tax deductibility in 2017 of fourth-quarter capital spending.
News of the windfall initially cheered investors — until confusion caused the stock to vacillate before eventually moving higher.
The picture is likely to remain blurred for the rest of the year as companies get to grips with the change. Quinlivan from Stinson Leonard said he expects companies to end up making adjustments to their tax estimates in every quarter of 2018.
“It might be driven by how soon the IRS gives guidance,” he said.
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