How Will BP’s Shareholders Benefit From The New Tax Bill?
The year 2017 has ended on a good note for the US corporate sector with the passing of the new tax act in the country. The new law not only entails the reduction of corporate tax from 35% to 21%, it also includes a number of other provisions that will particularly favor the oil and gas industry in the US. As a result, most of the oil and gas companies are likely to witness a surge in their valuation with the implementation of the new tax bill. In our previous analysis, Here’s How The GOP Tax Cut Will Impact BP’s Valuation, we had discussed how the reduction in corporate tax rate will impact BP’s valuation in the coming years. In this note, we aim to talk about the benefit that the recent tax cut will have on BP’s shareholders in the next few years.
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Lower Tax Would Boost Profitability
The US oil and gas industry has been suffering from low profitability and cash flows over the last three years due to the ongoing commodity slowdown. In fact, a number of these companies have been making losses, which helped them to dodge the payment of heavy taxes in the last couple of years. However, with the anticipated recovery in commodity markets, the profitability of these companies is expected to improve, causing them to pay higher taxes compared to the previous two years. That said, the reduction of the corporate tax rate from the existing 35% to around 21% would result in a lower tax obligation for these companies, which is expected to boost their profitability going forward.
Keeping this in mind, we expect BP’s net earnings to increase sharply starting in 2018. This would not only augment the company’s stock price, causing capital appreciation for the investors, but will also free up cash for the company to grow its dividend payouts or to expand its share buyback program. Besides, the integrated company could also utilize these tax savings to prepay its debt obligations and reduce its interest expenses, which would further improve its profits going forward. Thus, we figure that the tax cut will bolster BP’s profitability as well as valuation, which will, in turn, generate higher returns for its shareholders. Further, an effective use of these tax savings will be to allow the company to further enhance shareholder value going forward.
Incremental Gain From MLP
Apart from drastically reducing the tax burden for oil and gas companies, the new tax plan provides for some concessions that will further boost their returns. The new law provides for a 20% business income deduction for individuals holding ownership in pass-trough entities, such as master limited partnerships (MLPs). At present, an MLP is a corporate vehicle, popularly used by oil pipeline companies and real estate companies, that allows parent companies to receive a large portion of the MLP’s earnings without paying taxes on it. These distributions are taxed on an individual level rather than on a corporate level. Without this special concession, the individuals receiving income from any of these pass-through entities would have to pay a tax of 37%, based on the personal tax rate under the new law. However, with the provisions of the new act, these individuals would receive a 20% deduction on their pass-through income before paying their taxes.
Interestingly, BP had recently spun-off its midstream business to form an MLP, known as BP Midstream Partners (BPMP) to independently run its pipeline business, while taking advantage of a tax efficient structure of an MLP. Now, with the implementation of the new tax bill, we expect BP’s shareholders to save taxes on their income from BPMP, which will, in turn, enhance their overall return from the company.
Thus, we figure that the tax reforms implemented by the Trump government are likely to be beneficial for BP, as well as its shareholders, in the coming years.
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