Positives Of The GOP Tax Bill On Duke Energy

Having performed well in 2017, Duke Energy (NYSE:DUK), the largest utility company in the US, is entering 2018 on a skeptical note with the new tax bill enacted by the Trump government. While the Tax Cuts And Jobs Act passed last month has slashed the corporate tax rate from 35% to 21%, which is expected to result in significant tax savings for the company, there are certain provisions in the new act which could lower investments in wind and solar projects, hampering Duke’s future prospects. Thus, in this series of articles we aim to discuss how the new tax bill will impact Duke’s valuation in the near term. In this note, we will talk about the positive impact that the tax reforms will have on the company.

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Notable Tax Savings

One of the key highlights of the new tax act is the reduction of corporate tax rate from the current 35% to 21%, payable from 2018 onward. Further, the tax reform also has a provision that completely eliminates the corporate alternate minimum tax payable by US companies going forward. Combined, these two provisions would imply that Duke Energy would have lower tax obligations in 2018 and beyond, which would boost the company’s bottom-line. Over the last five years, Duke’s effective tax rate has averaged at around 33%. However, with the implementation of the new tax rules, the company’s tax rate is expected to come down to 21%, which will reduce its tax expense for the coming years. Below, we show how a lower tax rate will lead to a jump in the company’s earnings per share, and in turn, its valuation using our interactive platform.

Expensing Provisions For Capital Investment

Besides the tax cuts, the new tax bill allows capital intensive companies to expense 100% of their investments immediately for the next five years. In simple words, this would entail upfront expensing of capital expenditure by companies rather than splitting it over a few years in the form of depreciation, which would lower a company’s profits before tax, further reducing their tax liability.

Now, Duke Energy plans to spend $7.5-$8.0 billion per year in capital investment between 2017 and 2021 in order to augment its growth plans. This new provision will allow the company to charge its capital expenditure as an expense in its income statement, causing its profits to decline due to the high amount of capital charge. As a result of lower profits, the company’s tax bill will also come down, boosting its overall value in the near term.

Passing On The Tax Savings

Being one of the largest utility companies in the US, Duke Energy’s power business is somewhat regulated. Since the company is expected to benefit from the new tax bill in the form of tax savings, the regulatory authorities might require the company to pass-on the tax savings to its customers in the form of reduced power rates in 2018 or the following years. This would mean that the company’s tax savings, realized from a lower tax rate and capital expensing, could be marginally reduced as the company tries to lower its power rates to pass-on the benefit to its customers. That said, the amount and timing of this rate reduction for customers is unknown at the moment. Hence, we have used our interactive platform to create a scenario to depict this rate reduction and its impact on Duke’s valuation below.

Based on our estimates, reducing the power rates to pass-on the tax benefit to customers will have a minimal impact on Duke’s valuation. Thus, based on the provisions discussed above, we believe that Duke will have a sizeable upside from the amended tax bill.

In our next analysis, we will discuss some of the other provisions of the new tax bill which could negatively impact Duke Energy.

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