A Look At Big Pharma’s Value Sensitivity To Changes In Tax Rates

by Trefis Team
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Pfizer
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With the U.S. government’s new tax law coming into effect, many companies will see a significant impact from changes in their effective tax rates (some more than others, of course). In this note, we focus on some of the major pharmaceutical firms such as Pfizer (NYSE:PFE), Johnson & Johnson (NYSE:J&J), Merck (NYSE:MRK) and Bristol-Myers Squibb (NYSE:BMY). A lower corporate tax rate could allow these companies to potentially increase R&D investments with the freed up cash, and more projects may become economically viable – as the expectation of greater future profits due to a lower tax rate could encourage more risk taking. Although the expected benefits from tax reform are likely reflected in their current market prices to an extent, there remains some uncertainty around what the companies will do with the freed up cash, as well as how productive those uses will be. Ultimately, it will boil down to the expected taxable income growth and the expected change in their effective tax rates. We focus more on the effective tax rate as large companies often employ complex strategies to reduce their tax exposure, so the entire tax cut may not pass through, and the magnitude of the impact will vary on a case by case basis. We have created an interactive model that details how changes in effective tax rates can impact the valuations of big pharma companies. You can modify assumptions such as projected taxable income, long-term growth rate and discount rate (weighted average cost of capital) to see how the dynamics of effective tax rate / valuation change. The table below shows how much the aforementioned companies’ valuations would be impacted by a 1% reduction in their effective tax rates.

To reiterate, not all of the companies will see their effective tax rate change meaningfully. For instance, Pfizer has astutely managed its tax liabilities over the years, and has structured its business and subsidiaries to minimize its tax exposure in the U.S by consistently reporting operating losses in the region. The company has effectively turned its U.S. operations into a cost center. One way the company has done so is by developing drugs in the U.S., manufacturing them overseas, and then buying them back from its subsidiaries at high prices. Accordingly, we don’t expect the company to benefit to a significant degree from the tax code changes.

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