With a complex system of imports and exports of finished automobiles and inputs to the manufacturing process, it is not surprising that the impact of the DBCFT on the U.S. auto industry could be widely divergent.
Ford already has said publicly that it will benefit from the Republican tax plan. And it is possible to see why: it has a net export position (so its revenues from exports are not taxed) with local content in excess of 50%. The U.S. operations of Honda and Toyota are in the same situation. Non-U.S. automakers such as BMW and Kia have a relatively lower share of domestically-sourced content in cars built in the U.S. The difference in their respective positions can result in significantly different outcomes under the DBCFT.
Even trickier is the situation for parts suppliers. We believe larger suppliers such as Lear and Delphi are net importers for their U.S. operations. But it isn’t that clear. Many times some of the components of the finished autos coming across the border from Mexico contain content that was originally sourced from the U.S. What will be the tax consideration for that sort of sale? Meanwhile, roughly 40-50% of the tires on U.S.-made vehicles are imported, so that industry will face significant headwinds.
Ultimately, these shifts are significant enough that they may have an impact on the supply chain. The DBCFT may incentivize suppliers to shift capacity back to the U.S. where possible, particularly where labor costs are not a major factor. Companies may choose to direct some exports now headed into the U.S. market into other regions. In sum, the U.S. changes may force shifts down the supply chain that put production closer to consumption.
Current tax bills for many companies in the auto sector are still being held down by the presence of net operating losses from prior years. That has helped contribute to limiting many companies’ tax bite. Cash tax rates for some of those companies are less than their book rates, so that helps reduce current-year tax payments. Still, a lower tax rate will be a benefit for companies over the longer term, or more immediately for some smaller auto suppliers that aren’t carrying NOLs.
Considerations over the elimination of interest deductibility are also varied. If existing debt is grandfathered and remains deductible—but new debt is not—it may mean that buying back shares with new tax reform-generated cash flow will be more attractive than paying down outstanding debt. An investment grade company with significant cash stockpiles will need to choose whether to use that cash to reduce its need to pay interest. At Standard & Poor’s Ratings, more than 35% of the rated companies in the U.S. auto sector are owned by private equity, and any change to deductibility of interest payments could have a major impact, since the private equity model generally calls for significant debt as part of a company’s capitalization.
Full depreciation of capital expenses in the year the expenditure is made could be of benefit to original equipment manufacturers in the auto sector. Many of these companies have significant capital expenditures and R&D expenses, particularly for those companies looking toward electric vehicles. CapEx spending in the sector is at present running above normal level, driven in part by the electrification push.