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Morgan Stanley: Tax bills could drag some utilities' earnings, raise others

Current tax reform bills in Congress would have "mixed implications" for investor-owned utilities, according to a Nov. 21 research note by Morgan Stanley.

Several utilities could experience higher per-share earnings and rate base growth, but "most [are] facing lower cash flows and thus weaker credit metrics," the investment company said.

The U.S. House of Representatives and U.S. Senate have each proposed their own tax overhaul legislation. Both bills call for lowering the corporate tax rate to 20% from 35%, which Morgan Stanley said could benefit per-share earnings for several utilities with profitable nonregulated businesses. The lower corporate rate could also raise regulated rate base growth due to the reduction in utilities' deferred tax liabilities. Companies that could see the biggest earnings gains, in Morgan Stanley's view, include South Jersey Industries Inc., Dominion Energy Inc., Public Service Enterprise Group Inc., Exelon Corp. and NextEra Energy Inc.

Cash flows would decline for most utilities under the bills due to reduced customer payments from a lower tax rate, the "flowback" of the deferred tax liabilities reduction and the loss of bonus depreciation, a change that would reduce utilities' ability to shield income from cash taxes, Morgan Stanley said. Companies that could sustain the largest losses are FirstEnergy Corp., which could see its EPS drop by 8.5% if the corporate tax rate fell to 20%, followed by Duke Energy Corp., PPL Corp., Xcel Energy Inc. and CMS Energy Corp., which would all register about 2% declines in per-share earnings, according to Morgan Stanley's estimates.

The key tax reform elements Morgan Stanley considered in its projections were the decline in the corporate tax rate to 20%, loss of bonus depreciation, exemptions for regulated utilities and merchant power producers from the immediate expensing of capital expenditures and their continued ability to deduct interest expense, and a lower deferred tax liability. Morgan Stanley assumed no change in production tax credits for various energy resources, including new wind power facilities.

The House's tax bill would sharply reduce the value of the federal wind production tax credit and change eligibility requirements for the credit. The wind industry said the proposal would strand billions of dollars worth of new projects and eliminate thousands of jobs, but the Senate excluded any changes to the wind credit in its tax bill, making the provision less likely to become law.