US tax reform is predicted to do wonders for US multinationals, from becoming more competitive to becoming more liquid and possibly less levered. However, it may not do much for their credit quality, which is expected to remain about the same, according to Fitch Ratings.
“US corporate behavior will be the major determinant as to whether the potentially positive aspects of tax reform translate into improved credit quality,” Fitch says in a note to clients. As of now, Fitch says any positives derived to from improved cash flows will be offset by companies distributing repatriated cash (dividends and stock repurchases) and new cash savings from the cuts. Money could also flow toward M&A.
“Cash flows will benefit,” Fitch says, but it does not expect this fact “to generate material improvements in overall US corporate credit quality. Our base case assumption calls for most of the improved cash flows and readily available foreign cash to be used for buybacks and dividends.”
Instead, what could change or improve credit quality will be changes in policy, particularly those that reduce company debt. Since the end of the financial crisis US corporations have borrowed nearly $10 trillion in the bond market. That’s 62% more than companies borrowed eight years leading up financial crisis.
Fitch also says even with positive outcomes from the tax cuts, there remains downside risks. That’s because Fitch says the US economy currently is “in the later stages of the credit cycle and the economic impact [of tax cuts] is expected to be limited.” Further, “aggressive increases in capex, wages or hiring could leave issuers more exposed in a downturn, when combined with the rich valuations, aggressive capital structures and investor-friendly credit documentation primarily present in some pockets of the speculative-grade market.”
So at this point, Fitch says, only time will tell. “As companies digest the new law, the upcoming earnings season should offer more insight into what actions companies will take, if any, that could alter specific credit profiles in response to tax reform.”