Analysts See Many Winners Under Tax Plan
As the Dow keeps breaking records, the benefits of the tax reform package being voted on right now are largely already priced in for much of the market. But there are a handful of restaurants companies that still haven’t reached their projected post-reform prices.
Whether investors are skeptical given recent trends or they’re all invested in Bitcoin is unknown, but some restaurants could see major windfalls from the current tax reform bill.
According to Nicole Miller Regan, senior restaurant research analyst at Piper Jaffray, the restaurant sector would see a 32.5% effective tax rate on average without reform. But the new plan that includes a 21% federal tax rate and quicker write-offs would bring that effective tax rate down to 25.2% on average.
She wrote that there are some major gaps between projected earnings accretion and stock prices. For Fiesta Restaurant Group (NASDAQ: FRGI), what Regan sees is an 18% tax earnings accretion that would boost earnings per share by 39%. Share prices have ticked up about 15% since the tax conversation began in earnest—a 24% gap. Similarly, Del Taco (NASDAQ: TACO) is well behind its potential EPS growth. According to Regan’s research, with the combination of business-friendly tax updates, the brand could see a 35% earnings growth, but shares have only appreciated 1.41% since the updated tax bill was released. Dave & Busters, Chipotle, Potbelly and Starbucks are also lagging projected EPS growth.
Restaurant analyst Chris O’Cull at Stifel examined some of the best positioned companies, but also looked closely at the negative impacts under the new tax bill. While the federal tax rate gets a lot of attention, changes to the Work Opportunity Tax Credit (WOTC) and the FICA tip credit will mean big changes for some companies. Since O'Cull's note, the WOTC was taken off the chopping block, so the $9,600 credit for hiring veterans, disabled people, felons and young people during the summer remains in the tax code.
As for FICA—which will use the federal minimum wage of $7.25 instead of the previous rate of $5.15—it may not look like a big change, but it could be a big loss for casual diners.
“For example, assume a server works 30 hours a week and is paid $2.13/hour plus $400 in tips per week, or $463.90 per week,” wrote O’Cull. “In this scenario, the restaurant owner would receive a credit for the wages paid above the implied minimum wage (30 hours x $5.15 = $154.50) multiplied by 7.65% (FICA tax rate), or about $1,230 annually. Under the reform bill, the annual amount using this example would fall to $980. As a result, restaurants will have a lower FICA credit, which typically is the largest credit for company-owned casual dining chains.”
Still, he sees free cash flow ticking up by 15% at Darden (NYSE: DRI) and 13% at Brinker International (NYSE: EAT).
Chuy’s will see the greatest free cash flow boost under the tax plan. The brand (NASDAQ: CHUY) is projected to see a 36% boost to free cash flow per share, according to O’Cull.
He sees big earnings per share gains in fast casual. Stifel projects Chipotle (NYSE: CMG) will see a 28% EPS boost, Wingstop (NASDAQ: WING) will see a 25% boost and Domino’s (NYSE: DPZ) will see a 22% bump.
As for the most under-valued based on post-reform projections, it’s a mix. O’Cull has Jack In The Box as the greatest potential impact at an 18% upside, then Domino’s (17%), Wingstop (17%), Bojangles (15%) and Papa John’s (13%). None of his picks have appreciated anywhere near the potential impact since the new plan was released.
While investors are still a little skittish about big investments in the restaurant segment amid the recent shaky numbers, the good bets are still good bets.
Restaurant analyst Andrew Charles at Cowen called out McDonald’s as a good bet for the current performance, and tax reform would be a nice bonus. Under the new tax plan, Cowen projects a McDonald’s (NYSE: MCD) benefit of 8.7% EPS growth and an effective tax rate of 26%, down from 32%.