These Stocks Could Face Unexpected “Losses” in 2013
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In an ironic paradox, a host of firms could post fresh “losses” as a result of fresh tax cuts.
Yes, you read that correctly.
During October’s presidential debates, President Obama announced that he wants to trim the corporate tax rate from a high of 35% to a lower rate, potentially 28%. For most companies, this is great news – the additional capital could spur additional investment or fund increased dividend payouts to investors.
However, the tax rate changes don’t come without problems.
A host of major firms that took huge losses in the financial collapse hoard an asset called a tax-deferred asset, or DTA. The asset is housed on the balance sheet and is transferred to the income statement and ultimately to the cash flow statement when it is utilized.
Citi, AIG, Ford, and also Lockheed Martin (NYSE: LMT) hold such assets and are at risk for posting losses in 2013.
A “Real” Loss?
The reason that a loss could be booked is because the DTA is calculated using the current tax rate of 35%. If Congress agrees to drop that rate, then the companies with DTAs on their books must apply the new lower tax rate to their past loss, which results in a diminished credit.
Thus, it is not a loss from current poor performance. Rather, it is less of an offset against future net income.
During its third-quarter earnings conference call, for example, Citigroup said that the bank could take an estimated $4 to $5 billion charge from lower tax rates, and therefore DTAs. Citi posted an astronomical $27.68 billion loss in 2008, providing the bulk of Citi’s roughly $53.3 billion in DTAs.
While Citi has the most DTAs of any U.S. company, others also have large amounts. Ford has $12.9 billion, for example, exposing the company to the same risk. AIG has a similar amount, holding $12.8 billion. If tax rates were to drop to 28%, AIG could see a loss as large as $2.6 billion.
Finally, Lockheed Martin commented last quarter that it was possible that it could face write-downs if the corporate tax rate were lowered.
Betting on the Banks
“Investors are focused on tangible book value,” said one analyst, referring to the potential decline in banks’ tangible book value. DTAs are an asset and therefore make up a part of banks’ tangible book values.
The banking sector has the potential of getting hit here.
If DTAs shrink, so would the tangible book values. For this reason, I believe that the banking sector could be further stalled (assuming both a short-term time frame of less than six months and decreased tax rates). Thus the S&P Bank ETF (NYSEMKT: KBE) could stagnate or underperform the overall market. To see a list of the ETF’s holdings, look here.
However, DTA losses coupled with a market correction could provide a nice entry point for banking stocks or the banking ETF.
When to Go Long?
The potential tax cuts that could be a stimulator in the long run could cause short-term losses for companies who posted extreme losses during the financial crisis. Unsure about the DTAs on a company’s balance sheet? A quick glance at a company filing would provide the answer.
In all, short-term dips from these potential DTA losses could provide buying opportunities for the once-sick companies. The upside is that they have now become healthy.
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ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of American International Group, Citigroup Inc , Ford, and Lockheed Martin and has the following options: long JAN 2014 $25.00 calls on American International Group. Motley Fool newsletter services recommend American International Group and Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.