Personal Finance

Will President Trump's Tax Reform Help Retailers? The Devil Is in the Details

KSS Free Cash Flow (TTM) Chart

Earlier this month, top department store chains Macy's (NYSE: M) and Kohl's (NYSE: KSS) reported that their weak sales trends continued during the critical holiday season. Other department store chains also reported poor results. For the past two years or so, among apparel and home-focused retailers, only off-price merchants such as TJX Companies (NYSE: TJX) have consistently performed well.

One of the few potential bright spots for retailers such as Macy's and Kohl's is corporate tax reform. Both companies still produce plenty of free cash flow but face high taxes. A reduction in the corporate tax rate could boost their cash flow, allowing them to return more cash to shareholders.

KSS Free Cash Flow (TTM) Chart

Kohl's and Macy's Free Cash Flow and Income Tax Paid, data by YCharts .

If the statutory corporate tax rate declined from 35% to 15% or 20%, Macy's and Kohl's would probably see their cash tax burdens cut in half (roughly speaking), boosting their free cash flow. Since both companies return most of their free cash flow to shareholders, this extra cash would probably be used for further dividend increases or share buybacks.

Unlike Macy's and Kohl's, TJX has significant overseas operations. Even so, it generates the vast majority of its income in the U.S. and paid a whopping $1.3 billion in corporate taxes last year. That represented a little more than 35% of the company's net income. Thus, a lower tax bill could drive free cash flow higher at TJX, too.

On the other hand, since Macy's, Kohl's, and TJX spend more than half of their revenue on buying inventory and most of those goods are imported, a border-adjusted tax could drive their tax bills dramatically higher. If a large proportion of their costs become non-tax deductible, their tax bills could easily double or triple, even with a 15%-20% corporate tax rate.

A border-adjusted tax would dramatically increase Macy's tax bill. Image source: The Motley Fool.

To make matters worse, it wouldn't be feasible to switch to American suppliers for things such as apparel, handbags, and bedding. Thus retailers would have to raise prices to offset the border tax, which would probably drive further sales declines.

Who stands to win (or lose) the most?

A corporate tax cut with no border-adjustment impact would benefit Kohl's and Macy's more than TJX. Shares of both department stores have fallen dramatically since early December. If their share prices stay depressed, Kohl's and Macy's could use the extra free cash flow from their tax savings to buy back a ton of stock.

By contrast, Kohl's faces the most downside in a border-adjusted tax environment. TJX would be protected somewhat by its higher profit margin and international operations, while Macy's could fall back on its underlying real estate value if a border tax undermined its profitability.

Corporate tax reform could be a big catalyst for retailers later this year. But whether it will be a positive or negative catalyst still remains to be seen.

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Adam Levine-Weinberg owns shares of Macy's and is long January 2018 $60 calls on The TJX Companies and short January 2018 $90 calls on The TJX Companies. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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