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Chart 10: Sector EPS impact from border adjustment tax (15% rate)

Staples -23%
Discretionary -21%
Energy -8%
Health Care -4%
Info Tech -3%
Utilities 0%
Telecom 0%
Financials 0%
Real Estate 0%
Industrials 1%
Materials 3%
-30% -20% -10% 0% 10%

■ 15% tax rate

Source: BofAML US Equity & Quant Strategy, FactSet, S&P

Chart 11: Sector EPS impact from border adjustment tax (20% rate)

Staples -31%
Discretionary -28%
Energy -10%
Health Care -5%
Info Tech -4%
Utilities 0%
Telecom 0%
Financials 0%
Real Estate 0%
Industrials 1%
Materials 4%
-40% -30% -20% -10% 0% 10%

■ 20% tax rate

Source: BofAML US Equity & Quant Strategy, FactSet, S&P

Chart 12: Sector EPS impact from border adjustment tax (25% rate)

Staples -38%
Discretionary -35%
Energy -13%
Health Care -6%
Info Tech -5%
Utilities 0%
Telecom 0%
Financials 0%
Real Estate 0%
Industrials 2%
Materials 5%
-50% -40% -30% -20% -10% 0% 10%

■ 25% tax rate

Source: BofAML US Equity & Quant Strategy, FactSet, S&P

Offsetting BAT with a little math and some price increases
A company could fully offset the border adjustment tax by raising prices such that the after-tax increase in sales would exceed the drag from the lost deduction of costs. All else equal, the break-even price increase would be equivalent to the cost of goods sold as a % of sales multiplied by net % imported and the tax to after-tax ratio, which at a 20% rate is 0.25 (20%/80%).

BAT price offset = COGS (% of sales) * net import (%) * (tax rate (%) / (1 - tax rate (%)))

As an example, a company with a 25% gross margin that imports 30% of its goods would need to increase its prices by of 5-6% to offset the border adjustment tax, all else equal.

Offsetting BAT with FX
Some of the increase in the after-tax cost of imported goods can also be offset by a strengthening dollar. For example, companies producing goods in Mexico, which stand to see a 25% increase in the cost of imported goods, should see the cost increase partially offset by the 13% devaluation of the Mexican Peso against the US dollar since the election. The net cost increase is a more digestible 9%, especially when you also consider that the Peso has devalued nearly 30% since its 2013 peak. While it may offer little consolation to corporates, the US Dollar Index is up over 25% since mid-2014, so the border adjustment tax would presumably act as a reversal of the lowered cost of overseas production over that period.

Border adjustment sensitivity analysis
The table below illustrates how the change in the tax rate and the application of the border adjustment tax would impact the domestic earnings of a hypothetical company with sensitivity to different tax rates and net export assumptions. We assumed the company has a 40% gross margin, operating expenses are 20% of sales and an initial tax rate of 35%. As you would expect, the biggest benefit would accrue to companies with significant net exports at a high domestic tax rate (bigger tax shield) and the most negative impact to significant net imports at a high domestic tax rate (higher taxes on higher taxable income).

14 Equity Strategy Focus Point | 29 January 2017
Bank of America Merrill Lynch
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