Why Donald Trump's tax plan could be great for restaurant stocks

President Donald Trump wants to give American corporations a tax break, and no sector may be a better beneficiary than restaurants.

As one of many overtures to American businesses to encourage them to keep jobs in the U.S. and invest at home, in his first days in the Oval Office Trump said he favors lowering the corporate tax rate from the current 35% rate to 15%-20%.

At a meeting with business leaders last Monday, he said: "We are going to be cutting taxes massively for both the middle class and for companies. We're trying to get it down anywhere from 15% to 20%."

Though the nominal corporate rate is 35%, many businesses pay less than that amount because of loopholes, tax credits, or other breaks that favor certain industries over others. Companies with extensive international operations also tend to have lower tax rates, as the U.S. corporate rate is one of the highest in the world. In fact, 20% of big companies don't even pay corporate taxes.

The biggest breaks tend to favor things such as research and development, accelerated depreciation for machinery and equipment, and domestic manufacturing. Restaurants don't receive any such tax benefits, and since only the biggest chains have significant operations overseas, many end up paying a tax rate of around 40% when state and local taxes are factored in.

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Chipotle Mexican Grill, Inc. (NYSE: CMG) offers a good example. The burrito chain has more than 2,000 restaurants, almost all of them inside the United States. Until its recent food-safety problems, the company was among the busiest and most profitable restaurant chains, especially considering all of its stores are company-owned.

In 2015, the company generated income of $769.9 million in income before taxes but paid $294.3 million of that amount to Uncle Sam, or a tax rate of 38.2%, roughly consistent with Chipotle's tax rate throughout its publicly traded history. If that tax rate were cut by 20 percentage points, as Trump is aiming for, Chipotle's net income would be 33% higher, about $150 million more.

That pattern follows at most other publicly traded restaurants. Here are the most recent effective tax rates at some other major restaurant chains.

Data source: YCharts.

As those numbers show, the whole industry would benefit from a significant cut in the corporate tax rate.

It gets complicated

As most Americans know, little in Washington moves quickly, and tax policy is an especially divisive and complicated issue. Republicans have long been itching for corporate tax reform, claiming that the current rates discourage American investment and are the reason for the many "inversions" in recent years, in which an American company merges with smaller one abroad to move its headquarters abroad and benefit from a lower tax rate.

However, many Republicans demand that the government's tax cuts be paired with spending cuts, complicating the issue. Former President Obama offered to cut the corporate tax rate to 28% during his administration, but Republicans rejected any potential compromise, saying it didn't go far enough.

Making things even more difficult was Trump's recent call for a 20% import tax on goods from Mexico. Mexico is the biggest exporter of fruits and vegetables to the U.S., making up about half of our imports of fresh produce. The costs of any import tax would likely be passed on to consumers, and some restaurants are more dependent on goods from Mexico than others. The country is the world's biggest producer of avocados, a crucial cost input at Chipotle and other Mexican restaurants. The burrito chain already complained recently that rising avocado costs have pinched profits, and a border tax would be likely to exacerbate that effect.

At this point, talk of tax reform and such tariffs is mostly speculation, but Republicans in Congress seem to be more amenable to cutting the corporate tax rate than they are to a border tax, which they fear could cause prices to rise and prompt a trade war.

One thing is clear, though. Restaurant stocks have much to gain from a potential corporate tax reform.

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