The MP that can take Billions out of Suzano’s Cash Generation
An MP released by the Bolsonaro government at the end of 2022 has the potential to significantly reduce cash generation and profits for investee companies – including giants such as Suzano and WEG. MP 1152, published December 29, discusses so-called “transfer pricing” – the sale value companies use to export their goods to subsidiaries in other countries.
The provisional measure stipulates that these prices must be equal to the prices of similar transactions carried out with unrelated parties, which equates Brazil with the rules of OECD countries. If approved, the MP would end a practice widely adopted by exporting companies. Some of these companies – including Vale, Suzano and WEG – have set up subsidiaries in countries such as Switzerland and Austria as part of tax planning, that is, to pay less tax.
Basically, they practically sell their products at cost to these affiliates and then export the products from there to real buyers. In this way, the profit is credited to the subsidiary, where the tax is lower. Susanoo, for example, has a subsidiary in Austria, where it sells its pulp at cost plus a 15% commission. Since it has a margin of around 50%, all of the remaining revenue you accrue is in that affiliate. To be clear, imagine that Suzano sells his paper pulp to China for R$100 and his cost price is R$50.
It will sell this product for R$57 (cost price plus 15%) to its subsidiary in Austria and export the product from there. Exporting companies have been adopting these practices for years – and they have sparked controversy in the past. Vale, for example, introduced Refis years ago to pay for the revenue generated by the practice. Since then, the miner has adapted its practices and today sells its ore to its subsidiary in Switzerland with a discount of only 5% compared to the full price it sells to other buyers.
Vale still benefits, but much less, in relative terms, than Suzano, which continues to sell at cost plus 15%, which allowed it to pay no tax for years. In practice, countries like Switzerland and Austria levy a tax of around 20% on profits. “On paper, it’s as if they had already paid 20% there, which means that in Brazil they only have to pay 14%, in order not to suffer double taxation”, explains a lawyer. “But in practice, many companies don’t pay that 20%, either because they bought an operation with a tax loss there and use those losses, or because there are too many incentives in the region.”
In Brazil, Suzano also enjoys several tax benefits – including the Sudam and Sudene territorial incentives, and the stock interest incentive – which means she doesn’t even pay 14% in Brazil. MP 1152 was published by the Bolsonaro government, but has not yet been voted on by the Chamber of Deputies or the Senate. And since it has not yet been passed by Congress, the new government can demand the deputy’s return without even analyzing it.
But Economy Minister Fernando Haddad has already indicated that he wants to endorse the MP, as it would have positive financial effects for the country, according to Arko’s advice. The government has also said it wants to streamline MP regulations to ensure the rules are effectively in place from 2024. According to Principal’s calculations, if the new rules come into force next year, it will cause a cash outflow for Susanoo of 2 billion reais to 3 billion reais per year. “The impact is bigger for Susanoo because nearly 100% of its revenue comes from exports, but WEG will also have a negative impact of around 15% on the bottom line,” he said.
Today, WEG operates much the same as Suzano, but with a subsidiary in Switzerland. The impact will be less for them because they make a good part of their sales on the Brazilian market. The impact on the share price will be favorable for both. Especially because everyone at WEG is watching the P/E. “If earnings go down, there will be a price revision,” he said. A source close to Susanoo told the Brasil Journal that the impact should not be as big as analysts expected.
“They can look for other forms of tax improvement, which partially offset that,” he said. The Itaú BBA published a report attempting to measure the effects of this change on Suzano. However, the bank said it was already working on its models with a 25% income tax for Susanoo from 2024.
“Each percentage point increase in Susanoo’s effective tax (compared to our scenario e basis of 25%) will have a negative impact on the net present value (NPV) of R$1.36 billion (or R$1 per share), the analysts wrote. In the worst case, with a tax reaching 34%, the negative impact on the net present value would be R$12.2 billion (or 20% of the company’s market capitalization).
However, one executive said much of the market isn’t charging a 25% tax on the model as early as 2024. “All the purchases I make don’t,” he said. “Forever, obviously you can’t put that tax close to zero forever, but in the short term nobody will.” Shares of Susanoo fell 1.2% today. WEG is down 1.6%.