This market update is provided by the research team at Macquarie Equities and should be considered as general information only. If you would like to discuss your personal position and the implications please contact our office.
 The
Australian Federal Government has confirmed the resource industry's worst fears by
announcing its intention to implement a 40% Resources Super Profit Tax
(RSPT), commencing 2012/13. The Australian corporate tax rate will be
reduced to 28% (currently 30%) from 2014/15.
Impact
The lucky country?
Sitting here on a Sunday, we couldn't help but think how lucky we are
to be Australian. Firstly, we managed to negotiate the worst financial
crisis in a century relatively unscathed on the back of the economy's
leverage to a well run, world class mining industry and China's insatiable
appetite for the country's natural resources. Now, as the outlook for both
Australian and World growth looks to have turned the corner and the Government
aims to rebalance the books we can apparently apply a 'super profits
tax' to the same industry that saved the day in the knowledge that we'll
all be better off.... quite convenient, but what are the consequences of
such a game-changing shift in taxation policy?
Heightened perception of
political risk! First and foremost, eyebrows are
raised whenever the ground rules for investment are changed retrospectively,
wherever in the world that may be. In the past, we generally worried about
that type of risk in the developing world (think Chile, South Africa,
Mongolia etc...). The proposed move by the Australian Federal
Government definitively indicates that the concept of 'political risk' has
expanded to the developed world and there's no doubt in our mind
that such uncertainty will impact future capital flows - whether
that be related to a lower level of incentive for corporates to
reinvest in growth or the potential reduction in offshore investor
appetite.
Lower return on capital = reduced investment. With regards to the former,
initial analysis suggests returns will be reduced as a consequence of the
new tax, particularly as only a fraction of the 'capital shield'
associated with development can be applied in any one year (and
we've incorporated a sliding 60% rate). The strong position of the Australian industry generally means
that the miners rather than customers will be squeezed - that is, the
Australian players occupy the lower end of the cost curve in iron ore and
coal which ensures there will be limited potential for an associated
revenue offset.
With
that in mind, we once again remind investors that while the existing
Petroleum Resource Rent Tax (PRRT) is similarly structured, it is
relatively competitive when compared with other international petroleum
royalty regimes whereas the proposed RSPT looks to place
Australian mining investment at a clear disadvantage. That
said, it would be remiss of us not to suggest that the Australian move may
simply be a forerunner to similar moves worldwide.
Shareholders (including superannuants)
will pay as equities rebase. Interestingly, the
retrospective nature of the RSPT ensures the impact is most severe for
heavily depreciated, highly profitable incumbent assets (read iron
ore and coal). By way of example, our analysis suggests medium and
longer-term asset such as BHP Billiton's WA Iron Ore is
reduced by ~30% with an associated valuation hit of around 21%. Furthermore,
it's particularly important to remember that the valuation of many listed
vehicles (particularly at the larger end) is heavily skewed to those
incumbent assets rather than the next generation of growth which
means all shareholders will pay for the associated reduction in
equity value (and it will be interesting to compare any combined loss of
market value with the perceived savings attributable to the
Government).
...and ironically, the
Government looks to have assumed significant risk as well! Finally,
it's interesting to note that the Government appears to have agreed to
'cover' existing State based royalties. In effect, such a move
suggests the policy makers are 'banking' on the 'stronger for longer'
commodities thematic given the potential 'revenue' shortfall that may
arise should commodity markets fall over in the short to medium term.
Furthermore, our analysis actually indicates that the Government take
may actually fall in the early years of the Resources Super Tax given the
capital shield that many enjoy (and that's a clear focus for ongoing
analysis as it would appear to contradict the Federal message).
What happens from here?
As
part of the announcement the Government outlined the likely
implementation schedule. The first phase will be the formation of the
Resource Tax Consultation Panel followed by consultations on the
fundamental architecture of the RSPT and transitional arrangements for existing
projects throughout May and June 2010. The second phase is scheduled for
July 2010 and will expand on the Announcement Paper, seek submissions from
stakeholders and create the opportunity to provide comment on the policy design.
The third and final phase is anticipated to take place from late 2010, with
the outline of the detailed design of the RSPT, to July 1 2012 with
the finalisation of the legislative process and the commencement of
the RSPT.
INDUSTRY IMPACT
We highlight initial analysis for a selection of companies and the potential
earnings and valuation implications;
BHP - Outperform
recommendation retained, price target of A$50ps under review with likely
downside of ~10%. In a RSPT environment, our BHP's valuation falls
around 10% to 15% while earnings would be reduced by a similar ~10% to 15%
from 2015.
RIO - Outperform recommendation
retained, price target of A$94ps under review with likely downside of
~15%. Rio Tinto's valuation falls circa 15% to 20%, driven
primarily by its Australian iron ore and coal businesses. In spite
of this we are maintaining our outperform recommendation as Rio's valuation
still holds further upside as Rio's WACC increasingly needs to be
brought more in line with BHP's and additional iron ore price
increases have to be incorporated. Earnings implications are more
muted in the near term with ~15% to 20% impact post 2015.
FINAL WORD
As with any change to fiscal policy there will be winners and
losers and the Federal Government's proposal is no different. Firstly,
those companies operating outside of Australia immediately look relatively
better as they avoid the new impost and in some instances will actually
benefit from the proposed reduction in the corporate tax rate from 2014/15.
On the flipside, those companies solely operating in Australia will logically
suffer most. The diversified miners
sit somewhere in the middle (ie. BHP and RIO) as the value of their
Australian assets will be heavily weighed down by the new tax
although the blow will be somewhat softened by their Profit & Loss's
greater level of geographic diversity (in essence, ensuring that we
finally see some tangible benefit of diversity).
As with any legislation, significant uncertainty remains with
regards to both the legislative process and the finer detail. However,
from an equity investor's point of view, we've concluded that it's best to
assume that the Resources Super Tax will be enacted in its present form.
In that context, the relative impact for the equities that we cover
generally reinforces our equity recommendations already in place as
we believe recent lacklustre performance has reflected both the potential
for such an impost and concerns surrounding slowing economic activity in
China. | 
This time of year gets a little crazy in the run up to the end of financial year. With the 30th June being the final date to maximise tax deductions in this current financial year it it time to start planning to ensure you get a good taxation outcome.
