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The big question on investors’ lips is: how will Rudd’s 40 per cent tax (RSPT) on super mining profits impact commodity stocks this year?

This is the question we posed to a group of brokers to find out the impact of the tax on commodity stock recommendations.

According to Andrew Muir, mining analyst with Hartleys, the RSPT impact will vary markedly depending on whether a miner has major projects ahead for which their capital has not yet been committed.

According to RSPT methodology, if a company has capital on its balance sheet at the last date of audit, they qualify for the accelerated depreciated provisions of between 36 per cent in year one to 10 per cent in year four. Capital spent thereafter is only depreciated at normal tax rates, which are far less favourable.

According to Goldman Sachs JBWere, companies with long life, highly depreciated, high-margin mines will cop the biggest increase in tax liability. Conversely, companies with capital-intensive operations in an early phase of production, and especially those with high costs/lower margins, will be beneficiaries.

Goldman Sachs JBWere estimates that Fortescue Metal Group (FMG) will suffer a 33 percent hit on an EPS basis by 2018, affecting the valuation of the company by around 29 percent. Goldman also forecasts EPS hits on Rio Tinto and BHP in 2018 of 18 per cent and 14 per cent respectively.

Based on as yet inconclusive modelling, Muir expects the RSPT to reduce the valuation on Atlas – which has low CAPEX – by between 15 and 20 per cent. However even with the RSPT factored in, Muir still has Atlas trading on a 40 per cent discount to his 12-month price target of around $4.00.

But before you race out to buy Atlas shares note that based on Wilson HTM’s revised numbers Atlas – which was trading at a 23.8 per cent discount to its previous target price – is now trading above their revised target of $2.31. This highlights just how much uncertainty surrounds the potential impact of the RSPT and why so many investors are left scratching their heads.

Wilson HTM’s across-the-board valuations have been revised down by between 15 and 25 per cent on all stocks on the wrong side of the CAPEX equation. The notable exception is nickel miner Panoramic (PAN) which – based on modest exposures to the RSPT – has been upgraded to a Buy with a target price of $2.38.

According to Wilson HTM, the stocks hit hardest by the RSPT include Mount Gibson Iron (MGX), Atlas, Macarthur Coal (MCC), and Mineral Deposits (MDL). These stocks have been downgraded by the broker from a Buy to a Hold.

RBS Morgans analyst Roger Leaning expects the RSPT to impact the NPV of mining stocks by between 7 and 15 per cent. However, until there is greater clarity on myriad deductions and the all-important taxing-point, he says the impact of any RSPT remains uncertain.

Admittedly, the RSPT won’t itself impact commodity prices. But Leaning says it could have a major impact on where commodities, notably iron ore are sourced globally.

He says the punishment felt by share prices across the sector, especially from BHP and Rio Tinto – which fell by over 5 per cent and 7 per cent respectively following the RSPT announcement – reflects heightened sovereign risk now associated with investing in Australia’s mining assets.

He says the RSPT appears to penalise higher quality and more efficient mine producers which may acquire mines with marginal operations to offset their more profitable ones. “The RSPT could also open the door for China to be an alternative source of funding as investors look for opportunities beyond Australia.”

Despite being downgraded, Wilson HTM still sees Macarthur Coal providing good leverage to a recovering steel market through low volatile pulverized coal injection coal (LVPCI) coal demand. Assuming the merger with GCL proceeds, Wilson HTM have a revised target price of $14.58.

Even after downgrading its target price from $5.60 to $5.27 – Wilson HTM still believes that Centennial Coal (CEY) warrants a Buy at current levels. Based on robust demand for electrical power, Wilson HTM says Centennial is far less sensitive to economic conditions than metallurgical coal. “Centennial is continuing its program of stgeloping export load-out facilities at its western and central coast mines to facilitate an increased proportion of export sales and increased margins over the next 3-4 years,” says Wilson HTM.

With an upside to the target of 50 per cent (post RSPT modelling), one of Wilson HTM’s favoured base metal stocks offering good exposure to copper’s upside is Kagara (KZL). The broker likes Kagara’s ‘midpoint level’ cash costs on its exposure to copper and zinc concentrates – through its operating mines and concentrators in north Queensland – that currently offer good margins at existing commodity prices.

The immediate demand outlook for mineral sands and moderate to low zircon inventories also bodes well for Iluka Resources (ILU) – which experienced 80 per cent of its zircon sales in the December half-year as ordering resumed.

Based on certainty over near-term demand, cash flow and zircon price increases, Wilson HTM expects Iluka to outperform in the short term. With an upside to its target price ($5.24) of 17 per cent (post RSPT modelling) – the stock still looks significantly undervalued from a long term perspective.

Outlook for commodity prices

When you ask brokers for the standout commodities for 2010, iron ore, copper, zircon and coal appear high on the list.

One reason is that China imports over 60 per cent of its ziron and iron ore needs, and between 35 and 60 per cent of its nickel and refine copper. The other reason is that global demand for steel is accelerating worldwide – up 24.2 percent on February 2009 – and this is supporting higher mid to long-term prices.

Iron ore and coal

There is some uncertainty over iron ore and metallurgical coal prices once annually negotiated fixed contracts revert to quarterly based system later this year.

Goldman Sachs JBWere expects second quarter 2010 to mark the peak of iron ore’s price cycle (at US$170/t), with US$150/t forecast for calendar year 2011.

With the seaborne market for hard coking coal expected to remain structurally tight for at least the next two years, Goldman Sachs JBWere expects hard coking coal prices to average US$250/t through 2H10 and US$225/t for 2011 – 34 percent above its previous forecasts.

But if initial ‘reference prices’ – indicated by settlements with Japanese and Korean steel mills – are any proxy, Wilson HTM expects the next round of negotiations to deliver a tidy 87-90 percent upside to iron ore prices – with coking coal prices expected to jump by a corresponding 50 percent.

Copper

Goldman’s expects copper prices to climb from a projected average of US$3.52 in 2010 to an average US$3.75 in 2011.

The good news for the copper price is recovering global demand in the face of a depletion of inventories.

According to Hartley’s Muir, what makes the medium to long-term outlook for copper even more favourable is the limited potential of new mines coming on line any time soon.

Nickel

Some commodities look decidedly more exposed to correction having run hard over 2008-2009. According to Wilson’s, nickel is most in danger of a correction later this year.

 

Buy Recommendations – Post RSPT Modelling

COMPANY CODE SHARE PRICE TARGET PRICE SHARE PRICE DISCOUNT TO TARGET
Troy ResourcesTRY$2.48$4.4644%
Kagara LtdKZL$0.55$1.0950%
Red 5RED$0.13$0.2343%
Kingsgate  ConsolidatedKCN$8.40$11.9029%
Centennial CoalCEY$3.79$5.2728%
Independence GroupIGO$4.13$5.0418%
Iluka ResourcesILU$4.33$5.2417%
Panoramic ResourcesPAN$1.81$2.3824%

 Source: Wilson HTM

 

Downgraded From Buy To Hold – Post RSPT Modelling

 COMPANY CODE SHARE PRICE TARGET PRICE SHARE PRICE DISCOUNT TO TARGET
Atlas IronAGO$1.95$2.3116%
Mineral DepositsMDL$0.95$1.0812%
Macarthur CoalMCC$10.65$14.5827%
Mt Gibson IronMGX$1.35$2.0935%

 Source: Wilson HTM 

 

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