Material Matters: Oz Tax Review And A Short Term Correction

This story features OZ MINERALS LIMITED, and other companies. For more info SHARE ANALYSIS: OZL

By Chris Shaw

Speculation is growing in the media the Australian government will look to lift taxes on the mining sector as a result of the Henry Review of the national tax system.

As Citi points out, Australian miners already face some of the higher royalty and tax rates in the world. It estimates mining companies in this country pay a weighted average royalty of 5.2%, which trails only Russia at 5.5%.

The royalty rate is important as on Citi's numbers 7.7% of Australia's GDP is generated from the mining sector, which again is one of the highest rates in the world. Only Indonesia at 10.5% and South Africa at 8.7% have a higher proportion of growth generated by the mining sector.

Given the importance of mining to the Australian economy, Citi suggests any further increases to royalties and or taxes on Australian miners could curtain investment and so impact on the competitiveness of the Australian resource sector.

But the stockbroker takes the view the Henry review is not trying to add additional taxes to the mining companies, rather it is an attempt to simplify a confusing State-based royalty scheme and create a more standardised tax system.

There could still be some changes to tax rates in Citi's view, the most likely being some increases in those sectors where royalties are relatively low at present. Gold and copper are examples given current royalty rates of around 3.0%, compared to 6-8% for the coal sector. As well, Citi sees scope for an increase in royalty rates for the iron ore majors operating in Western Australia as these are relatively low at present.

In terms of any earnings impact on companies in the resources sector, Citi suggests it remains too early to make any clear estimates, but the companies most at risk of a high impact of up to 10% in its view are Oz Minerals ((OZL)) and Iluka ((ILU)).

Those that could see a medium impact on earnings, which Citi classes as a 2-5% impact, are Fortescue ((FMG)), Newcrest ((NCM)), Alumina Ltd ((AWC)), Energy Resources of Australia ((ERA)), BHP Billiton ((BHP)) and Rio Tinto ((RIO)).

Those likely to experience a low impact from any changes to Australia's tax system on miners, being a less than 2% change, are Lihir ((LGL)), Whitehaven ((WHC)), Centennial Coal ((CEY)) and Macarthur Coal ((MCC)). Citi expects no earnings impact on Aquarius ((AQP)), Equinox ((EQN)), PanAust ((PNA)), Platinum Australia ((PLA)), Riversdale ((RIV)) or Paladin ((PDN)).

Looking more broadly at commodity markets, Canada's BMO Capital Markets has adjusted its price forecasts for this year and beyond. For the industrial metals the changes reflect an improving price outlook given double-digit growth in China, aggressive restocking and a stronger than expected recovery in global industrial activity.

Additional drivers are concerns over the outlook for the US dollar, supply constraints in various metals and growing investor interest in the sector as a whole. Nickel is the major beneficiary as BMO's forecasts have increased by 18.5% this year and by 12.5% in 2011 to US$9.78 per pound and US$9.00 per pound respectively.

For copper BMO has lifted its forecast this year by 4.3% to US$3.44 per pound but its 2011 forecast is unchanged at US$3.70 per pound. Minor changes have been made to the group's lead and zinc forecasts, the former being reduced by 0.2% this year and the latter by 1.7% to US$1.00 per pound and US$1.08 per pound respectively. Forecasts for 2011 for lead are unchanged at US$1.00 per pound, while for zinc BMO's estimate has come down 8.3% to US$1.10 per pound. Aluminium forecasts are unchanged at US$0.96 per pound this year and US$1.00 per pound in 2011.

BMO has also adjusted its coal price forecasts, lifting its hard coking coal estimates by 10% this year and next to US$220 per tonne in both cases. For thermal coal BMO's forecasts have increased by 6.5% this year and 11.1% in 2011 to US$98 per tonne and US$100 per tonne respectively.

In terms of ranking the various commodities, BMO's order of preference has copper at the top, followed by metallurgical coal and silver. Iron ore and thermal coal are next on its list, these markets all seen as being supported by tighter market fundamentals and China's strong dependence on these commodities.

These are followed by gold, then zinc, nickel, molybdenum, uranium and aluminium (bottom of the list). For the industrial metals in general, BMO expects continued good long-term performance but cautions there could be a short-term correction as prices appears to have run a little ahead of fundamentals.

Longer-term BMO takes the view the current recovery phase in metal prices is quite young by historical standards and has at least another 12 months yet to run. This view is supported by strengthening demand from not only China, as other export economies are also delivering stronger results.

Assuming investors become convinced stronger commodity supply and demand fundamentals and therefore higher prices lie ahead, BMO expects there will be a further improvement in commodity-based equity valuations and earnings multiples. As the group points out, stocks on average tend to rally well ahead of a real economic recovery and any improvement in earnings.

With respect to preferred stocks to take advantage of its positive view on the outlook for commodity prices that are listed on the Australian market, BMO rates BHP Billiton, Rio Tinto and Equinox Minerals ((EQN)) as Outperform. BMO also rates the Canadian-listed Ivanhoe Mines as Outperform and Australian investors can gain some exposure to this via subsidiary, Ivanhoe Australia ((IVA)).

One metal not included in the BMO update was tin but here Standard bank suggests the market appears reasonably comfortable with current prices. While the price has run higher recently on the back of supply concerns and falling LME inventories, prices of 3-15 month spreads are trading in line with historical patterns.

In recent years China has emerged as the world's major tin producer and consumer, which has helped drive an upward shift in tin prices. Supporting prices now is Standard Bank's view the tin market will record a small deficit this year of around 2,000 tonnes, before this increases to a deficit of around 13,000 tonnes in 2011. This would be the largest deficit since 2004.

Given LME inventories are largely centred in Asian warehouses and European premiums are strong, Standard Bank bank expects tin prices will remain elevated for some time.

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