One of the biggest risks that go along with investing in mining stocks is the risk that sovereign governments will change the rules midstream. More than a few mining projects in Africa and South America have been canceled or curtailed by governments suddenly changing the rules, typically by tearing up contracts demanding a larger slice of the pie. Historically, Australia has been seen as a very mining-friendly country, but a recent proposal to change tax rules in that country has sent some major ripples through the sector.
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As part of a comprehensive tax policy review, the Australian government has proposed a new "resource super profit tax" of 40% that would be levied on companies with on-shore mining assets in Australia. In short, this tax would increase the effective corporate tax rate for mining in Australia to about 57%. Another way to look at it is that basically makes the government of Australia a 40% partner in all resource projects starting in the summer of 2012.
Who Is At Risk?
The nature of the tax is such that it will impact the EBITDA line and, therefore, will disproportionately impact more profitable sectors of the mining industry. That is bad news for Rio Tinto (NYSE:RTP), as it has a lot of Australia-based assets and is heavily-weighted to high-margin resources like iron ore and metallurgical coal. For similar reasons, it will have an impact on diversified miner BHP Billiton and iron miner Fortescue (FSUMY.PK).
Who else is going to be at risk? American coal giant Peabody Energy (NYSE:BTU) has been planning to garner significant growth from mining coal in Australia, and could see a mid-teens impact from this new tax. Likewise (though smaller in impact) for companies like Cliffs Natural Resources, Alumina, and Alcoa (NYSE:AA).
It is also not just the base metal minerals who are at risk. This will also impact gold producers as well, including the likes of Barrick Gold (NYSE:ABX), Newmont (NYSE:NEM), Northgate Minerals, Newcrest Mining, and AngloGold Ashanti. The good news here, though, is that the impact appears to be significantly lower, and I would estimate a high-single digit impact to earnings post-tax.
This tax could also have a significant impact on the rare earth mining sector. These stocks tend to be much more volatile and thinly-traded, but the sector has gotten a lot of attention as China talks of curtailing and restricting rare earth exports. Companies like Lynas immediately come to mind (with its large potential asset base in Australia), though the fact that these companies are years from production and are allowed to recoup 40% of invested capital before paying the tax should blunt the impact. It is also worth noting that these companies (as well as Fortescue) could benefit from an exploration rebate that is part of the proposal.
There are certainly some companies that could benefit from this move. I do not believe that this new tax will cripple the Australian mining industry (which already pays 18% of Australia's taxes), and this proposal is not yet a law. But even if the proposal passes, there is a chance that marginal projects will be canceled and that non-Australian producers could benefit.
Companies like Freeport McMoran (NYSE:FCX), Teck Resources, Anglo American, and Vedanta are major mining companies with relatively less Australia exposure. Similarly, Brazilian giant Vale (Nasdaq:VALE) could certainly benefit from any shortfalls in Australian iron mining. Let us also not forget the host of small Canadian mining companies looking to develop rare earth metal projects across the country of Canada.
There is no doubt that this proposed tax changes the playing field for mining companies and their shareholders. By the same token, if you believe that China and India are going to show sustained growth (and appetite for metals), it is certainly not unthinkable that metal prices will continue to rise and investors can still profit despite these taxes. It is also important to emphasize that this is a tax proposal and the parliament of Australia could significantly change it before passage (assuming it is passed).
All in all, I can still see a solid rationale for investing in mining companies, but investors should probably reconsider their growth expectations for companies at risk of this tax and change their valuations accordingly. If the stocks still meet your margin of safety, so much the better. If not, maybe it is time to look for miners operating outside of Australia.
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