Xstrata Shifts Focus from M&A to Project Execution

We're paring our fair value estimate on expectations Australia's mining tax will be implemented as presently conceived

Daniel Rohr, CFA 14 July, 2010 | 1:23PM
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We are paring our fair value estimate for Xstrata to reflect our expectation that the Australian government's mineral resource rent tax will be implemented as presently conceived. The terms of the MRRT, as promulgated by the new Gillard government, are significantly less onerous than the resource super profits tax plan put forth by the Rudd government. We had not elected to reduce our fair value estimate at the time of the RSPT's announcement because of the significant doubts we had regarding Labor's ability to implement the relatively punitive tax programme. We have more confidence concerning the implementation prospects of the MRRT, since it appears to be the product of consultation between the new government and the big mining companies (Xstrata included). Therefore, we think it is prudent to include the MRRT's ramifications in our fair value estimate.

The MRRT is a much better deal for Xstrata on several counts. First, whereas the RSPT would have applied to all mining activities, the MRRT will apply only to iron ore and coal. So, while RSPT would have dinged Xstrata's Australian coal, copper, nickel, and zinc operations, under MRRT all but the first is spared. Second, the headline rate is significantly reduced. Whereas RSPT slapped a 40% tax on resource producers (in addition to the corporate income tax), MRRT applies a 30% tax, which is softened by a 25% extraction allowance, which, in the government's words, would "further shield from tax the important know-how and capital that mining companies bring to mineral extraction." Effectively, this shakes out to a 22.5% tax, which is deductible for corporate income tax purposes. Third, the MRRT allows companies to use the market value of assets when calculating depreciation for tax purposes, reducing the resulting liability for assets with below market book values. Fourth, for new projects, the MRRT allows capital expenditures to be deducted immediately, a significant tax shield for early-stage projects. All told, we estimate the impact on Xstrata's net worth at about $4.5 billion, a modest sum compared with the valuation consequences of the RSPT, which we estimated at $10 billion.

Fair Value Estimate: 1,400p ¦ Uncertainty Rating: Very High ¦ Economic Moat: None

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Daniel Rohr, CFA  is a senior equity analyst at Morningstar.