May 20th, 2011
Western Australia’s move to raise iron ore royalties has increased sovereign risk in the Australian resources sector on the back of the proposed mining and carbon taxes, and Fortescue Metals Group is the most exposed to the royalty hike, according to analysts.
While the WA government’s decision yesterday isn’t expected to have a major impact on the Pilbara’s two biggest iron ore producers, BHP Billiton and Rio Tinto, JPMorgan analysts said today the change “materially” affects pure-play WA iron ore producers.
In a blow to the federal government, WA yesterday outlined plans to lift the royalty on iron ore fines from 5.625 per cent to 6.5 per cent from July 1, 2012, and to 7.5 per cent a year later, to align it with other forms of iron ore, including lump.
Colin Barnett’s government expects the royalty hike to raise a gross amount of $2 billion for the state over the three years from July 2012, in response to its “rapid and massive” decline in GST share.
But under the federal government’s peace deal with the miners last year, Canberra will effectively fund the $2bn from its budget under the mineral resources rent tax, which would credit state government royalties against MRRT liabilities.
The MRRT, which is proposed to start next year, would also give relief to capex on projects, which would benefit miners like Fortescue, which is planning to spend $US8.4 billion (7.87bn) expanding Pilbara operations.
“This news highlights the increased sovereign risk in the Australian resources sector on the back of the MRRT itself and the proposed carbon tax, and this heightened risk could impact foreign investment,” said JP Morgan analyst Mark Busuttil.
Along with other analysts, Mr Busuttil said the increased state royalties would hit Fortescue the most and cut his target price from $8.30 per share to $7.30; however, Mr Busuttil kept it at a buy given Fortescue’s growth platform and expectations of continued strength in iron ore prices.
Other miners to be affected include Mount Gibson Iron and Atlas Iron, while Gindalbie Metals and Murchison Metals would be largely unscathed as they would sell a concentrate product, which attracts a 5 per cent royalty, said analysts.
Rio and BHP would also be largely unhurt given their diversified operations, with UBS analyst Glyn Lawcock expecting their present net value to fall by about 1 per cent from the royalties hike.
By early afternoon, Fortescue shares were down 0.62 per cent at $6.45 after having earlier slipped more than 1 per cent in a weaker broader market.
BHP was 1.6 per cent lower at $44.11, Rio gave up 1.3 per cent to $80.06, Mount Gibson was off 0.26 per cent at $1.95 and Atlas was 1.06 per cent down at $3.72.
“Fortescue is the most affected as it is the only miner in our coverage currently shipping all fines product,” said Mr Lawcock.
“Rio and BHP will bear most of the absolute cost of ($2bn) to be raised, but due to their diversified suite of businesses, the fact that they sell lump, the NPV impact on our estimates is very minor.”
Merrill Lynch analyst Peter O’Connor described WA’s hike as surprising, but “more of a concern for the federal government’s future budgets, as opposed to any real impact on the miners at this stage”.