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View ‘Six stocks SMSFs will love and cherish’ – Financial Review PDF
Transcript:
Six Stocks SMSFs Will Love and Cherish
By James Frost
9th July, 2014: Financial Review
What a ride it’s been for the Self Managed Super Fund crowd. Over the past 10 years they’ve gone from passing fad to macro-economic factor du jour.
With everyone from top tier regulators to bulge bracket investment banks treading carefully around SMSFs, it’s no surprise that equity market strategies are emerging based on their preferences.
The latest of these comes from Elston Portfolios Chief Executive, Andrew McKie. Elston is one of the largest operators of individually managed accounts and manages close to $1 billion for SMSFs and retail investors.
With the corporate tax rate set to fall from 30 per cent to 28.5 per cent, strategists such as Elston have speculated about the impact of the changes, which will reduce the amount of franking credits that can be distributed.
Ian Kearney, a Director at accountant and tax specialist Moore Stephens, wrote in a note to clients that for companies that have the flexibility, it may be appropriate “for the timing of the dividends to be potentially accelerated.”
McKie has gone a step further, naming six stocks he believes have the capacity to return capital to income-hungry SMSFs ahead of the change including Rio Tinto, BHP, Woolworths, Harvey Norman, Caltex and JB Hi-Fi.
“There hasn’t been a lot of structured buyback activity and we think that will change,” he said. “The trigger event will be the corporate tax cut.”
His three-step screening process involves calculating the total number of franking credits relative to market capitalisation, evaluating its capability to make additional payments and, finally, factoring in the cost of capital.
The impact of the reduction in the corporate tax rate on dividends has been well documented with some forecasting a $5 billion hit to investor income from July 1, 2015.
McKie says that franking credits will take an immediate hit and that companies should be seeking ways to distribute surplus franking credits to shareholders this tax year, either by special dividends or structured buybacks.
“While some companies simply will not be in a financial position to do this, those that are should,” he said.
After the announcement of Woodside’s plans for a $2.7 million buyback of shares from Shell, investors have zeroed in on mining giants such as BHP and Rio Tinto, awaiting their next move.
BHP is an obvious candidate. Capital management has been placed on the agenda by Chief Executive Andrew McKenzie, with news expected at its full year results in August. BHP also has buyback experience, completing a $10 billion program in 2011 that was well received by investors who were able to make the most of the tax benefit.
However, McKie believes that it is BHP’s longtime rival, Rio Tinto, that is in a better position, citing its free cash flows, recent asset sales, modest level of gearing and low coast of debt.
What’s more, Rio Tinto had a franking balance of $14.3 billion or about 13 of their market capitalisation of $112 billion, according to its most recent accounts.
“Rio is our top pick as a candidate for a structured buyback or special dividend this year,” he said. “All the franking credit stars are aligning for Rio shareholders this year.”
The other ASX 50 candidate, Woolworths, also has form with regard to returning capital to investors in tax-effective methods, completing a $700 million buyback in 2010.
Rounding out the top six candidates are three stocks outside the ASX 50, with Harvey Norman, Caltex and JB Hi-Fi leading the charge.
Harvey Norman, in particular, has the balance sheet capacity and “a huge wedge of franking credits relative to market cap,” McKie said.
