Income Report / Income Report; Loopy Labor, Portfolio moves & views (BHP, FMG, ALF, PPT, WPL, VCX, TLS, GMA, SUN, NCK, NAB, CBA)

By Market Matters 14 March 18

Income Report; Loopy Labor, Portfolio moves & views (BHP, FMG, ALF, PPT, WPL, VCX, TLS, GMA, SUN, NCK, NAB, CBA)

Market Matters Income Update 14th March 2018

The market has opened down again today with the ASX 200 off 46pts at time of writing, and this is testing our bullish bias in the short term. Today’s report will look at Shortens plan for Super along with our technical views across the MM Income Portfolio holdings, while we’ll also cover the new CBA Hybrid.

In terms of the MM Income Portfolio over the week,  the portfolio was up 0.17% – the best performer interestingly enough was Genworth (GMA). Since inception (5/7/17) the portfolio has gained 7.068% tracking above the market and above the portfolios benchmark. As always, to view all recent activity on both MM Portfolios - click here - or navigate to the recent activity screen on the website.   

Shortens Cash Grab – some insight

Yesterday  it was announced by Labor Leader Bill Shorten that if Labor wins the next federal election, they plan to stop taxpayers receiving a cash refund for excess dividend imputation credits.

Some background

Franking credits are attached to most Australian dividend payments. They avoid company profits being taxed twice, once by the company itself and then by the taxpayer who receives the dividend from the company’s profit. The franking credit reduces the tax owed by the taxpayer, or in some instances, causes a tax refund to occur (when the franking credit is more than the tax owed by the taxpayer).

Labor are proposing that when the franking credit generates a refund for the taxpayer, the cash refund is ignored.

Who will it affect?

Whilst it is being portrayed as a policy to remove the loopholes enjoyed by the so-called wealthy, unfortunately it doesn’t look that way. Labor suggests that it will affect 1.2m taxpayers and 200,000 SMSF’s, however this is likely to be too conservative and the numbers quoted in the release appear obsolete. Interestingly, it looks like the statistics that Labor are using are based on the 2014-15 financial year. In that year, it has been reported that the top 1% of SMSFs received an average cash refund of $83,000. What that doesn’t consider though are the most recent changes to large member balance SMSF’s. In short, from 1 July 2017, a member with a balance more than $1.6m is unable to have 100% of their fund in a tax free pension account. Instead, they are required to have a portion in accumulation phase being taxed at 15%.

The effect would be a dramatic change to the statistics underpinning Labors policy given the cash refund of these SMSF’s would reduce significantly.

Some examples

Before detailing examples, lets revisit the main reason underpinning the policy announcement; to increase government revenue by closing tax loopholes currently available to wealthy Australians.

Example 1

Bill has 2600 shares in Commonwealth Bank worth around $200,000.  Along with the pension this is Bill’s only source of income.  The income accrued from the pension added to the dividend income from his CBA shares creates his annual earnings – which are tax free. If we assume CBA will pay $4.00 in fully franked dividends this financial year, the total value of dividend plus franking equates to $5.71, of which $4.00 is paid throughout the year, and the $1.71 is recouped as a refund at tax time. Under the Shorten proposal, Bill is worse off by $1.71 per share, or $4,446 per annum.

Example 2

Pam is a self-funded retiree with $1.5m in her SMSF and is currently in pension phase. Her portfolio is a mixture of equities and fully franked hybrid securities with an overall portfolio yield of 5%, franked at 75%. Her annual income from the fund would be $75,000 plus franking. Given the fund is in a zero tax environment, at tax time she would claim back her franking credits which would equal $24,107 giving her a total income of ~$100,000. Under Shorten’s proposal, Pam is worse off by the value of the franking credits

Both examples 1 & 2 debunk the notion that this is a tax for the wealthy.

Example 3

Hamish has $5m in a SMSF, $2.5m in property that yield’s 4% and $2.5m in a share portfolio that yields 5%, franked at 75%. Let’s say he is not in retirement and currently pays tax at a rate of 15%. Given the fund pays tax, Hamish would still be able to offset that tax payable with the franking credits accrued, and therefore his situation is unlikely to have changed under this proposal.

Example 4

Alex is a high income earner working in the IT space. She has a salary of $500,000pa which places here in the top marginal tax bracket. Alex also owns shares which are fully franked, and each year the franking benefit helps to offset the amount of tax paid. Under this proposal, Alex’s situation will remain unchanged.

In short, someone with $5m SMSF might not be affected at all, whereas someone with $200,000 would be. That doesn’t sound like it is hitting the so-called wealthy.

Impact on Asset prices

Clearly fully franked shares and other securities such as Hybrids that have imbedded franking credits will be impacted if Labor are successful at the next election and the policy is implemented. Furthermore, the recent May 2017 budget released by Treasurer Scott Morrison was meant to reduce the pressure of housing affordability while it seems to proposed plan of Shorten’s may in fact add to it by reducing the appeal of fully franked shares for income, and improving the appeal of property which typically provides unfranked yields.

Please note; When it comes to the superannuation system, the calculations can become more tricky. Inside a SMSF an investor may have a mixture of different types of investments like cash, property, unfranked dividends and franked dividends. A SMSF might be tax free, might be taxed at 15% or might be a combination of both. You might be contributing into your SMSF and the contributions are being taxed at 15% or 30%. Therefore, whether the proposed changes have a material impact on a SMSF or not will depend upon an individual’s situation. It will affect pensioners considerably more than it would affect a taxpayer that is still working and contributing to their SMSF. Importantly, Charity funds are exempt from the change.

Each individual investor will be different and it’s important to seek individual advice that suits your circumstances.

Contribution by Ben Atkinson of Peer Wealth. Ben is a superannuation specialist. www.peerwealth.com.au 

In our view, tweaking the composition of franking is not all negative - it’s very clear that our current taxation system makes the domestic share market less appealing to overseas investors, simply because our imputation rules create distortions around the value of the same stream of earnings from an ASX-listed company. In short, franked dividends are more valuable to an Australian investor than to foreign investors and with about 30% of the ASX owned by foreigners, a change to the structure could feed a bigger appetite for 1. Offshore investors to focus more on Australia & 2. Australians to invest offshore, however the approach taken in this instance seems to be impacting those that it shouldn’t – an ill thought out and poorly articulated strategy in our view.  

Portfolio Moves & Views

This week we’ll look at our portfolio holdings from a technical perspective , outlining targets and / or areas that we’d become concerned and potentially exit a position. The Income Portfolio will be taking a 5% allocation in the CBA hybrid security listing early April under code CBAPG and at this stage, will be increasing the portfolio’s existing exposure to MCP (MXT), the listed mortgage fund by 2.5% to 7.5% at $2.00 per security which is lower than the available quantity under the 1 for 1.7 rights issue recently announced to the market. (by taking a full allocation our holding would increase to 8.5%). We would expect that a reasonably high proportion of existing holders may not take up all available rights and these rights will be placed in a shortfall bookbuild process which will be available to new investors before the 29th of March. Given our current cash levels (5%) and expected spend as outlined above, clearly we are looking to raise some cash by reducing / selling some existing holdings in the next few weeks.

Technical views on the portfolio

BHP - Looks ok after going ex-div. however we would be concerned if it was to fall to sub $27.90 i.e. we are not looking to average this position. Our BHP target is $32.50-33 assuming it can hold around current levels….seasonally strong in April, not so in March given the dividend.

FMG – We are a little 50-50 here but a close back above $5 would look very nice technically. Our target is only $5.70 assuming it can hold around current levels.

ALF – Obviously neutral ~$1 but we would be good to average on a spike down towards the 90c level considering it has a negative correlation to ASX200 targeting $1.15 on the upside. Director buying last week from Braitling is also positive.

PPT – Getting hit today and needs to hold the $49 region – if it does, our target is $58 for PPT.

WPL – A fresh low towards $28 looks a strong possibility. WPL is a potential buy down there looking for a short term rally, however our upside target has been reduced to ~$30.

VCX – We are not keen on sector but $2.40 looks like reasonable support while a break back above $2.55 would look excellent short-term. A break of $2.55 targets $2.80 area.

TLS – No change to our TLS view we have had for some time now, buy at $3.20 and sell $3.75-80.

GMA – We like it if can close over $2.40 this week, potentially squeeze to $3 or higher. Our ideal target is ~$3.40.

SUN – No change, like it targeting $15.50-$16.

NCK – Still looks reasonable targeting $8, however markets are long this stock which is always a slight worry.

NAB – looks good for an assault on $32.

CBA – should bounce to $78.50 minimum however our gut feel suggests it could head towards $80.

In terms of MXT and the hybrid investments, the technical picture for these are not relevant.

CBA Hybrid

The Westpac Hybrid which was issued at a trading margin of 3.20% over the bank bill rate listed today and is trading at ~$99. Without going into the modelling, a price of $98.80 equates to a trading margin of 3.40% over the bank bill rate, which is the price of CBA has issued their Hybrid at – so based on those numbers, the CBA will open at a slim premium to the $100 face value. While the WBC is a ‘slight’ disappointment, it would be our expectation that both securities will trade above par not long after listing.

Below is a look at currently listed financial hybrids. The black bar is the margin while the orange of the yield to call (grossed for franking)  

Source; Shaw and Partners

Conclusion (s)

The Labor announcement yesterday relating to franking credits seems ill conceived however it may not be a negative for many. Any selling in franked Hybrids may present an opportunity if they are held in the right hands.
We will take an allocation in the new CBA hybrid in this portfolio with a 5% weighting
We continue to look for opportunities to reduce equity exposure into strength

Have a great day

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Wednesday, or after the session when positions are traded.

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All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 14/03/2018, 11.00am, unless otherwise stated.

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