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Paul Rickard
+ About Paul Rickard

Paul Rickard has more than 25 years’ experience in financial services and banking, including 20 years with the Commonwealth Bank Group in senior leadership roles. Paul was the founding Managing Director and CEO of CommSec, and was named Australian ‘Stockbroker of the Year’ in 2005.

In 2012, Paul teamed up with Peter Switzer to launch the Switzer Super Report, a newsletter and website for the trustees of SMSFs. A regular commentator in the media, investment advisor and company director, he is also a Non-Executive Director of Tyro Payments Ltd and Property Exchange Australia Ltd.

Follow Paul on Twitter @PaulRickard17

Are the shorters getting bullish on retail?

Thursday, March 14, 2019

If you have been reading the mainstream press, retail looks like a disaster area. Retail turnover rose in January by a tiny 0.1% following a very ordinary Christmas; consumers are feeling the “inverse wealth” effect of tumbling home prices and delaying discretionary purchases; consumer confidence is on the ropes; the Amazon juggernaut is going to destroy local retailers; and high street shops stand empty as consumers move their buying online and landlords refuse to budge on rents.

Supporting these stories has been the recent collapse of high profile retailers, including Roger David, Toys R Us, Max Brenner and Laura Ashley.

But the share market is telling a slightly different story, particularly from those who stand to make money from the retail sector falling into a hole. These are the professional investors who “bet” against the fortunes of a company by selling the shares short. That is, they sell a company’s shares with the aim of buying them back at a lower price and making a profit.

According to the latest figures from ASIC, which publishes data every day on the number and value of short positions, these are falling when it comes to Australia’s major discretionary retailers. Leading retailer JB Hi-Fi has seen its short position close from 17.77% of the total shares outstanding 3 months’ ago to 13.15% today.

While this is still a big short position, the reduction by more than a quarter represents the net purchase of 5.3 million JB Hi-Fi shares – worth about $125m. And as the table below shows, positions in Myer have closed from 11.75% to 10.07%, while Harvey Norman has reduced to 8.69%.

Major retailers - % of shares short sold  

 

* ASIC short position reports for trade dates 7 March 19 and 7 March 18

Looking at the share prices, the major retailers have bounced hard. Harvey Norman is up almost 28% from its low in November 2018 of $2.99, JB Hi-Fi is up 16.7% from its low on 4 January, while Super Retail Group (which owns the Rebel Sports, BCF, Supercheap Auto and Macpac brands) is up 23% from its low on 14 January.

Harvey Norman (HVN) – 3/14 to 3/19

JB Hi-Fi (JBH) – 3/14 to 3/19

Super Retail Group (SUL) – 3/14 to 3/19

So, what’s behind the short covering and recent share price surge? No doubt part of the answer is that retail stocks got “too cheap” and moved into “value” territory, encouraging some of the short sellers to cash in on their profits. But there are also two other key factors.

Firstly, the realization that the “Amazon juggernaut” hasn’t made that much headway. While it is not quite stalled, it isn’t getting much traction with Australian consumers. Logistics is proving to be more challenging than expected, the range of goods is narrower and Australian retailers are fighting hard on-line with price.

Next, the half year profit reports weren’t too bad. JB Hi-Fi reported a profit for the December half of $160.1m, up 5.5% on the corresponding period in FY18. The company re-affirmed guidance for full year profit of $237m to $245m, up by 1.6% to 5.1% on the 2018 result. In its key Australian JB Hi-Fi retail business, it grew both comparable store sales and margin. The recently acquired Good Guys business, which had been struggling, showed a small re-bound in sales.

Harvey Norman also posted an improved profit result for the December half, up 7.3% to $222.7m, but removing some one-offs, the underlying profit result was flat. While there was some weakness with the Australian business (comparable store sales growth fell by 0.6% in the half, and for the first 7 weeks of 2019, was down 2.2% on the same period last year), the market liked the improved contribution from Harvey Norman’s offshore businesses. In fact, 25.4% of group profit now comes from Harvey Norman’s stores offshore, in New Zealand, Singapore, Malaysia, Ireland, Northern Ireland, Slovenia and Croatia.

More upside to come?

Retail stocks remain cheap, trading in the main on multiples of around 11.0 to 12.0 times forecast FY19 earnings (fast fashion jewellery chain Lovisa is an exception, trading on a multiple of almost 28 times). And yields are attractive, with Harvey Norman (according to FN Arena) forecast to yield 6.7% fully franked (based on a current share price of $3.84), and JB Hi-Fi 5.9% (current share price $23.36).

While the calling of the federal election will help, it is unlikely to prompt a big rebound in consumer confidence and translate into a lift in retail turnover. Amazon may not prove to be the threat that some expected, but the shift online will continue and in this environment, margins will remain under pressure. The negative macro factors aren’t going away in the short term.

Hence, I am approaching the sector using a “buy in weakness”/”buy in dips” style strategy. JB Hi-Fi, Australia’s premiere retailer, is my pick. The major broker analysts are marginally positive on the stock (3 buy, 3 neutral, 2 sell recommendations) and have a target price of $24.74. At lower prices, nearer to $3.00 than $4.00, Harvey Norman also has appeal. Being more exposed to the state of the Australian housing market, I view it as higher risk than JB Hi-Fi. The broker analysts  agree, with a target price of just $3.72 (below the current market price) and 2 buy, 2 hold and 2 sell recommendations. Myer is in another category all together- forget.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

These stocks could be winners under Bill Shorten!

Thursday, March 07, 2019

If the polls and the bookmakers are right, Bill Shorten will become Australia’s 31st Prime Minister and could be sworn in by the Governor General as early as Monday 20 May. Sportsbet is, for a $1 bet, paying $1.20 for an ALP win. It is paying $4.20 for a win by the Coalition.

After six years of Coalition government, an incoming ALP government is sure to throw out some existing policies, refresh the Government’s investment priorities and implement several new spending initiatives. Typically, higher taxing and higher spending than their Coalition counterparts, government monies will flow to the private sector and many companies will see their revenues go up.

While a lot has been written about who may “lose” under the election of an ALP Government, there hasn’t been as much discussion about potential “winners”, particularly companies listed on the ASX. Let’s look at this by considering the industries that may benefit from any government largesse.

1.     Healthcare

The opinion polls say that the ALP rates higher than the Coalition when it comes to the question of “who is most trusted to deliver improved health care services”, so it is not unreasonable to expect that an ALP government will spend more in this portfolio. While State Governments are key players, the bulk of services are delivered by the private sector.

Possible winners include Healius (ASX: HLS), formerly known as Primary Health Care, and Sonic Healthcare (SHL). Healius is involved in delivering GP services, pathology and imaging. While Sonic is more internationally focussed, 39% of revenue still comes from Australian pathology, imaging and clinical services. Both could benefit, if the ALP “unfreezes” the Medicare rebate or implements other initiatives to trigger patient demand.

Although short term “losers”, health insurance companies Medibank Private (ASX: MPL) and NIB Holdings (ASX: NHF) may prove to be long-term winners, if the ALP implements its pledge to cap the rise in health insurance premiums to no more than 2% pa. While no company welcomes price controls, it will give them increased negotiating power with the private hospital operators Ramsay (ASX:RHC) and Healthscope (ASX: HSO), as well as helping to address their long-term Achilles heel relating to the affordability of private health insurance.

2.     Energy

The ALP proposes to achieve 50% renewable energy by 2030 as a way to combat climate change. This means more support for the renewable energy industry and potentially government investment and/or incentives.

A clear winner could be Infigen Energy (ASX: IFN), Australia’s largest listed wind power generator by installed capacity. It has several wind and solar projects currently under development.

Less clear is the position of traditional big energy companies AGL (ASX: AGL) and Origin Energy (ASX:ORG). While both are investing in “clean energy” and related energy services, they have legacy wholesale coal/gas generating businesses and their behaviour as producers and retailers has come under fire from all sides of politics and the ACCC.

3.     Housing

The ALP says that it is going to can negative gearing, except where it relates to investment in new housing. Existing negative gearing arrangements will be “grandfathered”.

Although no date has been announced for the “commencement date” (the date it is canned from), most commentators agree that it will be a net negative for the property market. This may lead to an adjustment in rents (higher), and over the medium term, more investment in new housing. If this happens, major developers and builders, such as Stockland (ASX: SGP) and Mirvac (ASX: MGR) could benefit. Residential development accounts for approximately 35% and 15% respectively of their earnings.

The ALP also has policies promoting the development of affordable housing. Innovative companies that are able to respond to stimulus here could be big winners.

4.     Education

Like health, education is another key focus area for the ALP, which almost invariably means higher spending. Because services are essentially delivered by Government (government run schools and universities), the private sector is less involved.

Two listed companies involved in the tertiary sector (international students, online learning,  training etc) are Navitas (ASX:NVT) and IDP Education (ASX:IEL), although the latter is very focussed on Asia.

Short-term winners

And while the election period is usually bad for consumer facing firms, as consumers tend to defer major purchases, there are some short term winners. The TV companies, Nine Entertainment (ASX: NEC), Seven West Media (ASX: SWM) and Prime Media (PRT) will get a sugar hit from the political advertising. They will be offering a “special” thank you to Clive Palmer.

 

Shorten’s franking credit changes contribute to dividend bonanza for Rio!

Thursday, February 28, 2019

The announcement last night that Rio would return to shareholders a special dividend of US$4 billion caps off a remarkable company reporting season. While company profits and outlook statements have in the main been a touch disappointing, shareholders have been flooded with cash returns.

Increased ordinary dividends, special dividends, and share buybacks are the go as companies react to Bill Shorten’s proposed change to franking credits and generally favourable economic conditions. There is not a company board in Australia that isn’t looking at its franking credit balance and reviewing its capital needs to see whether it can increase short term returns to shareholders.

Franking credits are of no value to the company. Representing the tax the company has already paid, they are only valuable in the hands of shareholders. So with Bill Shorten looking like a shoo in come May, companies are acting before his 30 June deadline. This is why we have seen special dividends from BHP, Rio and Wesfarmers (amongst others), an “extraordinary” ordinary dividend from Woodside, and off-market share buybacks from Caltex and Woolworths. Next cab off the rank will be the three major banks (ANZ, NAB and Westpac) who will look at accelerating the payment of their interim dividend. These have typically been paid in early July, but watch for the dates to be moved to June or earlier.

All this money has to go somewhere and with the RBA now sounding “dovish” on the cash rate and some economists even predicting that the cash rate will be cut, income stocks are back in vogue. This is why the market has remained well supported above 6000, notwithstanding a fairly uninspiring company results season.

Back to Rio, it will pay a special dividend of US 243c per share or approximately A$3.39 per share. This is on top of a final dividend of US 180c per share (A$2.51), unchanged from 2017. The stock will trade ex-dividend on 7 March, with the dividend payment to be made on 18 April.

As good as it gets for Rio?

Rio’s underlying EBITDA for the full year of US$18.14bn was down US$0.44bn on 2017, a fall of 2.4%. This was a little short of broker forecasts. Improvements in the realised price of the commodities, a more favourable exchange rate and production increases added a combined US$1.4bn to earnings, while higher energy costs, raw material cost headwinds, inflation and other costs and one offs subtracted US$1.6bn from the result.

While cost pressures particularly impacted aluminium, Rio is struggling to make further  headway in reducing costs with its Pilbara iron ore. Cash costs were US$13.30 per tonne, down very marginally from US$13.40 in 2017.

Since the end of the commodity boom in 2014, the major miners have been very focussed on improving shareholder returns. They have strengthened their balance sheets by selling underperforming assets, repaid debt, been very disciplined about capital investment and focussed on increasing productivity and efficiency, thereby lowering per unit production costs.

But the news from this report (and competitor BHP’s report) is that it is getting harder and harder to lower per unit costs. In fact, both miners reported “negative” productivity improvements.

Rio’s balance sheet is in fine form with adjusted net debt (after paying the special dividend  and previously announced share buybacks) down to a proforma US$8.0b. This gives it a gearing ratio of less than 10%.

And while there is a development pipeline and a ramp-up of projects, with capital expenditure forecast to rise from US$5.4bn in FY18 to US$6.0bn in FY19,  earnings growth is going to be largely dependent on higher commodity prices. There aren’t further assets to sell, and productivity and production increases will be challenging.

Interestingly, Rio began its investor presentation with a couple of slides describing 100 tailings storage facilities they operate, and their assurance processes for managing tailings and water storage. The fallout from Vale’s Brazilian mine tragedy is ringing alarm bells with investors and analysts.

What do the brokers say?

Going into the result, the major brokers were moderately positive on Rio with 3 buy recommendations and 4 neutral recommendations. The consensus target price (according to FN Arena) was $89.94, 5.5% below Wednesday’s pre-result closing price on the ASX of $95.12.

Broker target prices for resource companies are hugely dependent on forecasts for commodity prices, so a small uplift or downgrade to their commodity outlook can have quite a big impact on the target price. The company doesn’t have to do anything. But the history of broker forecasts shows that in the main, they aren’t any better than anyone else at forecasting commodity prices, so the target price is only of limited use. This all said, I expect that the brokers will be a tad disappointed with the result and over the next few days, there will minor downgrades to target prices.

The bottom line

If commodity prices  continue to head higher, Rio’s share price will be well supported. The  run up in the iron ore price following competitor Vale’s dam collapse could have further to go. But in terms of what the company can control, I reckon that this is as close to “as good as it gets”. Too late to buy. Use rallies to reduce weighting..

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

Will a new era dawn for Coles?

Friday, February 22, 2019

“It’s time for a new era at Coles”. That was the promise made by Coles CEO Stephen Cain as he delivered an uninspiring first half profit result for Coles on Tuesday.

Using the following chart, he pointed to Coles success in lifting earnings by 125% between 2009 and 2016.  Investment in management, stores and brand drove sales growth (red line) and with it, earnings growth. Since 2016, earnings growth has been in decline, mainly due to intense industry competition, but also because Coles sales performance has been ordinary (red line for comparable store sales growth).

Cain wants to turn Coles around and drive sales growth.

He says he will do this through a “strategic refresh”, which includes a “fresh tomorrow” strategy for supermarkets, making life easier for customers, executing faster, efficiency programs to simplify the business and offset inflation, investment in automation and digital, and “winning together” sustainably with supplier and communities.

But the market didn’t buy this (which to be honest, could have been a strategy for almost any company), and Coles shares have fallen by 9% from $12.59 to $11.37 since the result was announced.

The market didn’t like that earnings continued to fall in the half, down by 5.8% to $733m. Adding to this was news that Coles was beaten in the sales war by competitor Woolworths, reporting same store sales growth in the December quarter of 1.5% compared to Woolworth’s 2.7%. While Coles can boast that it has delivered 45 consecutive quarters of comparable sales growth, the only quarter it has beaten Woolworths was the September quarter this year when Woolworths got badly caught up in the plastic bag fiasco and Coles ran its “little creatures” promotion.

In supermarkets, the EBIT margin (earnings as a percentage of gross sales) declined by 0.12% from 3.8% to 3.7% as expense headwinds grew. The cost of doing business rose by 0.27% to 20.4%. Demonstrating that Woolworths has the lead not just in sales but how it manages its business and supply chain, it reported an EBIT margin for Australian food of 4.7%, an increase of 0.08%.

On the back of an improved margin and product mix, Coles liquor division grew EBIT by 7.0% to $85m. An upside for Coles going forward will be the new alliance agreement with Viva Energy (who supply petrol to the Coles branded service stations and Coles Express). Coles will no longer have direct exposure to retail fuel price movements but rather receive a commission on fuel volumes achieved. Coles is positioning Express to be Australia’s leading convenience retailer.

What do the brokers say

The major brokers had been a touch bullish on Coles, seeing it as undervalued compared to rival Woolworths. Following the somewhat disappointing result, most cut their target price and lowered their earnings forecasts for FY19 and FY20. The consensus target price slipped to $11.92, a 4.9% premium to Wednesday’s closing price of $11.37. Ord Minnett downgraded its rating from “hold” to “lighten”.

The following table from FN Arena show individual recommendations and target prices, with the latter ranging from a high of $13.40 (Citi) to a low of $10.84 (Credit Suisse).

The brokers have Coles trading on a multiple of 19.4 times FY19 earnings and 17.4 times FY20 earnings. Coles won’t be paying its maiden dividend until September 19, which will cover the period after the Wesfarmers demerger from 28 November 18 to 30 June 19. It is targeting a payout ratio of 80-90%. For the next full year (FY 20), the brokers forecast total dividends of 55.6c which puts Coles on a forecast yield of 4.9%.

Bottom line

I haven’t bought the story that Coles is the classic demerger story and that set free of “big brother” Wesfarmers, Stephen Cain and his team will magically work wonders (see http://www.switzer.com.au/the-experts/paul-rickard/would-you-buy-or-sell-coles-right-now/) . And I also can’t see a “new era dawning for Coles”. This is a super competitive industry, and with the discount supermarket operators (Aldi, Costco and Kaufland) aggressively expanding, life is going to remain pretty tough for both Woolworths and Coles. Growing sales, margin and earnings will be challenging.

But every stock has its price and Coles, at the right price, offers investors a high dividend yield with a relatively high degree of earnings certainty. Not quite an annuity, but close.

Buy at $11.00. Sell around $13.00. 

 

Shorten screwing brokers is a big bank bonanza

Thursday, February 14, 2019

Australia’s 31st Prime Minister, Bill Shorten, is set to hand the big banks a fee and revenue bonanza. He says that an incoming ALP Government will implement in full all the 76 recommendations from the Royal Commission. This includes Commissioner Hayne’s ideas about the mortgage broking industry.

Hayne and his team of lawyers have made 5 recommendations about “intermediated home lending” or mortgage broking. The first, that the law should be amended such that mortgage brokers must act in the best interests of the intending borrower is sound and arguably, should already have been in place. Strengthening reporting about misconduct and regulating mortgage brokers under the same laws that govern the conduct of financial advisers also makes sense.

But the big recommendation, and the one that will make the big banks richer, is to eliminate all commissions. The consumer, not the lender, should pay the fee to the mortgage broker.

A user pays system, free of conflicts.

Hayne sees this fundamental change to the industry happening over two to three years, first by prohibiting lenders from paying trail commissions on new loans, and then prohibiting lenders from paying other commissions.

This has the major banks licking their lips because it will lead to the demise of the mortgage broking industry. With mortgage brokers out of the way, the major banks will save around $2,400 per loan in upfront commission and then the same again in ongoing trail commissions (on an average loan of $400,000, banks typically pay upfront commission of 0.60% and then a trail commission of 0.20% pa.) They will also increase market share, as mortgage brokers won’t be around to promote the loans of the pesky minor banks and smaller credit providers, who don’t have large branch or proprietary distribution networks.

Why will it lead to the demise of the mortgage broking industry? Simply, Australian consumers won’t pay directly for the service, or if they do, not enough to make it profitable to run a mortgage broking service.

All the evidence, be it in financial advice, superannuation, insurance, real estate, the travel industry etc. is that Australian consumers are very reluctant to pay directly for “intangible” services. That’s why so few Australians have a financial adviser, there are so many self-managed superannuation funds, insurance brokers are paid by the insurer, real estate agents are paid by the seller out of the sale proceeds and travel agents are paid by the airline or travel provider.

Australians are tight and don’t like paying. They certainly won’t want to fork out around $5,000 for a loan.

Hayne acknowledges this problem. Firstly, he suggests that the brokerage service fee could be capitalised in the loan amount and repaid by the consumer over the life of the loan. In other words, consumers would take out bigger loans so they could pay the mortgage broker.

And then his craziest idea – that banks charge an additional fee to consumers who deal with them directly. That’s right, another bank fee! An establishment fee by any other name, but only paid by borrowers dealing directly with the bank.

As I have indicated, it may be that to create a level playing field between banks and brokers, banks should be required to charge a fee to direct customers based on the costs that are incurred by the bank when there is no broker”.

He then goes on to suggest that the ACCC should be responsible for monitoring the fee.

For those with short memories, establishment fees were charged on most home loans up until a decade ago. As competition in the industry picked up, banks realised that  establishment fees were a big turn-off for consumers and eliminating them was an easy market differentiator that led to an immediate boost in share. A thing of the past, it has now turned the full circle with some banks paying customers an upfront bonus to take out a loan. A “negative” establishment fee. This experience is further testament to the fact that consumers don’t like paying

Commissioner Hayne’s recommendation is wrong, not theoretically, but practically. His  ideas to address this (capitalisation and an establishment fee) aren’t going to be welcomed by consumers. And the big banks won’t say too much because it is in their collective interests to see the mortgage broking industry suffer and dwindle.

Bill Shorten needs to pause and reflect very carefully on the Royal Commission’s recommendations. A well-regulated mortgage broking industry is important to competition and helping to ensure that the consumers gets a good deal. He doesn’t want to hand the big banks a revenue bonanza.

 

Would you buy or sell Coles right now?

Thursday, January 24, 2019

Last November, 530,915 Australians became shareholders in Coles (COL), making it one of the most widely held stocks. While this number has now reduced a tad with shareholders exiting small parcels, it still has one of Australia’s most inverted registers with more than 90% of shareholders owning less than 5,000 shares and the top 0.2% of shareholders owning 60% of the shares on issue.

This is typical of newly demerged companies, but Coles isn’t your typical demerger. Normally, they are the unloved “problem division” that the parent company doesn’t know what to do with, starves of capital, and keeps under a pretty tight leash. This is one of the theories offered to explain why demerged companies have historically outperformed over the medium term. Think S32 from BHP, Orora from Amcor, Pendal from Westpac, BlueScope (eventually) from BHP, Dulux from Orica and Treasury Wine Estates from Fosters.

“Big isn’t always better” and a refreshed management team removed from the bureaucracy and constraints of “head office” is set free to thrive.

But Coles isn’t in this category. It has had access to almost 60% of Wesfarmers capital and been part of a conglomerate that operates with a culture of a thin head office and very autonomous business divisions.

To find out what the upsides and downsides are for Coles investors, plus Paul Rickard's call for the stock, click here to take a free 21-day trial to the Switzer Report.

 

Shorten to slug our super even more

Thursday, January 17, 2019

Last week, I outlined how Bill Shorten’s proposed tax slugs would hit millions of Australians, (see http://www.switzer.com.au/the-experts/paul-rickard/shortens-6-big-tax-slugs-to-hit-aussie-middle-class/). These slugs are aimed at investors, self-funded retirees and those earning more than $180,000.

But there are also 5 proposed changes to super that will raise an estimated $19 billion over the next decade. Writing in The Weekend Australian, Treasurer Josh Frydenberg labelled these as a “desperate tax grab” and said that they would hit another million workers, including those Mums and Dads taking parental leave, individuals wanting to make voluntary contributions and tradies wanting to start their own business.

Here’s a look at the 5 changes, Frydenberg’s estimate of the number impacted, and my view to whether the change will make the system “fairer”.

1. Non-concessional contribution cap slashed to $75,000

Originally set at $150,000 12 years ago for the 2007/08 financial year, increased to $180,000 for 2014/15, reduced back to $100,000 for 2017/18 and 2018/19, the annual cap on non-concessional contributions is set to be cut back to just $75,000.

Non-concessional contributions are, of course, personal contributions to super from your own resources and are made from your “after tax” monies.

The cut in the cap will reduce the ability to make a large “one-off” contribution to super that may come from the proceeds of selling an asset, an inheritance, a termination payment or some other means. By using the ‘bring-forward’ rule, a person under 65 can make three years’ worth of non-concessional contributions in one year. This means that under current policy, a person can get $300,000 into super in one hit, while a couple can potentially contribute up to $600,000. Under the ALP, this will fall to $225,000 or $450,000 for a couple.

Frydenberg says that this change will hit about 20,000 taxpayers. While that’s a small number in the first year, the change continues the recent shift in thinking in Canberra, which is directed at narrowing the utility of super as a savings vehicle. “We want you to have some money in super…….but not too much”.

2. Abolish catch-up concessional contributions

Probably the dumbest of Shorten’s super slugs, he plans to abolish ‘catch-up’ concessional contributions. This will impact, according to the Treasurer, about 230,000 workers.

An initiative of the current Government, the ability to make ‘catch-up’ contributions only came into effect last July. It is designed to allow people with interrupted work patterns, such as a mother who goes on maternity leave, to make additional super contributions when they return to work and still receive the same tax concessions.

The unused portion of the annual concessional cap of $25,000 can be carried forward for up to five years. Concessional contributions are primarily your employer’s compulsory 9.5% plus salary sacrifice contributions. If you don’t make any concessional contributions for four years, you could potentially make a concessional contribution of up to $125,000 in the fifth year. Or if you made a concessional contribution of $5,000 in the first year, you could make a concessional contribution of $45,000 in the second year. 

Eligibility is restricted to those with a total superannuation balance under $500,000 (as at 30 June of the previous year).

Shorten says that he will announce policies that deal with some of the perceived inequities of the super system (such as the materially lower balances women have when they retire), but for some reason, ‘catch-up’ contributions doesn’t appear to pass the test. Hard not to think that this isn’t a case of the “not invented here” syndrome at work.

3. End deductibility of personal contributions within the concessional cap

Concessional contributions include your employer’s compulsory super guarantee contribution of 9.5%, salary sacrifice contributions and personal  contributions you make and claim a tax deduction for. They are capped at $25,000 in total.

Until recently, the third category was only available to “self-employed” persons who satisfied the “10% rule”, that is, they received less than 10% of their income in wages or salary (i.e. genuinely self-employed). Last year, the Government scrapped the 10% rule so that anyone who was eligible to contribute to super could claim a tax deduction for personal super contributions (within the overall concessional cap of $25,000). This was designed to assist, amongst others, employees whose employer didn’t offer salary sacrifice facilities.

Shorten says that an ALP Government will reverse the change and scrap the widespread deductibility of personal super contributions. (It is not clear whether this means the re-instatement of the 10% rule.) According to Frydenberg, this would also impact up to 800,000 workers who are working part-time at the same time as running a small business. Many are using the salary from their part-time job as the cash flow to make their business grow. He says that “the concession (tax deduction) specifically encourages the dual objective of entrepreneurship and savings for retirement, and helps strengthen the small business sector – the backbone of the economy”.

4. Higher income super tax lowered to $200,000

Persons on incomes from $200,000 to $250,000 will have their concessional super contributions taxed at 30% (rather than 15%). Known as Division 293 tax, a higher tax rate (effectively 30%) applies to concessional super contributions made by higher income earners. Originally introduced to apply to persons on incomes of $300,000 or more, the threshold was reduced last year to $250,000. Now, Shorten proposes to lower it to $200,000.

130,000 additional people will pay 30% tax on their super contributions. While they are not going to thank me, I am not against the change per se because they currently get the biggest tax concession on salary sacrifice contributions. The problem is that the highest marginal tax rate of 47% starts at too low a level of $180,000, meaning that this group (for equity reasons) needs to be drawn into the Division 293 tax net.

And if you are wondering why the threshold is $200,000 rather than $180,000, the income definition for Division 293 tax includes super contributions (which is approximately $180,000 plus the 9.5%).

5. SMSFs won’t be allowed to borrow  

David Murray’s Financial System Inquiry recommended that SMSFs be prohibited from borrowing to purchase investment assets such as property. The current Government chose not to adopt this recommendation.

Shorten’s Treasury Spokesman Chris Bowen has stated that an incoming ALP Government would adopt this recommendation and change the law to prohibit SMSFs from borrowing. Presumably, this will apply prospectively, with some form of grandfathering or transitional “wind-down” period applying to SMSFs with existing loans. If it doesn’t, then we will all be screaming.

 

Shorten’s 6 big tax slugs to hit Aussie middle class

Thursday, January 10, 2019

In a little over four months, Australians are set to elect Bill Shorten as their 31st Prime Minister. He will lead a left of centre, anti-business Government that will slug millions of Australians with higher taxes. Those impacted will include investors, self-funded retirees, small business entrepreneurs, professionals, managers and savers. While the “filthy rich” will also be hurt, the majority will be hard working, middle class Australians.

What can you do about it?

Well, apart from voting for the other side or the populists who sit on the Senate cross-bench, spread the word about the extent and impact of the changes. They are not “top of mind” issues with the general populace, so Shorten hasn’t been required to debate their consequences. The tax slugs will reduce the incentive to invest, save and work harder, lead to increased property rents and unfairly punish self-funded retirees and others who have played by the  rules. If they are going to hurt you, they will one day hurt your children or grandchildren.  

Spread the word. Here is a run-down on the six big tax slugs that Shorten is proposing.

1. Tax on capital gains to soar

Australia will have one of the highest effective tax rates on capital gains in the world  under Shorten’s plan to slash the discount from 50% to 25%.

Presently, an investor who holds an asset (such as shares, property, land, managed funds etc) for more than 12 months pays tax on 50% of any gain. This means that an individual who is paying tax at the highest marginal tax rate of 47% (45% plus 2% Medicare Levy) pays an effective tax rate on a gain of 23.5%. 

Under the Shorten plan, only 25% of the gain will be exempted, so that tax at the marginal rate will apply to 75% of the gain. For an investor paying tax at the highest rate of 47%, the effective tax rate will rise to 35.25%. And, with the top marginal tax rate set to rise by a further 2% to 49% (see below), the effective tax rate will be 36.75%.

The tax paid on a capital gain of $100 of $23.50 will increase to $36.75, an effective increase of 56.4%.

The only good news is that the lower discount rate won’t be applied retrospectively so that investments made before the effective date of the change  (“sometime after the election”) will be grandfathered. 

2. Negative Gearing

Negative gearing will be limited to “new housing”. The commencement date will be announced after the election, with investments made before this date grandfathered.

The change will also apply to other assets including shares which are purchased with the assistance of a margin loan, or an investment in a business using borrowed monies. While interest will still be deductible, it will only be deductible to the extent that the income and the allowable deductions are fully offset – you won’t be able to claim a ‘net’ investment loss.

Although grandfathering will help existing investors, all property owners could be impacted if investors withdraw from the market and house prices fall. Rents are expected to increase, as investors will require higher returns to compensate for the loss of the tax benefit.

3. Retiree tax

Shorten will stop the re-funding in cash of excess franking credits. Attached to share dividends paid by companies such as Telstra, Woolworths, BHP and the major banks, the franking credits act as a tax offset and if not used, are currently refunded in cash by the Australian Taxation Office.

The change will apply to dividends paid from 1 July 2019.

Known as the “retiree tax”, this change will impact hundreds of thousands of self-funded retirees who are drawing a pension from their SMSF. While the impact will vary, a typical example sees a self-funded retiree drawing a pension of $60,000 pa from their SMSF being around $10,000 pa worse off.

Other low rate or 0% taxpayers, such as a non-working spouse who owns shares, will also be impacted.

In his first backdown, Shorten announced that persons in receipt of a government benefit such as the aged pension, or an SMSF where one member was on a government benefit on 26 March 2018, will be exempted from the change.

4. Top tax rate rises to 49%

A legacy of the horror 2014 Abbott/Hockey budget, a temporary “budget repair levy” of 2% was applied to those on the highest marginal tax rate of 45%. The levy expired on 30 June 2017.

Shorten proposes to re-instate the levy by making a permanent increase of 2% to the top tax rate. Under Shorten, the top tax rate will increase to an effective 49% (47% plus 2% Medicare Levy). Taxpayers earning more than $180,000 pa will be impacted.

5. Super contributions cap slashed to $75,000

Two years ago, the cap on non-concessional contribution to super – those contributions using your own ‘after tax’ monies  – was reduced from $150,000 to $100,000 pa. Now, Shorten proposes to lower this again to just $75,000 pa. 

The cut in the cap will reduce the ability to make a large “one-off” contribution to super which may come from the proceeds of selling an asset, an inheritance, a termination payment or some other means. By using the ‘bring-forward’ rule, a person under 65 can make 3 years’ worth of non-concessional contributions in one year. Under current policy, a person can get $300,000 into super in one hit while a couple can potentially contribute up to $600,000. Under Shorten, this will fall to $225,000 or up to $450,000 for a couple.

Clearly, Shorten doesn’t see the super system as a place for savers or the “comfortably off” to invest their surplus funds.

Shorten has also announced that he will abolish ‘catch-up’ concessional contributions and end the deductibility of personal contributions within the concessional cap. The latter can be used by individuals whose employer doesn’t offer salary sacrifice facilities.

6. More to pay higher tax rate on super contributions

Known as Division 293 tax, a higher tax rate (effectively 30%) applies to concessional super contributions made by higher income earners. Originally introduced to apply to persons on incomes of $300,000 or more, the threshold was reduced last year to $250,000.

Shorten proposes to lower it to $200,000, meaning that persons on incomes from $200,000 to $250,000 will have their concessional super contributions taxed at 30% (rather than 15%).  

For savers and those planning to fund their own retirement (as opposed to the Government), another change that makes the super system less attractive.

 

Preparing for Prime Minister Bill Shorten

Thursday, January 03, 2019

It is now almost certain that Australia will go to the polls on Saturday 18 May 2019, the last possible day that a half Senate election can be held in conjunction with the House of Representatives. And if the outcome of the Victorian state election is any guide, the prospects of a change of Government and Bill Shorten becoming Australia’s 31st Prime Minister look increasingly likely.

On paper at least, some of the policies he has announced are troubling to investors and retirees. What are these policies, and what actions can you take now to prepare for this possibility of an ALP Government? Here is my assessment.

1. Capital gains tax discount

In the medium term, the halving of the capital gains tax discount for individuals from 50% to 25% could be the most significant change as this will apply to all investments – shares, property, managed funds, collectables etc.

Presently, an investor who holds an asset for more than 12 months pays tax on half the gain. This means that an individual who is paying tax at the highest marginal tax rate of 47% pays an effective tax rate on a gain of 23.5%.  

Under the ALP plan, only 25% of the gain will be exempted, so that tax at the marginal rate will apply to 75% of the gain. For an investor paying tax at the highest rate of 47%, the effective tax rate will rise to 35.25%.

The good news is that the ALP says that the change in tax rate won’t be applied retrospectively so that all investment made before the effective date of the change  (“sometime after the election”) will be fully grandfathered.

Super funds won’t be impacted, so that the current discount of one-third that applies to investments owned by a super fund (which effectively brings the tax rate down to 10% for an SMSF in accumulation phase) will be maintained.

No action required.

2. Negative Gearing

The ALP says that it “will limit negative gearing to new housing from a yet-to-be-determined date after the next election. All investments made before this date will not be affected by this change and will be fully grandfathered.”

The policy will also apply to other assets including shares which are purchased with the assistance of a margin loan, or an investment in a business using borrowed monies. While interest will still be deductible, it will only be deductible to the extent that the income and the allowable deductions are fully offset – you won’t be able to claim a ‘net’ investment loss.

In the residential property market, although grandfathering will protect investors with existing properties, the  impact on the market could be material if investors withdraw from the market. Offsetting this in the medium term could be an increase in rental returns.

If the property market comes under pressure, ASX companies involved in the industry could be impacted. This would include real estate listings and advertising groups REA Group (REA) and  Domain (DHG), real estate agent McGrath (MEA) and new home builders such as Mirvac (MGR) or Watpac (WTP).

No action required, but if you are considering investing in an existing rental property and negatively gearing, you may want to act before the change takes effect.

3. Franking credits

The ALP will stop the re-funding in cash of excess franking (imputation) credits. Persons in receipt of a government benefit such as a pension, or an SMSF where one member was on a government benefit on 26 March 2018, will be exempted.

The policy will apply from 1 July 2019, which means it will only affect future earnings and franked dividends that start flowing in the 19/20 financial year.

Importantly, the change will have no impact on taxpayers paying tax at a marginal tax rate of 30% or higher (above the company tax rate), very limited impact on most institutional investors, and no direct impact on foreign investors.

It will however impact low or zero rate taxpayers such as a SMSF in pension mode or a non-working spouse who owns shares, and some SMSFs/super funds in accumulation mode who have excess credits and presently receive a cash refund. If they don’t receive a cash refund, they aren’t directly impacted.

As a tax change, it will need to be legislated and pass through the Senate. The position of a “populist” Senate cross bench is unknown and could be interesting.

So, should you take any action now?

The major banks and “high yielders” such as Telstra and hybrid securities could be impacted if some of the “SMSF army” decide to reduce their holdings. The data says that they are on average overweight these stocks. Against this is the proposition is that the yield on these stocks will still be relatively attractive, notwithstanding the loss of the tax refund.

My sense is that some of the recent underperformance in the financials sector is due to concerns about the prospect of a Shorten government. Given the uncertainty around the legislation and that only part of the investor community is impacted, I am not convinced that we are going to see a further markdown on these stocks.

Listed investment companies (LICs) paying fully franked dividends could be more severely impacted, particularly if they are trading at a premium. This is because they have retail investor bases (very few, if any, institutional or foreign investors), a finite number of buyers and if trading at a premium to the LIC’s net tangible asset value, are arguably over-valued.

Consider selling LICs trading at a premium.   

4. Industry specific policies

Industries that are subject to regulation, or rely upon the Government for subsidies or spending, are always vulnerable to a change of government and a redirection of priorities or policies. This category includes healthcare, telecommunications, energy, education, aged care, financial services and media.

Healthcare is right up there, and one of the earlier announcements from the ALP was a proposal to cap the increase in health insurance premiums to 2% pa. There has been some commentary that this policy is under review as it could have unintended consequence on some of the smaller regional health funds. If the policy is implemented, potential losers would include Medibank (MBL) and NIB (NHF). Private hospital operators Ramsay Health Care (RHC) and Healthscope (HSO) could also feel the pressure if the insurers are being squeezed.

Sectors that could be positively impacted includer renewable energy, education and infrastructure, although the timing might be too far off for investors to capitalise on this opportunity.

In the short term, review exposures to sectors that could be negatively impacted, particularly companies in the hospital/insurance sector.

 

5 even “sexier” ways to boost super

Friday, December 28, 2018

Peter Switzer lamented the other day that “a problem for super is that it’s not sexy like property. Everyone wants to talk about property when we go out to dinner but who wants to spoil a good night out by uttering the word “super”?” (read the full article here).

Focusing on how women (and men) could boost their super balances, he outlined 6 key strategies:

1. Know what you’ve got — what’s the balance now?

2. Know what you want — set yourself a dollar goal and date it, like $1 million by age 65.

3. Get into the best fund — compare your fund against the best of breed and check out what you’re being charged.

4. Put extra in — either do it by salary sacrifice or slam extra in maybe by doing a second job or starting a part-time business. 

5. Do a budget — get your spending under control. 

6. Avoid dud partners — divorce is a wealth-killer!

I particularly like the “avoid dud partners” strategy. No doubt easier in hindsight, some  would also be reminded of the refrain from their parents of “I told you so”. But with more than 1 in 3 marriages ending in divorce, this is clearly a big wealth-killer.

Now let’s focus on the “putting extra in”, particularly in relation to your partner, and 5 even “sexier” ways to boost their super.

1. Get a tax offset for topping up your partner’s super

This could make you popular.

While it has been around for decades, the Government has recently increased the income test threshold to make this more accessible. Known as the Spouse Tax Offset, if you contribute $3,000 to your partner’s super, you can claim a personal tax offset of 18% of the contribution, up to a maximum of $540.

Your partner needs to earn less than $37,000 for you to get the full tax offset, and the tax offset phases out completely if he/she earns more than $40,000. For calculation purposes, your maximum rebatable contribution of $3,000 is reduced on a $ for $ basis for each $ of income that your spouse earns over $37,000. The offset is then 18% of the lesser of the actual super contribution or the reduced maximum rebatable contribution.

Your spouse’s income includes their assessable income, fringe benefits and any reportable employer super contributions such as salary sacrifice. And to cover the rest of the fine print,  you cannot claim the offset if your spouse exceeded their non-concessional cap of $100,000 or their total super balance was more than $1.6 million. Your spouse must be under 70, or if aged between 65 and 69, meet the work test.  

2. Split contributions with your partner

This could make you even more popular.

You can split your concessional contributions with your spouse, which means that  contributions such as the 9.5% your employer pays or salary sacrifice contributions are “transferred” to  your spouse. You make the election to split after the completion of the financial year.

While “splitting” won’t increase the amount you and your partner have in super, it can be a good idea if the balances are uneven or if you are getting close to the total super balance cap of $1,6000,000. Also, looking to the future and Governments’ propensity to change the super system, restrictions based on account balance can’t be ruled out 

The amount you can split is up to 85% of your concessional contributions (this is the amount left over after the super fund pays tax at 15% on the contributions), and as concessional contributions are capped at $25,000, a maximum of $21,250.

In regards to the fine print, your spouse must be under 65, or if over the preservation age and under 65, not retired. You make the application to split to your super fund in the following financial year (so you can apply now to split contributions made in 17/18).

3. Get the Government to make a co-contribution

There aren’t too many free handouts from Government, but the government super co-contribution remains one of the few still available. A legacy from John Howard’s era, if eligible, the Government will contribute up to $500 if a personal (non-concessional) super contribution of $1,000 is made.

The Government matches a personal contribution on a 50% basis. This means that for each dollar of personal contribution made, the Government makes a co-contribution of $0.50, up to an overall maximum contribution by the Government of $500.

To be eligible, there are 3 tests. Your taxable income must be under $37,697 (it starts to phase out from this level, cutting out completely at $52,697), you must be under 71 at the end of the financial year, and critically, at least 10% of your income must be earned from an employment source. Also, you can’t have exceeded the non-concessional contributions cap of $100,000 or have a total super balance over $1.6 million. 

While you may not qualify for the co-contribution, your partner might and can be a great way to boost their super. If they qualify and don’t have the cash, give them the money to make a  contribution. 

4. Help your partner claim a tax deduction

Many people use salary sacrifice to make additional contributions to super from pre-tax monies. However, not all employers offer this facility and many of us are self-employed.

An important change last year to the super system was the abolition of the ‘10%’ rule. This rule allowed the self-employed (which were defined as those who received less than 10% of their income in wages or salary) to claim a tax deduction for personal contributions to super (up to the concessional cap of $25,000). Now, everyone who is eligible to make super contributions can potentially claim this tax deduction. 

So, if you (or your partner’s employer) doesn’t offer salary sacrifice, you (or your spouse) could make an additional contribution to super and claim a tax deduction. You aren’t allowed to exceed the concessional contributions cap of $25,000, which also includes the employer’s 9.5%.  

Let’s take an example. Fiona is 45 and earns a gross salary of $100,000. Her employer contributes $9,500 to super, but doesn’t offer a salary sacrifice facility. Prior to 30 June, Fiona contributes a further $15,500 to super and claims this amount as a tax deduction. She does this when she completes her 18/19 tax return.

Fiona will also need to notify her super fund that she is claiming a tax deduction, which she is required to do before she lodges her tax return for the 18/19 year.

5. Can your partner make “catch up” contributions?  

Announced back in the 2017 Federal Budget, the ability to carry forward unused concessional contributions and make “catch up” contributions commenced from 1 July. This may suit someone with a low superannuation balance who leaves the workforce for a period of time (such as maternity leave), or who for other reasons is unable to utilise their full concessional cap. 

The unused portion of the concessional cap of $25,000 per annum can be carried forward for up to 5 years. This means that if you didn’t make any concessional contributions for four years, you could potentially make a concessional contribution of up to $125,000 in the fifth year. Or if you made a concessional contribution of $5,000 in the first year, you could make a concessional contribution of $45,000 in the second year.  

To be eligible, your total superannuation balance must be under $500,000 as at 30 June of the previous year.

Contributions are measured over a rolling five- year period and unused portions expire if not used. As the scheme only started this year, the first year that you can access it to make a higher concessional contribution is next financial year (2019/2020) and the carry forward will only relate to 2018/19. 

 

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