The increase in taxes may limit the investments of metallurgical companies

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Daniil Karimov, Otkritie Bank. 16 September 2021 17:10

The largest metallurgical and chemical companies held a meeting with First Deputy Prime Minister Andrei Belousov and Finance Minister Anton Siluanov on September 15, 2021. The purpose of the meeting was to discuss changes in the tax burden on companies in the conditions of high prices for raw materials assets.

Indeed, prices remain at high levels, even though a number of commodity assets have undergone a corrective decline. For example, the accumulated average value of copper quotations in the third quarter of 2021 is $9422 per ton, which is 50% higher than the average value for 2020. It is assumed that in 2021, mining companies will record a significant increase in their financial indicators, but in the medium term, after a negative price correction and an increase in expenses, the situation may change.

Already in 2022, companies, even without an increase in the tax burden, may face a decrease in EBITDA against the background of an increase in operating costs. The trend of growth in production costs is expected in general for the entire sector of the global mining industry. This may mean that the peak of operating profit will be reached in the 2nd half of 2021. The costs of electricity, photovoltaics, third-party services, costs tied to commodities prices, and other items may be higher in the following years. In addition, the additional costs associated with protection from COVID-19 are becoming the generally accepted norm of operating costs, leading to their growth.

Under these conditions, a change in the tax burden may significantly negatively affect the dynamics of investments in the next few years. In the mining industry, investments cannot react quickly to changes in the market environment, because the processes associated with new projects usually take a very long time at the stage of preliminary preparation, where capital investments are minimal. For example, on average, the launch of a new copper mining project in the world from the discovery of a deposit to reaching the design capacity can take 13 years. At the same time, significant investments in construction begin only from 5-6 years.

In particular, this may explain the absence of a sharp increase in capital expenditures this year. On average, observations show that investment growth is 2 years late from EBITDA growth. Therefore, the most noticeable amount of capital expenditures, as a result of the current favorable market conditions, could be expected in 2023-2024. At the same time, the reduction in potential EBITDA in 2022 will affect the companies ' investments in 2024-2025, despite the improvement in metal prices during this period.

To justify the relatively small increase in investment in Russia, it can be noted that the preservation of a restrained growth in capital expenditures is observed all over the world. Unlike the previous cycle of price growth in 2010-2012, the management of global mining companies decided not to strive for a rapid increase in capacity due to investments in questionable projects. Instead, companies are preparing new projects that demonstrate high profitability, as well as increasing exploration costs, while transmitting a favorable state of the market to investors through high dividends and buy-backs.

The management of Russian companies follows a similar path, realizing that high metal prices may be temporary. Therefore, high dividends and repurchases may be the optimal capital allocation strategy.

At the same time, similar trends are observed in other developing countries, where the mining sector is a significant source of budget revenues. The increase in taxes is being discussed in Latin America (Chile, Peru), Africa and the countries of Southeast Asia. As there, an unambiguous reaction to changes in tax policy is perceived in Russia as a deterioration of the investment climate. The additional costs caused by the increase in the mineral extraction tax may make new projects in the mining sector less profitable and attractive. As a result, this may lead to investments in foreign assets or to the postponement of the development dates previously planned.

Daniil Karimov, Managing Director of the metallurgy sector of the analytical department "Otkritie Research".

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