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Citi believes a Labor election win will favour BHP Billiton Limited (ASX:BHP)

Credit: Lucas Walters

Investors should prepare themselves for a new Labor federal government going by recent developments and that means the removal of franking credit cash refunds.

The upcoming by-election of Wentworth will give greater insight into the probability of a Shorten government, which Citigroup believes will favour BHP Billiton Limited (ASX: BHP) over Rio Tinto Limited (ASX: RIO).

These aren’t the only high-yield stocks that will be impacted by the change in franking rules – other income stocks with large franking balances like big banks Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC), as well as Telstra Corporation Ltd (ASX: TLS) will also be caught up in this change as shareholders won’t get any franking benefits above their tax obligation.

But Citi’s spotlight on the two mining giants comes at a time when there’s some debate among brokers about whether BHP or Rio Tinto is the better one to back for FY19.

This issue is also relevant to the discussion on these mining giants being more attractive to income investors than more traditional high-dividend paying sectors.

Some point out there are more near-term stock catalysts for BHP following its US$10.8 billion sale of its unconventional US oil and gas assets with most of the proceeds coming back to shareholders.

However, some analysts prefer Rio Tinto on valuation grounds as our largest iron ore producer is trading at around a 12% discount to BHP on consensus FY19 price-earnings (P/E).

Now Citi has pointed out another near-term catalyst for BHP’s share price. The Big Australian will likely have handed back the cash from the US asset sale to shareholders (likely through a share buyback, although one shouldn’t rule out a special dividend either) before the new policy comes into effect on July 1, 2019 – assuming Bill Shorten becomes our next prime minister.

Buybacks are popular, particularly with investors using an SMSF, because of the franking credits attached to the large dividend component of the buyback.

Citi said that this is therefore more a risk for Rio Tinto given its Australian earnings skew. Companies only accrue franking credits for distribution on their Australian earnings and Rio Tinto generates more profit here (through its massive Pilbara operations) than the more geographically diversified BHP.

However, the immense popularity of the past share buy-backs that have prompted a 70% plus scale back on shares tendered into the buy-back is something to consider.

As no one likes paying more tax than we have to.

Labor’s proposed franking change is aimed at recovering around $5 billion a year to government coffers. Those on a pension or receiving some disability payments from the government will be exempt, but it’s estimated that around 1 million taxpayers will be worse off.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, Rio Tinto Ltd., Telstra Limited, and Westpac Banking. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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