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Dividend Investing in the Land Down Under

By Roger Conrad on September 16, 2011

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Investors’ need for yield, robust energy spending and the growing wealth of emerging economies: Those three trends transcend the current turmoil in the stock market. Betting on them is likely to be critical to investing success for years to come.

High-quality Australian stocks tap into all three. First, there’s a tradition of paying out a high percentage of earnings as dividends to stockholders. The country’s biggest telecommunications company, for example, boasts a yield of nearly 10 percent.

Second, Australia along with Canada, South Africa, the US and Russia is one of the world’s true resource storehouses. The country produces a fair chunk of the world’s key industrial metals, including bauxite (aluminum ore), copper, iron ore, lead, nickel and zinc, as well as platinum group metals (PGMs). It also produces gold and sizeable quantities of precious stones, such as diamonds. And it’s a major player in global agriculture as well.

Australia also has huge reserves of energy, including thermal coal, metallurgical coal (used in making steel), oil, natural gas and rich hydroelectric potential. In 2009, Australia exported a little less than 10 percent of the world’s liquefied natural gas (LNG), a total value of $7.71 billion. That market share is on track to reach 30 percent in the next couple years, as major projects such as Gorgon start to ramp up.

Some $214 billion in projects are already under way and tens of billions more are likely to be spent over the next decade–with an estimated “stranded reserves” of 140 trillion cubic feet in Australian waters a primary target.

Third, Australia is on the doorstep of Asia, which is rapidly becoming the world’s biggest import market for a wide range of natural resources. Geographic proximity means less expense to transport to markets. And Australian expertise is in heavy demand as well. Iron ore and metallurgical coal–both key elements in making steel–have been in particularly high demand in China and increasingly from India.

Chinese demand for LNG, meanwhile, is on track to skyrocket, as the country’s gas usage rises from the level of Germany’s (2010) to that of the entire European Union by 2035. The Gorgon field already has contracts from China and India totaling $64 billion, even with actual production not scheduled until 2014.

Resource wealth and Asian demand for it kept Australia high and dry during the 2008 debacle. The country’s stock market gave up some ground. But its economy was the only major that did not slip into a recession.

It would be even better prepared for a still unlikely reprise of 2008. Today’s debt burden is less than 7 percent of gross domestic product (GDP). That compares to more than 70 percent for the US and nearly 130 percent for Japan. And its banks are strong, with limited exposure to European sovereign debt woes and the pole position for investing in high-growth, high-savings Asia.

Over the past 110 years, Australia’s stock market outperformed the world. The big numbers above don’t guarantee a repeat performance. Neither does being tapped into the three transcendent trends of investor demand for income, rising spending on energy and Asia’s emergence. But they do make the land “down under” one of the best bets for big investment returns in late 2011.

Better, stocks of solid Australian companies are cheaper than they’ve been in quite a while. Ironically, that’s in large part due to fears that we’ll see a new global recession that will slow Asian demand for the country’s resources, despite the fact that this did not occur in 2008-09.

Australian stocks hold one other key advantage for investors: a strong currency. The Aussie dollar has a close correlation to prices of oil and other natural resources. It’s also allowed to fluctuate against the US dollar more than the Canadian dollar is, as Australia depends far less on US trade.

That should add up to considerable upside against the greenback in coming years, as prices of energy and other commodities rise. US investors will benefit from both share price appreciation and higher dividends, as the US dollar value of what’s paid in Aussie dollars rises.

As for risks investing in Australia, the chief one is that Asian growth comes unglued. In fact, overblown worries about a slowdown in what are currently the world’s most vibrant economies are likely to keep Australian stocks volatile in coming months, or at least until fears of a global recession subside.

With such a slowdown already priced in, however, the risks of further downside if one does occur are slight. And if the world does muddle through, things are likely to turn higher in a hurry.

The country has a longstanding reputation of encouraging foreign investment, particularly in the all-important natural resource sector. Occasionally, however, governments come to power that want a larger piece of the profits.

The Labor Party government’s loss of its majority in parliament last year halted momentum for a massive “resources super profits tax” on major resource producers. But as is the case in many English-speaking countries, there’s a strong strain of populism that’s always a threat to tread on the rights of shareholders, with foreigners prime targets.

Temptation to impose a new super tax just might become too much to resist, should resource prices remain robust and the rest of the Australian economy weaken. That, in turn, could slow the country’s economy, even if Asia demand for output remains robust.

The good news is that it was voter anger that has largely tabled the resource tax, as Australians worried about the effect on investment and jobs. The tax still has its advocates, but that’s a very pro-business sentiment–and should be quite encouraging to investors.

Lastly, there’s the fact that for most of the broker universe, Australia is largely an undiscovered country. Information on New York Stock Exchange-listed companies such as BHP Billiton (ASX: BHP, NYSE: BHP) is relatively easy to come by. But stocks that trade only over-the-counter (OTC) in the US will take more effort. As for commissions and fees, more than a few investors will be in for a shock if they try to use their regular brokers to buy Australian stocks.

Fortunately, employing a little research to find the right brokers will easily surmount all of these problems. Wise selection can avoid most regulatory and political risk. And even the 15 percent dividend withholding tax–a standard for investing in most countries–can be recovered by filing a Form 1116 with your US taxes.

In short, if investors are willing to think a little outside the mainstream, they can reap all the benefits of holding solid, high-yielding Australian stocks and avoid the pitfalls. And to that end, my frequent collaborator David Dittman and I are launching a new, complimentary weekly service, Down Under Digest.

Down Under Digest is free to all Utility & Income readers. Click here to sign up to receive weekly issues.

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