It’s good to own assets that other investors covet. That’s what makes the buy-low-sell-high/greater-fool-theory cycle spin.

But there’s a smart way to go about the process that will help you build wealth for the long term, and that’s to focus on high-quality businesses with identifiable, easily understood revenue, earnings and cash flow that pay sustainable and growing dividends.

That’s the No. 1 principle of our investing philosophy. We employ a data-driven Safety Rating System that takes account of capital management, debt and dividend-paying history to support this philosophy.

Sometimes it’s all aces. Sometimes it’s tough all over.

During 2013, for example, a sudden and steep pullback in the Australian resource boom and Reserve Bank of Australia rate-cutting coupled with accelerating US growth and the rollback of extraordinary monetary policy by the Federal Reserve shook the foundation of the Australian dollar’s recent record strength, eroding total returns for US investors who are long Australian equities.

More specifically, we had a nice takeover-premium gain in GrainCorp Ltd (ASX: GNC, OTC: GRCLF), a charter member of the AE Portfolio, wiped out by a rash decision driven by short-term political considerations.

US-based global agribusiness giant Archer Daniels Midland Co (NYSE: ADM) wanted GrainCorp for its position as the largest grain handler on Australia’s east coast as well as the opportunity it represented vis-à-vis emerging Asian markets such as China.

Unfortunate as it seems in the short run, Australian Treasurer Joe Hockey’s decision to block the deal, which would have put a total of AUD13.20 per share in GrainCorp shareholders hands (our original recommendation was at AUD6.82), provides an opportunity for new investors to establish positions at bargain levels and for continuing investors to own a piece of a strategically important business that’s set to grow its dividend for the long term.

We make the case for GrainCorp in one of this month’s Sector Spotlights, the monthly features wherein we identify our top recommendations for new money right now.

The other Sector Spotlight this month focuses on DUET Group (ASX: DUE, OTC: DUETF), which owns interests in electricity and gas distribution as well as pipelines and pipeline development.

DUET Group is the de facto replacement for Envestra Ltd (ASX: ENV, OTC: EVSRF), which has agreed to be taken over in whole by fellow AE Portfolio Conservative Holding APA Group (ASX: APA, OTC: APAJF).

APA will pay approximately AUD1.17 per share for the 67 percent of Envestra it didn’t already own.

DUET itself is the subject of takeover rumors.

State Grid Corp of China, the largest state-owned electric utility in the world, is reportedly on the hunt for as much as USD50 billion worth of international power assets. DUET and AE Portfolio Aggressive Holding Spark Infrastructure Group (ASX: SKI, OTC: SFDPF) have been identified in the financial press among Australia’s most attractive takeover targets.

In December 2013 State Grid won regulatory approval to buy Australian assets including almost 20 percent of electricity and gas company SP AusNet (ASX: SPN, OTC: SAUNF).

DUET, with a market value of USD2.2 billion, and the USD1.9 billion Spark may be the next targets because of their regulated, long-term cash flows from gas and electricity assets.

State Grid is looking to boost its return on invested capital and is looking Down Under because it’s a relatively safe place to invest due to is stable economic and political environment and a regulatory regime that’s generally understandable and reliable.

State Grid has noted that it’s drawn to Australia’s “stable regulatory environment, high-quality assets and attractive commercial environment” without identifying specific targets.

State Grid paid Singapore Power Ltd AUD824 million (USD739 million) for 19.9 percent of SP AusNet. Mr. Hockey, in a statement released at the time of that deal, said, perhaps a bit ironically, “Australia is open for business, and we welcome foreign investment when it is not contrary to the national interest.”

This approval should give Chinese buyers confidence in the aftermath of the ADM-GrainCorp refusal. Mr. Hockey said that foreign control of the local grain handler wasn’t in the national interest.

There’s little threat to Australia from a Chinese owner of SP AusNet, DUET or Spark because Australian power companies are regulated by the Australian Energy Regulator, which determines how much a network operator can charge, usually over a five-year period. The regulator is so heavily involved that there’s not much a foreign investor could do to hurt the country.

But this very process–the regulator stipulates a fair return and a fair cost of debt–makes such assets appealing to a large buyer such as State Grid.

He’s not as well-known as folks like Warren Buffett, Peter Lynch and Bill Gross, but Dean LeBaron is among the most innovative and successful investors of our time.

In a recent interview with Jason Zweig, author of The Wall Street Journal column “The Intelligent Investor,” Mr. LeBaron, who founded Batterymarch Capital Management in 1969 and was one of the first money managers to employ statistical analysis rather than human judgment to pick stocks, said, “I follow China around the world and invest where they invest.”

Sounds like smart money to me.

Portfolio Update

The AE Portfolio Conservative Holdings generated an average US dollar total return of 4.8 percent from Dec. 31, 2012, through Dec. 31, 2013. The Aggressive Holdings, meanwhile, posted an average loss including dividends of 15.3 percent.

For purposes of comparison, iShares MSCI Australia Index Fund (NYSE: EWA), a decent benchmark for the Conservative Holdings, posted a total return of 1.8 percent for the relevant time period.

IQ Australia Small Cap ETF (NYSE: KROO), a reasonable analog for the Aggressive Holdings, was down 12.6 percent for the year.

The broad-based S&P/ASX 200 Index, meanwhile, posted a US dollar total return of 3.3 percent. In local terms the main Australian benchmark was up 20.2 percent in 2013.

The S&P 500 Index gained 32.4 percent for the year, while the MSCI World Index was up 27.4 percent.

A significant factor for US investors who are long Australian stocks in 2013 was the weakening of the Australian dollar.

The aussie closed 2012 at USD1.0394, just above its average for the year of USD1.0357.

The aussie hit a closing peak of USD1.0598 on Jan. 10, 2013, trading as high as USD1.0545 as late as April 10.

The aussie closed 2013 at USD0.8917, down 14.2 percent for the year. From its 2013 peak the decline was 15.9 percent. From its all-time high closing high of USD1.0993 on July 29, 2011, the slide was 18.9 percent. As of this writing the Australian dollar is valued at USD0.8781.

But there’s still a solid case in favor of holding dividend-paying Australian equities.

Portfolio Update has total return numbers for 2013, details on APA Group’s (ASX: APA, OTC: APAJF) deal for Envestra Ltd (ASX: ENV, OTC: EVSRF) and updates from Conservative and Aggressive Holdings that illustrate solid wealth-building potential for the long term.

In Focus

Australia’s latest housing data appears to be quite promising, though concerns that the market is approaching bubble territory and poses a potential threat to a nascent economic recovery persist.

The value of home loans approved in Australia rose 1.1 percent month over month in November 2013 and 15 percent compared to November 2012.

And new-home sales rose by 7.5 percent in November 2013 from October 2013, the fastest pace since January 2010 and a positive sign for a broader recovery dependent on a pickup in areas such as construction and consumer spending.

The more new homes sold, the greater the need for buyers to fill them with furniture, appliances and other household goods. And stronger demand for new houses and apartments means more work builders, which means more jobs.

Other data should at least partially allay fears that house-price gains are way out of line with more modest improvements in the Australian economy.

What will provide long-term support for the Australian housing market is an effort to mitigate what appears to be a supply-demand imbalance that’s helping drive prices higher.

Rising house prices drive confidence. And that should drive demand for new housing. Meeting this demand should fix the supply-demand imbalance, providing jobs outside the resources space.

In Focus takes a look at the debate over the condition of the Australian housing market, including a review of recent data and a supply/demand imbalance the resolution of which will benefit four building supply companies.

Sector Spotlight

DUET Group’s (ASX: DUE, OTC: DUETF) DBP Development Group unit, launched in 2011, has recently announced two pipeline deals backed by long-term, take-or-pay contracts that will add meaningful distributable cash flow as soon as fiscal 2015.

DUET’s Multinet Gas unit and the Dampier-Bunbury Pipeline, meanwhile, both have stable regulated asset bases and growth outlooks, making them steady, cash-generating businesses. And United Energy is expected to deliver strong growth in revenue and asset base, while DBP Development Group provides a new avenue to pursue accretive growth opportunities.

Management’s growth focus is on businesses with regulated or long-term contracted revenue as well as tariff structures that limit exposure to changes in volumes. DUET also prioritizes businesses with limited exposure to volatility in energy and commodity prices.

Hedging programs at each of its operating businesses limit interest-rate exposure across the group.

DUET met its fiscal 2013 distribution guidance of AUD0.165 per security and recently reaffirmed distribution guidance for fiscal 2014 of AUD0.17 per security. As of this writing, based on a Jan. 15, 2014, close of AUD2.06 on the Australian Securities Exchange (ASX), DUET is yielding 8.1 percent.

DUET Group, well positioned to explore new growth opportunities while still delivering a stable and predictable yield, is a new addition to the AE Portfolio Conservative Holdings as a buy under USD2.20.

We have more on Duet Group in this month’s first Sector Spotlight.

We’ve written extensively about AE Portfolio Aggressive Holding GrainCorp Ltd (ASX: GNC, OTC: GRCLF) in recent issues, primarily with regard to its aborted acquisition by US-based global agribusiness giant Archer Daniels Midland Co (NYSE: ADM).

The denial by the Australian government of ADM’s attempt sent GrainCorp shares sliding from a takeover-premium-infused closing high of AUD12.83 on the Australian Securities Exchange (ASX) on April 29, 2013, to a low of AUD8.01 as of the close of trading Down Under on Jan. 15, 2014.

GrainCorp closed at AUD8.12 on the ASX on Jan. 17 and is yielding 5.5 percent.

The recent steep selloff presents a new opportunity to own a company strategically placed to help Australia serve the growing appetites of Chinese and other Asian consumers.

GrainCorp is a charter member of the Australian Edge Portfolio, one of the original “Eight Income Wonders from Down Under.” We identified it in the early days of preparation to launch AE because it’s a high-quality company with easily identifiable cash flows.

GrainCorp is a buy under USD10.

This month’s second Sector Spotlight focuses on GrainCorp.

News & Notes

A Step Forward and a Step Back: Although Australia’s trade balance has improved markedly in recent months, its labor market appears to be weakening even further, notes AE Associate Editor Ari Charney.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced lower dividends during fiscal 2013 earnings reporting season Down Under as well as those that have lowered earnings guidance in recent weeks.

The ADR List: Many Australia-based companies that list on the home Australian Securities Exchange (ASX) are also listed on the New York Stock Exchange (NYSE) or over-the-counter markets as “sponsored” or “unsponsored” American Depositary Receipts (ADR).

How They Rate

How They Rate includes 113 individual companies and four funds organized according to the following sectors/industries:

• Basic Materials
• Consumer Goods
• Consumer Services
• Financials, including A-REITs
• Health Care
• Industrials
• Oil & Gas
• Technology
• Telecommunications
• Utilities
• Funds

We provide updated commentary with every issue, financial data upon release by the company, and dividend dates of interest on a regular basis. The AE Safety Rating is based on financial criteria that impact the ability to sustain and grow dividends, including the amount of cash payable to shareholders relative to funds set aside to grow the business. We also consider the impact of companies’ debt burdens on their ability to fund dividends. And certain sectors and/or industries are more suited to paying dividends over the long term than others; we acknowledge this in the AE Safety Rating System as well. We update buy-under targets as warranted by operational developments and dividend growth.

In Closing

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David Dittman
Editor, Australian Edge

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