Fiddling, Fussing and Five Thousand
It’s an artfully direct headline plump with irony: The astonishing ineptitude of the MRRT.
No. 1, it teases another in a pile of recent policy failures heaped up by governments the world over. No. 2, one cannot help but reflect on the collective hissy fit thrown by Australian mining mucky-mucks and wonder, “What was that all about?”
But, no. 3, who cares? The S&P/Australian Securities Exchange 200 Index has surged past the 5000 mark, establishing post-Great Financial Crisis highs on a regular basis now.
Prime Minister Julia Gillard may be hoisted on her own early election-call petard due to the apparent failure–at the most basic level–of Australia’s Minerals Resource Rent Tax and a host of other issues, including resignations from her cabinet, within days of her historic announcement, well ahead of the now-calendared Sept. 14, 2013, election, amid whispers as well as charges of corruption and fraud.
And Fortescue Metals Group Ltd (ASX: FMG, OTC: FSUMF, ADR: FSUGY) Chairman and Founder Andrew “Twiggy” Forrest certainly doesn’t care whether he came off as whiny, first, and obtuse, second, when he pitched such a storm of protest over a “tax” that was then suspected and is now revealed to have been not just negotiated but written by major minerals companies.
Ms. Gillard’s poll numbers are tanking, but iron ore prices are rallying. The former story approaches satire. The latter, for us, is substance.
Non-resources sectors of the Australian economy–including pockets of the retail sector and manufacturers–have been buoyed by a softening, however, slight in the value of the Australian dollar versus the US dollar.
The aussie has backed off an early 2013 high of USD1.0598 to USD1.0305 as of this writing following a series of overnight cash rate target cuts by the Reserve Bank of Australia (RBA). The RBA, during its first meeting of 2013 on Feb. 5, held its benchmark at 3 percent, down from 4.75 percent after 175 basis points of cuts in five separate moves from November 2011 through December 2012.
The RBA’s stance is decidedly dovish, as in his concluding paragraph in his statement on the monetary policy decision Governor Glenn Stevens noted, “The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand.”
Over the long term the Australian dollar, due to the fundamental strength of the underlying economy and the sound fiscal position of the federal government, will look good versus its global counterparts. In the short term Mr. Stevens is providing support to struggling sectors of the domestic economy.
It’s important to note that at 3 percent the RBA’s overnight target remains among the highest such benchmarks for developed-world central banks.
News on the US economy continues to skew to the positive, though, as one should expect so early in the aftermath of the financial-crisis-induced downturn we’re still digging out from, there is mixed in some negative as well.
Mergers-and-acquisitions activity appears to be on the upswing, at least judging by the recent USD23 billion move by Warren Buffet’s Berkshire Hathaway Inc (NYSE: BRK/B) for iconic HJ Heinz Co. Elsewhere, American Airlines Inc (NYSE: AMR) merged with US Airways Group Inc (NYSE: LCC) to create the world’s largest airline, and Comcast Corp (NSDQ: CMCSA) bought the 49 percent of NBC Universal that it didn’t already own from General Electric Co (NYSE: GE) for USD16.7 billion.
The brighter outlook isn’t limited to boardrooms, as the Thompson Reuters/University of Michigan index of consumer sentiment increased to a three-month high of 76.3. Retail sales, meanwhile, grew 0.1 percent in January, and sales were up 4.7 percent compared to January 2012. And initial claims for unemployment benefits declined by 27,000 to 341,000.
The National Federation of Independent Business’ small-business optimism index rose 0.9 points to 88.9 in January, and the February 2013 Empire State Manufacturing Survey indicates that conditions for New York manufacturers improved for the first time since the summer of last year, with the index at 10.04.
Finally, US equity markets continue their steady climb higher, as large caps, small caps, transports and financials have all made new highs.
At the same time, however, the CBOE Market Volatility Index hit its lowest level since 2007, suggesting a complacent market. And a regular survey by the American Association of Individual Investors revealed that bullish sentiment fell to 42.25 percent from 42.77 percent, the third straight weekly decline.
US Industrial production fell 0.1 percent in January following biggest back-to-back gains in three decades, and an executive at Wal-Mart Stores Inc (NYSE: WMT) said February sales were the company’s worst in seven years, blaming the expiration of the federal payroll tax cut.
And gas prices pushed up by USD0.03 per gallon to USD3.61, and the price of oil has now risen 10 percent since December. Rising fuel prices could put a damper on confidence and discretionary sales.
Currency markets are unsettled, as worries about a global “currency war” prompted an opaque statement from the G7 this week.
Around the world, Japanese gross domestic product (GDP) for the fourth quarter of 2012 unexpectedly declined by 0.1 percent sequentially, or negative 0.4 percent on an annualized basis, as opposed to forecast growth of 0.4 percent on an annualized basis.
Third-quarter GDP was revised lower to negative 3.8 percent on an annualized basis. That’s three consecutive quarters of contraction for the world’s third-largest economy.
Indian wholesale price inflation declined to 6.62 percent year over year in January, well below the 7.18 percent in December and the 6.98 percent expected. The decline will make it easier for the Reserve Bank of India to cut interest rates further, though the recent increase in oil prices will feed through in coming months.
Italian fourth-quarter GDP declined by 0.9 percent sequentially and 2.7 percent year over year, worse than the 0.6 percent forecast decline and the 0.2 percent contraction in the third quarter of 2012.
French fourth-quarter GDP declined by 0.3 percent sequentially, worse than the 0.2 percent forecast contraction. GDP was flat for 2012, as opposed to growth of 1.7 percent in 2011.
Insee, the French national statistics office, reported that French manufacturing output declined by 2.3 percent in the fourth quarter compared to the third quarter following a 0.9 percent increase from the second to the third quarter.
And German fourth-quarter GDP contracted by 0.6 percent sequentially, as opposed to the gain of 0.2 percent in the previous quarter and worse than the forecast 0.5 percent decline.
On a positive note, it appears that the fourth quarter was the worst of it, as recent data points to a decent pick-up in the German economy in the current quarter.
Overall eurozone GDP declined by 0.6 percent quarter over quarter, worse than the 0.4 percent forecast contraction and 0.1 percent decline in the third quarter. It was the worst GDP data from Europe since the first quarter of 2009.
Things continue to be lumpy and jagged all over the world. That’s why we continue to favor high-quality companies that pay dividends.
Portfolio Update
So far, 2013 looks a lot like profitable 2012 for the Australian Edge Portfolio. In fact, if long-underperforming natural resource companies in the Aggressive Holdings continue to perk up, we’ll be well on track to beat last year’s 25.8 percent return.
Five AE recommendations finished 2012 underwater, all Aggressive Holdings. All of them are in the black this year, and as a group the quintet is running 18 percentage points ahead of last year.
Momentum is a difficult thing to buck. And it’s rarely been more of a challenge than now, with so many investors afraid to hold any stock that loses value and, conversely, so ready to discard notions of value and chase rising stocks.
Nonetheless, year in and year out one year’s underperformers routinely become the next year’s outperformers, and vice versa. And that’s definitely the case again for the first six weeks of this year in Australia.
Last year’s five laggards were challenged in 2012 by a range of factors, including flagging demand from China for Australian natural resources, a rising Australian dollar making exports less competitive and overseas sales less profitable, rising costs and tax uncertainty in their home country. And all five suffered from an earnings standpoint for it.
Looking ahead to the rest of 2013, most of these factors remain challenges. The difference, however, is these stocks are starting the year from a much lower level of expectations that will be much easier to beat. Meanwhile, underlying businesses have adjusted, and overall conditions appear to have stabilized.
That’s a formula for higher stock prices, even though the numerical comparisons with recent years are likely to lag.
In Focus
Regulation is part of life in developed-world economies. Some industries are regulated more than others–utilities, for example, where in Australia, as in the US, a phalanx of local, state and federal officials scrutinize practically every move essential-service providers make.
Navigating a regulatory thicket where state-level demands often come in conflict with mandates from the federal government is one of the most important activities in which power and pipeline companies engage.
Good relations with elected and appointed official go a long way when it comes to making rate-request applications, seeking merger or acquisition approval and/or siting and constructing new facilities.
The broader regulatory outlook for Australian utilities has improved in recent weeks. South Australia’s decision to deregulate establishes an important precedent for other states Down Under and bodes well for merchant utilities. And, with the Australian Energy Market Commission’s process of establishing new rules now drawn to a close, network utilities that will have to abide by these revised standards have some clarity.
There are rate resets yet to come and there have been requests for pass-through of capital expenses recently denied for specific companies. Yet in general regulatory risks for both merchant and network utilities appears to be waning.
There are opportunities, therefore, in utilities with no short-term rate-reset exposure as well as those trading at solid valuations.
Sector Spotlight
Spark Infrastructure Group (ASX: SKI, OTC: SFDPF) describes itself as “a specialist infrastructure fund.” Included in its “investable universe” are regulated water, electricity and natural gas transmission and distribution businesses in developed-market jurisdictions.
Its current portfolio includes 49 percent interests in two entities that control three power companies: SA Power Networks, which was formerly known as ETSA Utilities, and Victoria Power Networks, the holding company for CitiPower and Powercor Australia that recently changed its name from CHEDHA Holdings Ltd.
Ownership of Spark by US investors is limited to “qualified purchasers,” which the Securities and Exchange Commission defines, in relevant part, as individuals “who own not less than USD5,000,000 in investments.”
The “qualified purchaser” standard is more exacting than the SEC’s “accredited investor” standard, which includes, in relevant part, those with “individual net worth, or joint net worth with the person’s spouse, that exceeds USD1 million at the time of the purchase” as well as those “with income exceeding USD200,000 in each of the two most recent years or joint income with a spouse exceeding USD300,000 for those years and a reasonable expectation of the same income level in the current year.”
Because Spark has advised that it “may require an investor to compete a statutory declaration as to whether they are an ‘Excluded US person’” we are going to add the stock to the Aggressive Holdings rather than the Conservative Holdings.
We’ve decided to make the addition because, though the great majority of AE subscribers are US-based investors, we do have a number of readers in foreign jurisdictions that don’t have similarly onerous burdens on cross-border investing.
As for the merits of Spark Infrastructure as an investment, the power companies in which it holds interests are all stable from a regulatory perspective, with no resets until 2015; growing, with the overall RAB expanding 4 percent in the first half of 2012 and 9.3 percent for the 12 months to June 30, 2012; and building wealth, with the interim distribution for 2012 up 10.5 percent and management guiding to 3 percent to 5 percent annual growth through 2015.
WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY), in line with a recent theme, announced–on the same day it revealed results for the first half of fiscal 2013–a new contract award, this one to provide engineering services at the Fort Hills oil sands project.
The fact that the company continues to consistently win new business from and renew contracts with the world’s biggest energy and resource companies supports WorleyParsons’ standing in the AE Portfolio. Although the challenges presented by economic uncertainty have impacted the stock, as a going concern WorleyParsons is getting stronger.
Management has introduced initiatives that should arrest and reverse a recent deterioration in margins, the balance sheet positions the company to grow and it clearly has the confidence of those companies that are driving development of energy and resources around the world.
That WorleyParsons surpassed guidance and expectations with its fiscal 2013 first-half report bodes well for the remainder of the year and for its long-term wealth-building capabilities.
During the period WorleyParsons won a total of 61 “significant and long-term contracts,” 12 power projects, 13 infrastructure and environment projects, 17 hydrocarbons projects and 19 minerals, metals and chemicals projects.
News & Notes
Gillard’s Gambit and the Muffed MRRT: Australian Prime Minister Julia Gillard has broken with tradition by declaring a parliamentary election seven and a half months ahead of the day of the vote. Ms. Gillard’s campaign is off to a rocky start.
About That Tax: The minority Labor government is also under scrutiny due to the apparent abject failure of one of its highest-profile legislative accomplishments, the Minerals Resource Rent Tax (MRRT). A parliamentary committee has been tasked with investigating whether concessions granted to mineral giants are responsible for the mining tax revenue shortfall, a step that will prolong the political pressure on Ms. Gillard.
The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced dividend cuts during fiscal 2013 first-half earnings reporting season Down Under as well as those that reduced earnings guidance in recent weeks. It also includes those that cut payouts during their most recent reporting period that haven’t yet released results during the current reporting season.
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).
Here’s a list of those companies, along with an explanation of what these ADRs represent.
How They Rate
How They Rate includes 115 individual companies 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
Co-Editor, Australian Edge
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