|
Surf's Up Down Under
By: Carl Delfeld
Lucky?
This lucky country’s economy is on a record-breaking 14-year roll. The big
question: Will it continue?
Just imagine: From a few convicts dropped ashore in 1788, Australia has
developed into a first-class global economy. The reforms enacted by former Prime
Minister Bob Hawke and Treasurer Paul Keating during the 1980s set the stage for
a remarkable run of prosperity. Specifically, they slashed import tariffs,
floated the currency and reduced the power of big labor. The current prime
minister, John Howard, who has been elected four times, has continued and
expanded these reforms riding a wave of economic growth – 14 years of
uninterrupted 4% to 5% growth.
The national debt has been virtually eliminated, the currency is strong, the
government has recently signed a free-trade pact with America, and it is
starting to negotiate a pact with China. Australia received $42 billion in
foreign direct investment in 2004.
This is all great news, and our portfolio allocation in the Australia iShare
(AMEX: EWA) has done very well, with a 105% gain over the past two years. The
Australian iShare is up 15% so far this year and provides investors with
exposure to about 60% of the total stock market.
Some Warning Signs
The question is of course, what should we do now. When things are going this
well for so long, investors need to be skeptical and weigh the potential upside
with the downside risk.
- A shortage of skilled and semi-skilled workers and relatively high labor costs
(minimum $400 a week).
- Complicated and rigid labor rules continue to hamper productivity growth,
which seems to be slowing.
- The total tax take by the Australian federal government is 22%, which is
higher than the rest of Asian competitors and the U.S. (average of 16%).
- From 2000-2004 housing prices were up 100%, and household debt is now 160% of
disposable income.
Australia is taking some measures to address these matters. It recently enacted
a $17 billion cut in personal income taxes over three years, and the independent
central bank is raising rates. The leadership has also introduced a package of
“radical” labor reforms, which if enacted would also be a big plus. The aim is
to give employers more flexibility and to bring labor negotiations down to the
local level. The measures would increase probationary period for new employees
from three to six months, exempt businesses with less than 100 employees from
unfair dismissal laws, and favor individual contracts over collective
bargaining. All of these measures will be fought by the Labor Party and trade
unions.
While much is made of Australia’s dependence on China and commodity exports, the
Australian economy is well diversified, with 5% of gross domestic product
attributed to mining, 5% to tourism and 80% to services. It also has the
third-largest stock market in the region and a leading regional financial
center.
Taking Profits
After looking closely at the situation, I have decided to keep Australia in our
portfolio, but will take some profits by halving our position. Here is my
reasoning:
- The decline in housing prices has been incremental and has therefore not
affected banking, consumer and construction stocks as expected.
- International fund managers are underweight on Australia.
- The market is not especially expensive. The 12-month forward price-to earnings
ratio is about 15, in line with the average over the past three years and below
a high of 18. But keep in mind that this low multiple is based on forward and
aggressive forecasts of corporate profits.
- Average dividend yield for Australian stocks is around 5%.
One company to keep an eye on is BHP Billiton (NYSE: BBL), the world's biggest
mining group, which reported an 85% rise in net profit, compared with a year
ago, to $6.5 billion for the year ended June 30, 2005. The Anglo-Australian firm
set a new Australian corporate profit record, and after being up sharply in 2003
and 2004, it has confounded skeptics by going up 26% so far this year. The
company's good fortune, like that of other mining concerns, comes from rising
demand in China.
Another great Australian mining company is Rio Tinto (NYSE: RTP), which has a
lower valuation because it doesn’t have oil and gas operations, which contribute
about 30% of BHP’s total revenue.
Last Bit of Advice
The center of gravity for the world’s economy is shifting to the Asia-Pacific
region, and Australia is in the sweet spot. Keep an eye on housing prices and
corporate profit performance, but for now keep some exposure to Australia in
your global portfolio.
For more information go to www.chartwellasia.com or call 877-221-1496
About the Author:
Carl Delfeld is head of the global advisory firm Chartwell Partners and editor
of the Chartwell Advisor and the Asia Investor Intelligence newsletters. He
served on the executive board of the Asian Development Bank and is the author of
The New Global Investor. For more information go to
http://www.chartwellasia.com
or call 877-221-1496
|
