PPI, CPI Leave RBA Room to Cut

By David Dittman • April 26, 2012 • Pacific Digest

The Australian Bureau of Statistics (ABS) reported Tuesday, Apr. 24, in Canberra that the Consumer Price Index (CPI) increased by 0.1 percent during the first three months of 2012. This represents a slight acceleration from the fourth quarter of 2011, during which the CPI was unchanged. Expectations were for a rise of around 0.5 percent.

The CPI rose 1.6 percent through the year ended Mar. 31, 2012, compared to an increase of 3.1 percent during the 12 months to Dec. 31, 2011. The underlying inflation rate most closely watched by the Reserve Bank of Australia (RBA) is at a 13-year low of 2.1 percent, just inside the monetary authority’s target range of 2 percent to 3 percent.

The CPI data follow similarly tame Producer Price Index (PPI) data, released by the ABS Apr. 23. During the quarter ended Mar. 31 prices paid by manufacturers for material inputs fell 1.1 percent–the biggest quarter-over-quarter decline since 2009–while the prices received for outputs rose 0.1 percent. Input prices were up 1.7 percent year over year, while prices received for outputs rose 0.3 percent.

The RBA acknowledged risks to growth during its April meeting but said it would wait for first-quarter inflation data before making a move on its target overnight interest rate, or “cash rate.” At 4.25 percent the RBA’s official benchmark is the highest in the developed world.

The ABS releases inflation data only four times a year, on a quarterly basis, unlike most developed nations, which provide monthly statistics. Based on the minutes from the April meeting, released mid-month, it appears the RBA now has sufficient evidence upon which to base at least a 25 basis point reduction in its cash rate.

The minutes include the clear-for-central-bank-speak statement, “If slower growth in demand could be expected to result in a more moderate inflation outcome, then a case could be made for a further easing of monetary policy.” This language leaves room for plenty of discretion, though markets by midweek had fully priced in a May 1 cut.

The Australian dollar was softer against the US dollar on the expectation of a coming rate hike by the RBA, that is until the US Federal Reserve and Chairman Ben Bernanke on Wednesday held the fed funds rate at 0 to 0.25 percent and reiterated a commitment to keep rates in this historically low range until 2014 and to resort to other tricks should conditions warrant it.

Whether a reduction in the RBA’s cash rate would have any impact domestically is still an open question. Australia’s “Four Pillar” banks have been reticent to pass on two previous rate cuts to consumers–25 basis points each, in November and December 2011–as their costs are determined by factors beyond RBA policy.

The Four Pillars–Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY), Commonwealth Bank of Australia Ltd (ASX: CBA, OTC: CBAUF, ADR: CBAUY), National Australia Bank Ltd (ASX: NAB, OTC: NAUBF, ADR: NABZY) and Westpac Banking Corp Ltd (ASX: WBC, NYSE: WBK)–are constrained because since late 2011 the banking crisis in Europe has driven up their wholesale funding requirements.

In mid-April ANZ raised it standard variable rate by 6 basis points, or 0.06 percentage point, to 7.42 percent, effective Apr. 20. In early 2012 ANZ CEO Mike Smith instituted a policy of announcing any changes to its mortgage rates on the second Friday of each month in order to decouple his bank from the RBA’s monthly interest-rate cycle.

The RBA cut by a total of 50 basis points late last year as the crisis over Europe’s debt situation intensified. After a period of calm in early 2012 the euro zone is again a focus of concern. On the still-critical Iberian Peninsula, Spain successfully sold 12-month, 18-month, two-year and 10-year debt, with yields steady but near their highest levels since December.

And pricing for credit default swaps (CDS) on Spanish debt reached record highs. The yield on Italian government 10-year debt rose to its highest level since February, and Italian CDS are at their most expensive since January, as are prices for protection on French government bonds.

Fears have also been growing about China, which downgraded its gross domestic product (GDP) growth target to 8 percent recently. The most recent HSBC Flash China PMI figure also stoked fear because it came in below 50–the bright line separating “expansion” and “contraction”–for a six straight month.

On the other hand, Flash PMI was higher in April at 49.1 percent versus 48.3 in March.

Meanwhile, the Conference Board reported Apr. 25 that its Leading Economic Index for Australia was unchanged in February at 126 following a 1 percent increase in January and a 0.4 percent decline in December.

The Conference Board’s Coincident Economic Index (CEI) was also unchanged. The CEI ticked up 0.3 percent in January on the heels of a 0.2 percent decline in December.

The LEI for Australia has declined in four of the last six months, though the CEI has been on a slightly rising trend since mid-2011. “Taken together,” in the estimation of the Conference Board, “the recent behavior of the composite indexes suggests that moderate economic growth is likely to continue in the near term.”

And data provider Australian Property Monitors reported this week that home prices in Australia rose modestly during the first quarter, ticking up 0.9 percent from January to March. This is the second consecutive quarter of rising prices after 15 straight months of declines.

Perhaps most critically, the ABS reported in mid-April that the Australian economy added 44,000 jobs in March and that the unemployment rate remained steady at 5.2 percent. Part-time additions were 28,200, while 15,800 Australians found full-time work. The overall labor force participation rate rose to 65.4 percent from 65.2 percent in February. Experts were looking for the jobless rate to rise on a modest 6,500 additions to the workforce.

Australia’s economy is strong relative to the rest of the developed world, though it, too, will suffer amid this jagged, lumpy and underwhelming recovery from the Great Financial Crisis. In an environment of constrained growth it’s even more critical to focus on productive assets tied to easily identifiable long-term trends, such as China’s rising middle class and the global hunger for energy and materials.

This is the reason for Australian Edge.

The Roundup

AE Portfolio Aggressive Holding Newcrest Mining Ltd (ASX: NCM, OTC: NCMGF, ADR: NCMGY), the world’s No. 3 gold miner, is trading near a three-year low after issuing another full fiscal year output downgrade–its second in six months–along with its 2012 first-quarter production update.

Newcrest’s Cadia East development in Australia was hampered by heavy rains during the period, while long-term underinvestment in equipment maintenance by the previous owner at a gold processing plant at its Lihir mine in Papua New Guinea led to further production disruptions.

For the March quarter Newcrest reported an 8 percent drop in production t o 532,237 ounces of gold against the previous quarter. Newcrest cut its fiscal 2012 production guidance to 2.25 million to 2.35 million ounces of gold from earlier, already lowered guidance of 2.43 million to 2.55 million ounces. Fiscal 2013 production will likely be impacted to the tune of about 250,000 to 300,000 ounces.

Newcrest has committed to spending AUD600 million to AUD700 million to duplicate an existing plant on site. This effort, forecast to boost capacity to over 1 million ounces per year, is also subject to tie-in challenges that Newcrest revealed with the quarterly report. Similar difficulties at Cadia East will cause shortfalls in both fiscal 2012 and fiscal 2013.

The market had already priced in a significant degree of risk for Newcrest’s production targets in the aftermath of the first Lihir-related downgrade, but the possibility that production will be impaired as far out as fiscal 2013 was a bit of a surprise.

The result is that Newcrest will be making significant capital outlays over the next several quarters with no associated production growth. But on the bright side, unit production cost came in at AUD609 per ounce, while Newcrest’s cash margin–the difference between its unit production cost and its realized selling price–remained robust at AUD978 per ounce.

In light of these rebased expectations as well as the increased operational risks we’re reducing our buy-under target for Newcrest Mining to USD32 for investors who don’t already own the stock.

Elsewhere around the Portfolio, Aggressive Holding Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY) produced a much more upbeat quarterly production update, though production was lower on a quarter-over-quarter basis due to planned maintenance shutdowns at two of its processing facilities.

Management reiterated full-year production guidance of 6.2 million to 6.7 million barrels of oil equivalent per day.

During the three months ended Mar. 31 Oil Search produced 1.46 million barrels of oil equivalent, down 11 percent because of 16-day turnarounds at its Central and Agogo processing facilities.

Oil sales were 1.25 million barrels, slightly higher than the prior corresponding period, with an average realized of USD124.14 per barrel, a 9 percent increase from the fourth quarter of 2011. Total operating revenue for the quarter was USD187.2 million, up 22 percent from USD153.3 million in the fourth quarter.

The company also announced Apr. 19 that it discovered more gas in Papua New Guinea, firming up the potential of its recent P’nyang development to support an expansion of its USD15.7 billion joint venture with Exxon Mobil (NYSE: XOM).

According to the company, a sidetrack well to its recent P’nyang South-1 well has found the original gas zone extends about 200 meters deeper than the lowest known gas in P’nyang South-1, indicating an increase in the total gas column to about 380 meters.

Management is in the process of assessing bids from parties interested in buying into the PNG LNG development.

“Discussions with potential partners were ongoing during the quarter and a number of bids to farm-in to these licences were received late in the reporting period,” management said in a statement. Oil Search is reviewing the offers and said a sell-down of its interests in the assets is likely around mid-year.

Oil Search is a buy below USD8 on the Australian Securities Exchange (ASX) using the symbol OSH and on the US over-the-counter (OTC) market using the symbol OISHF.

Oil Search also trades as an American Depositary Receipt (ADR) on the US OTC market under the symbol OISHY. Oil Search’s ADR is worth 10 ordinary shares and is a buy under USD80.

Following are dates (confirmed, tentative or estimate) for each AE Portfolio Holding’s next earnings announcement.

Conservative Holdings

  • AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY)–Aug. 22, 2012 (estimate, FY 2012, end Jun. 30, 2012)
  • APA Group (ASX: APA, OTC: APAJF)–Aug. 21, 2012 (estimate, FY 2012, end Jun. 30, 2012)
  • Australand Property Group Ltd (ASX: ALZ, OTC: AUAOF)–Jul. 26, 2012 (confirmed, CY/FY 2012 1H, end Jun. 30, 2012)
  • Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY)–May 2, 2012 (confirmed, FY 2012 1H, end Mar. 30, 2012)
  • Cardno Ltd (ASX: CDD, OTC: COLDF)–Aug. 16, 2012 (estimate, FY 2012, end Jun. 30, 2012)
  • CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY)–Aug. 21, 2012 (confirmed, FY 2012, end Jun. 30, 2012)
  • Envestra Ltd (ASX: ENV, OTC: EVSRF)–Aug. 27, 2012 (estimate, FY 2012, end Jun. 30, 2012)
  • M2 Telecommunications Group Ltd (ASX: MTU, OTC: MTCZF)–Aug. 29, 2012 (estimate, FY 2012, end Jun. 30, 2012)
  • Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY)–Aug. 9, 2012 (confirmed, FY 2012, end Jun. 30, 2012)
  • Transurban Group (ASX: TCL, OTC: TRAUF)–Aug. 2, 2012 (confirmed, FY 2012, end Jun. 30, 2012)

Aggressive Holdings

  • BHP Billiton Ltd (ASX: BHP, NYSE: BHP)–Aug. 22, 2012 (confirmed, FY 2012, end Jun. 30, 2012)
  • GrainCorp Ltd (ASX: GNC, OTC: GRCLF)–May 22, 2012 (confirmed, FY 2012 1H, end Mar. 30, 2012)
  • Iluka Resources Ltd (ASX: ILU, OTC: ILKAF, ADR: ILKAY)–Aug. 23, 2012 (confirmed, FY 2012 1H, end Jun. 30, 2012)
  • Mineral Resources Ltd (ASX: MIN, OTC: MALRF)–Aug. 20, 2012 (estimate, FY 2012, end Jun. 30, 2012)
  • Newcrest Mining Ltd (ASX: NCM, OTC: NCMGF, ADR: NCMGY)–Aug. 13, 2012 (confirmed, FY 2012, end Jun. 30, 2012)
  • New Hope Corp Ltd (ASX: NHC, OTC: NHPEF)–Sept. 20, 2012 (estimate, FY 2012, end Jul. 31, 2012)
  • Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY)–Jul. 24, 2012 (confirmed, FY 2012 1H, end Jun. 30, 2012)
  • Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY)–Aug. 23, 2012 (estimate, FY 2012, end Jun. 30, 2012)
  • Rio Tinto Ltd (ASX: RIO, NYSE: RIO)–Aug. 8, 2012 (confirmed, FY 2012 1H, end Jun. 30, 2012)
  • WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY)–Aug. 29, 2012 (estimate, FY 2012, end Jun. 30, 2012)

Stock Talk

Comments Guidelines
Guest One

Burt Yano

I own shares of M2 Communications. In my brokerage account, I see what appears to be warrant for share rights that expire on 5/11/12. Do you have any information on these share rights and whether they are open to US citizens? Thank you.

David Dittman

David Dittman

Hi Mr. Yanovich,

These warrants are part of a Renounceable Entitlement Offer that M2 is using to raise equity capital–a total of AUD83.2 million–from existing shareholders to fund part of the acquisition of Primus Telecom Holdings. Unfortunately, this offer is not open to US shareholders.

Thank you for reading AE, and thanks for your question. Please let me know if there’s any further information you require on this issue.

Best regards,

David

Guest One

michael karpoff

I have been a canadian edge subscriber as well as a couple of your other publications, and I am thinking of subscribing to Aussie Edge. My problem is that I do not understand the Aussie vs USA tax ramifications on dividends re: franked, not franked, withholding, etc. You were gracious enough to give me a one-time pword to the newsletter, so I could get the info, but I cannot find it. Can you either give me a brief explanation, or lead me to the place where I can find the info? Thx. I really appreciate your help.

David Dittman

David Dittman

Hi Mr. Karpoff,

Great to hear from you again, and I’m glad you’re considering AE. Here’s an article I wrote for the News & Notes section of AE in March that should shed some light on the franking issue as well as withholding:

Dividends paid to Australian resident shareholders by Australian resident companies are taxed under a system known as “imputation.” The tax the company pays is attributed to shareholders in the company. The tax paid by the company is allocated to shareholders through “franking credits” attached to the dividends they receive. This is often referred to as “grossing up” a dividend.

Australian resident shareholders include an amount equal to the franking credit attached to the dividends they receive in the “assessable income” they report on their tax returns. Australian shareholders are also entitled to a “franking tax offset” equal to the amounts included in their income, subject to exceptions or “anti-avoidance” rules.

The franking tax offset will cover, or partly cover, the tax payable on the dividends. If the tax offset is more than the tax payable on the dividends, the excess tax offset will be applied to cover, or partly cover, any tax payable on other taxable income the Australian resident shareholder received.

Franking credits represent, in a real sense, additional income to Australian resident shareholders–a fact that many observers Down Under believe is lost on many investors. According one estimate, franking credits add more than 1 percent to the post-tax return from Australian shares for Australian investors. With Australia’s corporate tax rate at 30 percent, dividends are grossed up by AUD30 for each AUD70 of dividends received. This means that Australian companies that pay tax at the 30 percent company tax rate have AUD428.57 of attached franking credits for every AUD1,000 of dividends they pay out.

If any excess tax offset is left over after that, the Australian Taxation Office (ATO) will refund that amount.

Non-residents–including US-based investors–can also be paid or credited franked dividends or unfranked dividends by Australian companies, at least nominally. But we’re taxed differently from resident shareholders.

For us non-residents, the franked amount of dividends–the “grossed-up” dividends–you are paid or credited are exempt from Australian income and withholding taxes. At the same time, you aren’t entitled to any “franking tax offset” for franked dividends. You can’t use any franking credit attached to franked dividends to reduce the amount of tax payable on other Australian income, and you can’t get a refund of the franking credit.

The “gross-up-and-credit” effectively does not exist for non-resident investors.

The unfranked amount, on the other hand, which is effectively a “net” dividend in the context of this imputation system, will be subject to withholding tax.

If you do have income other than dividend income from Australia and you file with the Australian Tax Office, you should not include the amount of any franked dividend or any franking credit on your return.

Australian resident companies may also pay or credit an unfranked dividend, to which there is no franking credit attached. In general unfranked dividends paid or credited to a non-resident are subject to a final withholding tax, which is imposed on the full amount of the unfranked dividends–that is, no deductions may be made from the dividends. A flat rate of withholding tax is applied whether or not you have other Australian taxable income. Withholding tax is also deducted from the unfranked amount of any partly franked dividends that you are paid or credited.

Withholding tax is deducted by the company before a dividend is paid, so you’ll be paid or credited only the reduced amount. The general rate of reduction is 30 percent. Australia has entered into a double-taxation agreement with the United States that limits the rate of withholding tax on dividends to 15 percent, at least through 2012.

The withholding tax on unfranked dividends is a “final tax,” so you’ll have no further Australian tax liability on the dividend income. If the only income you earned was dividend income that was a fully franked dividend or an unfranked amount of a dividend which was either subject to withholding tax or declared to be “conduit foreign income,” you don’t need to file an Australian tax return.

And if you use username/password combination super/jump you should have access to the site until Jun. 8.

Please let me know if you have any other questions.

Best regards,

David

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