Prepare for September

By David Dittman • August 31, 2012 • Pacific Digest

The S&P/Australian Securities Exchange 200 Index pushed out to multi-month highs last week, pulled higher through the summer as economic data in the US seemed to be dragging Federal Reserve Chairman inexorably toward another market-moving speech in Jackson Hole, Wyoming. Mr. Bernanke hinted strongly that the Fed would act should economic conditions warrant additional monetary stimulus, but he stopped short of committing to a new round of quantitative easing.

More positive momentum was derived from hopes the European Central Bank (ECB) would announce its own new round of bond buying after its governing council meets on Sept. 6, the market anticipating that ECB President Mario Draghi would put some meat on the “whatever it takes” commitment he made at the end of July. Expectations have shifted to Sept. 12, when Germany’s Constitutional Court will rule on the constitutionality of the European Stability Mechanism, the fullest attempt to rescue of the periphery and the union.

Although recent polls and one online trading exchange indicate the incumbent is on course to hold the White House, President Obama’s lead is far from comfortable and his approval ratings continue to suggest vulnerability. This week the Republican National Convention formally nominated Mitt Romney to make the challenge, and next week the Democratic National Convention will ratify Mr. Obama for another run. We’ll know after that whether either one will assume a commanding lead heading into the final sprint to Nov. 6.

On Sept. 7 the US Dept of Labor’s Bureau of Labor Statistics will release its report on the employment situation for August. Total nonfarm payroll employment rose by 163,000 in July, the biggest payroll increase since February, as the private sector was up 172,000, with most industries, including manufacturing, adding more jobs than in the prior few months. But the unemployment rate was essentially unchanged at 8.3 percent, and the share of the population employed declined.

Returning to the Continent, a Sept. 12 Dutch election could throw a wrench into German Chancellor Angela Merkel’s attempts to preserve the European Union. A third of Dutch voters back the Socialists, who oppose more spending cuts and refuse to hand over more sovereignty to Europe, or the Freedom Party, which seeks an exit from the European Union and the euro. It’s hard to imagine the incumbent Liberals, strong allies of Ms. Merkel’s, forging a new coalition that will continue the Netherlands’ current course.

This is all a prelude to the Sept. 12-13 meeting of the US Federal Reserve Open Market Committee (FOMC), which is when we’re likely to hear about a third round of quantitative easing (QE3). We’ll hear updated economic forecasts from committee members as well as another press conference with the chairman himself, Mr. Bernanke.

The Fed’s efforts to provide monetary stimulus during the Great Financial Crisis–QE1, QE2 and “operation twist”–have had undeniably positive effects as far as equity indexes are concerned: Stocks have risen in the aftermath of their implementation, although, and this is equally undeniable, their impact has been progressively worse from one to the next.

So far their impact on inflation has been negligible. It’s hard to determine whether economic growth has been aided by them. The unemployment remains stubbornly above 8 percent, and though the rate was revised upward this week in the second-quarter gross domestic product expanded by just 1.7 percent, well below historical averages and not sufficient to make a dent in the unemployment rate. The Fed has kept its benchmark rate near zero since December 2008, and its asset purchases have swelled its balance sheet to a record of almost USD3 trillion.

Policymakers at the central bank have said they are prepared to provide new stimulus “fairly soon” unless they’re convinced the economy is poised to rebound, according to the minutes of the FOMC’s Jul. 31-Aug. 1 meeting released last week. Mr. Bernanke wrote in an Aug. 22 letter to Congressman Darrell Issa (R-CA), who chairs the House Oversight and Government Reform Committee, that he sees “scope for further action.”

Eric Rosengren, president of the Federal Reserve Bank of Boston, and Charles Evans, head of the Chicago Fed, have called for additional stimulus since the last FOMC meeting. St. Louis Fed President James Bullard “wouldn’t do it right now,” he said in an Aug. 23 CNBC interview.

Economic data have firmed a bit since the Jul. 1-Aug. 1 meeting. But clouds remain, specifically over Europe as well as around China.

The next FOMC meeting is in late October, too close to the US election for major policy shifts.

We’ll know a lot more about US monetary policy and the shape of Europe’s efforts at recovery and a future as a currency union on Sept. 14, which will also mark the fourth anniversary of Lehman Brothers’ bankruptcy filing.

September is, at any rate, historically a rocky month for equities. From 1950 to 2009 the S&P 500 Index shed an average of 0.8 percent in September. In September 2010 the world’s most-watched index added nearly 9 percent, but last year it returned to its losing ways with a 7 percent decline in the aftermath of Standard & Poor’s downgrade of Uncle Sam’s credit from AAA.

Other notable September numbers include the 10 percent decline in September 1929, setting the stage for the Great Crash in October punctuated by Black Tuesday, Oct. 29, 1929. The worst month ever for the Dow Jones Industrial Average, a 30.7 percent decline, occurred in September 1931. And the Dow shed 777.68 points on Sept. 29, 2008, the biggest single-day drop in that index’s history.

And anxiety is creeping back into the market: Since hitting a five-year low of 13.45 on Aug. 17, the Chicago Board Options Exchange Volatility Index, known as the VIX, has surged to 17.47.

It’s enough to suggest we focus a little more on defense, beginning with AE Portfolio Conservative Holding CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY). CSL, which makes blood plasma derivatives, vaccines, anti-venom, and cell culture reagents, posted 4.5 percent growth in reported net profit after tax (NPAT) to AUD982.6 million. This includes an unfavorable foreign exchange impact of AUD108 million. On a constant currency basis NPAT was up 16 percent to AUD1.1 billion.

Sales revenue was AUD4.4 billion, up from AUD4.2 billion a year ago and 12 percent in constant currency terms. CSL Behring, which makes plasma proteins for biotherapeutics and is CSL’s largest operating division, posted sales of AUD3.6 billion, up 11 percent in constant currency terms.

Immunoglobulin sales grew by 15 percent as did albumin sales, while specialty products posted 18 percent growth.

Overall cash flow from operations grew by 14 percent to AUD1.16 billion.

Cash on hand as of Jun. 30, 2012, was AUD1.16 billion, with debt outstanding of AUD1.27 billion. CSL spent AUD355 million on research and development during the year.

Management announced a final dividend of AUD0.47 per share along with operating results, up from AUD0.45 a year ago, bringing the full-year payout to AUD0.83 per share, up from AUD0.80 during fiscal 2011.

Management noted in a statement announcing these results that CSL “anticipates trading conditions to be similar to those of fiscal 2012, with global demand tempered by ongoing economic pressures” but forecast profit growth of approximately 12 percent in constant currency terms. Management is also contemplating another AUD900 million share buyback program, the execution of which would lift fiscal 2013 earnings per share.

CSL has posted an impressive 41.86 percent total return in US dollar terms since we added it to the AE Portfolio Conservative Holdings in October 2011.

Other health care names under AE How They Rate coverage include Cochlear Ltd (ASX: COH, OTC: CHEOF, ADR: CHEOY), which makes cochlear implants, bone conduction implants, implants for electro-acoustic stimulation and implants for direct acoustic stimulation to solve hearing loss.

Concerned or angry about Obamacare in the US? Sonic Health Care Ltd (ASX: SHL, OTC: SKHCF, ADR: SKHCY)  management would have you ponder the possible upside, at least for its business, of an additional 30 million patients gaining health insurance and the testing and procedures it avails them. Sonic is a medical diagnostics company that furnishes pathology and radiology services to doctors, hospitals and other health care providers in the developed world. Sonic hasn’t cut its distribution in the last five years.

Ramsay Health Care Ltd (ASX: RHC, OTC: RMSYF) is Australia’s largest private hospital owner, and it has operations in the UK and Europe as well. It has 117 hospitals around the world, with around 10,000 beds, and employs approximately 30,000 people.

Twenty-two thousand doctors are attached to its service, and Ramsey is approaching 3 million patient days per year. That positions it well to capitalize on one of the surest trends alive, rising health care costs.

Most impressive about Ramsay is that it’s never failed–never–to boost its interim or its final dividend from one corresponding period to the next.

The Roundup

Grange Resources Ltd (ASX: GRR, OTC: GRRLF) has cut its interim dividend to AUD0.01 per share from AUD0.02 a year ago. This is a second significant strike–as we reported in the Jul. 27 Down Under Digest the managing director of the company unexpectedly resigned for “personal reasons,” effective immediately–on a recommendation and Portfolio addition that’s proven to be egregiously bad, in timing at the very least if not completely in substance.

According to management, “The reduced dividend amount provides [Grange] with additional time to assess the business impact of recent reductions in the global price for iron ore, softening demand for iron ore from China and confirm the impact of re-sequencing of the Life of Mine Plan following the rock slide on the eastern wall of the North Pit in July 2012.”

Grange had also announced the occurrence of a rock slide on the eastern wall of the North Pit at its Savage River mine site on Jul. 18. Geotechnical controls in place at the site highlighted the potential for a partial wall failure and, as a precaution Grange had removed personnel and equipment ahead of the event. Management noted that no personnel were exposed and no injuries were sustained and that resources were redeployed to alternate locations at the mine. Production was maintained at planned levels. “At this stage,” management said in a statement, “the slip is not expected to have a material adverse effect on the operation and it is anticipated that the 2012 production target is not materially at risk.”

We’ll consider the rock slide a foul ball, as it appears no financial damage will accrue. But we won’t wait around for the proverbial “strike three,” however, after the abrupt management change and the dividend cut for a company already with a limited payout history. Sell Grange Resources.

Given the uncertain environment for iron ore pricing amid a continuing Chinese slowdown, I’m no longer comfortable maintaining exposure to a resource company that lacks the diversification of a BHP Billiton Ltd (ASX: BHP, NYSE: BHP) or a Rio Tinto Ltd (ASX: RIO, NYSE: RIO).

Operationally the company appears to have a compelling future. Its primary output is a specialized segment of the market; Grange’s pellets are more efficient than the other forms of iron ore, lumps and fines, the use of which will actually decline over coming decades as global resources decline, even as China’s urbanization continues.

But the concern I noted in the July 2012 Sector Spotlight in which I introduced the stock to the Portfolio about its already sparse dividend history has only increased with this latest reduction.

Grange reported net profit after tax (NPAT) of AUD55.4 million for the six months ended Jun. 30, 2012, down from AUD58 million for the prior six-month period. Magnetite pellet sales of 1.2 million metric ton were up from 700,000 in the first half of 2011, but revenue from mining operations declined 7 percent to AUD193.6 million from AUD208.9 million. The average pellet price received was USD162.84 per metric ton, still a premium to spot prices for regular iron fines but down from USD221.57 per ounce a year ago. Lower pellet prices were offset by below-budget costs and a weaker Australian dollar-US dollar exchange rate on sales.

Grange produced 1.18 million tons of concentrate, up from 851,076 tons in the prior corresponding period. Pellet production also increased, to 1,097,080 tons from 840,018 in the six months to June 2011.

In a statement announcing results Grange noted that Phase 1 of its East Wall remediation work at Savage River was completed during the half year, with access to the main ore zone of the North Pit re-established during the fourth quarter of 2011.

New Managing Director Richard Mehan said that reestablishing this access resulted in cash costs of AUD102.66 per ton of pellets produced, a 22.5 percent improvement from the preceding half year, owing to improved ore grades and consequent concentrate and pellet production.

The rock slide in July brought forward part of the Phase 2 remediation work for the East Wall. This remediation work was scheduled to be completed as part of the 2015 operating plan and was now being rescheduled into the 2013 operating plan.

Mr. Mehan noted that this would require ore to be sourced from other deposits on the mine site on several occasions during the remediation work. It was expected that the redesign and rescheduling plans would be finalized by early September.

Following are dates (confirmed, tentative or estimated) for AE Portfolio earnings announcements. Where companies have reported recently, we’ve included a link to our discussion and analysis of results.

Conservative Holdings

Aggressive Holdings

  • BHP Billiton Ltd (ASX: BHP, NYSE: BHP)–Aug. 27 Flash Alert
  • GrainCorp Ltd (ASX: GNC, OTC: GRCLF)–May 23 Down Under Digest (FY 2012 first half, ended Mar. 30, 2012), Nov. 14, 2012 (estimated, FY 2012, end Sept. 30, 2012)
  • Grange Resources Ltd (ASX: GRR, OTC: GRLLF)–Aug. 31 Down Under Digest
  • Mineral Resources Ltd (ASX: MIN, OTC: MALRF)–Aug. 27 Flash Alert
  • 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)–Aug. 21, 2012 (confirmed, FY 2012 1H, end Jun. 30, 2012)
  • Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY)–Aug. 27 Flash Alert
  • Rio Tinto Ltd (ASX: RIO, NYSE: RIO)–Aug. 10 Down Under Digest
  • WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY)–Aug. 29, 2012 (confirmed, FY 2012, end Jun. 30, 2012)

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