Stability Now

By David Dittman • November 1, 2012 • Pacific Digest

As of 4:00 p.m. Eastern time in the US Thursday afternoon, or 7:00 a.m. Friday morning in Sydney, the S&P/Australian Securities Exchange 200 Index (ASX) was poised to open almost 1 percent higher on the last trading day of the week.

US equity indexes, including the S&P 500, the Dow Jones Industrial Average and the Nasdaq Composite, all closed up more than 1 percent Thursday, while the S&P/Toronto Stock Exchange Composite added about 0.6 percent.

Rallies abound because recent data–from North America as well as emerging Asia–suggest stabilization, at least, for countries critical to global growth, including the US, still the world’s biggest economy, and China, still the most important engine of expansion.

In the US, the revamped report from the research unit of payroll processor Automatic Data Processing Inc (NYSE: ADP) showed that 158,000 private-sector jobs were added in October, up from a revised 88,200 in September.

(The September revision from 162,000 resulted from a change that better aligns this survey’s approach with the methodologies employed by the monthly employment report proffered by the US Dept of Labor.)

It’s the biggest gain for the ADP Research Institute survey since February. Of the 158,000 jobs created, 144,000 came from services and 14,000 from goods production, of which 23,000 were construction jobs. But manufacturing jobs contracted by 8,000.

Because the data ADP Research Institute relies upon are derived from the actual payroll slips its parent processes, this should be an accurate measure of employment.

The website The Daily Jobs Update provided further reason for confidence in the Bureau of Labor Statistics’ monthly non-farm payroll report due out Friday morning, as its research found that “over the past three weeks, the year-over-year growth rate of federal withholding-tax collections was a respectable 4.72 percent.”

In addition, US manufacturing expanded more than forecast, consumer confidence rose to a four-year high, and fewer Americans filed claims for unemployment benefits.

The Institute for Supply Management’s factory index rose to a five-month high of 51.7 in October from 51.5, The Conference Board’s sentiment index increased to 72.2, the highest since February 2008, and  applications for jobless benefits fell by 9,000 to 363,000 in the week ended Oct. 27, the Labor Dept reported.

This is all positive for the US, of course, and for the global economy, which, for better or worse, still relies upon America and its consumers as a “market of first and last resort” for goods of all types.  A stabilizing and improving US labor market is good for US consumption, which in turn is good for the global exporters. These are the simple building blocks of a sustainable recovery.

As for the Middle Kingdom, the National Bureau of Statistics of China and the China Federation of Logistics and Purchasing reported Thursday that the official manufacturing Purchasing Managers Index (PMI) rose to 50.2 in October to 50.2, up from 49.8 in September.

PMI readings below 50 show contraction, while readings above 50 indicate expansion. October’s marked the first official PMI “expansion” reading since July.

China’s official Purchasing Managers’ Index rose to 50.2 in October, up from 49.8 in September, suggesting an increase in manufacturing activity.

Meanwhile, the “unofficial” PMI report from HSBC rose to 49.5 in October from 47.9 in September. This was better than the HSBC Flash China PMI of 49.1 that we discussed in this space last week.

The difference between the official and expanding PMI and the unofficial and still-contracting-but-getting-better HSBC PMI suggests that large manufacturers in China (read: state-owned enterprises, or SOEs) have started to expand their manufacturing activities, while medium and small enterprises (read: privately owned) continue to keep their powder dry.

The HSBC survey is based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 430 manufacturing companies–but not SOEs. Both it and the official reading do, however, lend further evidence to the case that China is at least stabilizing.

The rise in the final HSBC PMI compared to the flash reading is encouraging because it confirms to some extent the more bullish tone established by the “expanding” official reading and it could suggest accelerating growth within the month.

As for implications for future policy, the ruling Chinese Communist Party will hold its 18th Congress meeting on Nov. 8 for the once-a-decade leadership handover. Membership of the Politburo Standing Committee is likely settled at this point, which leaves room Mainland leaders to re-focus on the economy.

Recent data provide some confirmation that China’s efforts to boost the economy, including the acceleration of large projects beginning last spring, have begun to take effect and likely argue against more significant stimulus. But further easing of reserve requirements by the Peoples Bank of China may be in the offing. Growth is not yet assured and officials, new to office, have no room for complacency.

Already half a decade ago, in 2007, China surpassed Japan as Australia’s largest trading partner. The Middle Kingdom is the largest destination for exports from the Land Down Under, and it’s the largest source of Australian imports. Overall Australia is China’s eighth-largest trading partner.

Despite the recent slowdown, China’s growth plan for 2011 through 2015 period and its increasingly surging demand for commodities such as iron ore and coal will continue to spur growth in Australia.

Although demand for minerals has softened in the short term, Chen Yuming, China’s Ambassador to Australia, recently asserted that “from a long-term perspective, it is unnecessary for us to worry about the Chinese economy and its demand or to hold any doubts about the closer bilateral economic and trade relations between China and Australia.”

“China will continue to be the growth engine of the Australian and global economies in the next five years,” said Mr. Chen in early October.

The Roundup

AE Portfolio Conservative Holding APA Group (ASX: APA, OTC: APAJF), at its annual general meeting last week, reported that with all key conditions satisfied or waived it had declared its offer for Hastings Diversified Utilities Fund (ASX: HDF) “unconditional” and noted that as of Oct. 25 it owned 82.7 percent of the target.

Management anticipated crossing the 90 percent ownership threshold “over the next few days,” at which point it can proceed to compulsorily acquire the remaining 10 percent of Hastings. On Oct. 31 APA extended the offer period for its bid for all of the HDF securities it doesn’t own to 7:00 p.m. (Australian Eastern Daylight Time) on Nov. 14, 2012.

In order to get Australian Competition and Consumer Commission approval APA is required to sell Hastings’ Moomba to Adelaide Pipeline System. Nevertheless, the remaining assets–the South West Queensland Pipeline and the Pilbara Energy Pipeline–will enhance APA’s network and reinforce its market-leading position in Australia.

Once the transaction closes, APA will own or operate a unique footprint of 14,000 km of gas pipelines.

Management noted during its presentation that “the business is performing in line with our expectations and guidance” in the first quarter of fiscal 2013. Chairman Len Bleasel also noted that “as a consequence of our offer for HDF being declared unconditional” guidance for fiscal 2013 earnings before interest, taxation, depreciation and amortization (EBITDA) “is altered.”

Specifically, APA now expects fiscal 2013 EBITDA in the range of AUD660 million to AUD670 million, up from a prior forecast of AUD540 million to AUD550 million. APA posted fiscal 2012 EBITDA of AUD526 million, which was up 6.9 percent from fiscal 2011.

Assuming it meets the midpoint of its new target range fiscal 2013 EBITDA growth will be 26.4 percent.

Management noted that this revised guidance doesn’t take into consideration any earnings that will come from HDF once HDF’s operating results are consolidated into APA’s books. It merely reflects the increase in APA’s ownership stake from 20.7 percent at the time its original offer for HDF was made.

APA will provide a further EBITDA update once it’s had access to financial information sufficient to allow it to accurately assess that specific impact.

Management reiterated its previous guidance for fiscal 2013 distributions of “at least 35 cents per security.”

Earlier this week two large block trades, one of 15 million shares at AUD4.98 per, another of 10 million shares at AUD5.02, crossed the wire. These high-volume trades carried APA to a four-month closing high of AUD5.16, or USD5.35, on Oct. 31 on the Australian Securities Exchange.

Still yielding 6.8 percent as of this writing after a Nov. 1 ASX close of AUD5.11, or USD5.31, APA Group is a strong buy up to USD5.50.

Note that APA’s US over-the-counter (OTC) listing, APAJF, closed at USD5.45 on Nov. 1.

Fellow Conservative Holding AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY) also provided fiscal 2013 at its annual general meeting last week.

AGL’s fiscal 2013 forecast is for underlying profit in the range of AUD590 million to AUD640 million, compared with AUD482 million in fiscal 2012. “Underlying profit” is statutory net profit after tax (NPAT) adjusted for significant items and changes in the fair value of electricity derivatives.

Earnings are expected to skew to the second half of the fiscal 2013, with approximately 55 percent of full-year profit being recognized in the six months from Jan. 1, 2013, to June 30, 2013.

This is largely due to the imposition of the carbon tax as of Jul. 1, 2012, but recovery of that cost from retail customers not commencing until after that date. This will most significantly affect the split of earnings for AGL’s retail business, with approximately 65 percent to 70 percent of the full-year profit to be recognized in the second half of the year.

Driving the expected increase in full-year fiscal 2013 earnings is the contribution from the Loy Yang A power station that AGL acquired on June 29, 2012. Guidance also includes the anticipated impact of the adverse regulatory pricing decision of the Queensland Competition Authority (QCA) in Queensland and the draft regulatory pricing decision of the Essential Services Commission of South Australia (ESCOSA) in South Australia.

If the draft South Australian decision to reduce the price of electricity by AUD27.20 per megawatt-hour is ultimately confirmed, it will reduce AGL’s fiscal 2013 underlying profit by approximately AUD45 million. On a full-year basis both decisions together would reduce underlying profit by approximately AUD60 million.

AGL has “substantially” reduced its marketing activities in Queensland as a result of the QCA decision, including the removal of all door knockers, who engage in person-to-person marketing efforts on the ground, and the cutting of discounts available to customers. Management noted “a substantial reduction in churn rates, retail competition and customer choice” in the Queensland market.

AGL announced at its annual general meeting that it will take similar steps in South Australia, with a significant scaling back of marketing activity, including cessation of all door-knocking activity. AGL will also suspend any further investment in power generation, including renewable energy, in South Australia as a result of ESCOSA’s draft decision.

AGL is reviewing its future level of retail activity in New South Wales, including consideration of whether to suspend door-knocking activities, as a result of the potential knock-on effects of the ESCOSA and QCA decisions on regulatory pricing decisions and competitive conditions in that state.

AGL has added approximately 35,000 new electricity customers in New South Wales in the first quarter of fiscal 2013, but management reiterated its stance that its level of activity will only continue while it makes economic sense for shareholders.

AGL Energy is a buy under USD16 on the ASX using the symbol AGK and on the US OTC market using the symbol AGLNF.

AGL also trades on the US OTC market as an American Depositary Receipt (ADR). AGL’s ADR, which is worth one ordinary ASX-listed share, is also a buy under USD16.

Following are links to our discussion and analysis of the most recently announced financial and operating results for Portfolio Holdings.

Conservative Holdings

Aggressive Holdings

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