China’s New Leadership

By David Dittman • November 21, 2012 • Pacific Digest

It happens once every 10 years, and with each passing decade its importance in a global context increases. What was 20 years ago simply a Chinese event 10 years ago was an Asian event.

China’s 18th Communist Party Congress, which officially ended Nov. 15, now sets the stage with new actors who will lead what is already an established economic force but with still vast potential to influence international commerce and geopolitics. For all the esoterics arising out of this transition perhaps the most pressing and pragmatic question is, what will the new leaders do to bolster the Chinese economy in the short term?

As for mechanics, Xi Jinping succeeded Hu Jintao as the General Secretary of the Communist Party, a move that was expected. Mr. Xi was also named chairman of the Central Military Commission, which oversees China’s armed forces.

Current Vice-Premier Li Keqiang is now in position to replace Wen Jiabao as prime minister when government positions are set in the spring of 2013. Besides Mr. Xi and Mr. Li, the members of the elite committee are Zhang Dejiang, Yu Zhengsheng, Liu Yunshan, Wang Qishan and Zhang Gaoli.

Cheng Li, Director of Research at the John L. Thornton Center at the Brookings Institution, suggested that the new lineup is evidence that Jiang Zemin, the 86-year-old predecessor of Mr. Hu, is still an influential force in the Communist Party of China (CPC).

According to a biography compiled by the Xinhua News Agency, the official press agency of the People’s Republic of China, Mr. Xi entered the workforce in January 1969 and joined the CPC in January 1974. He graduated from the School of Humanities and Social Sciences at Tsinghua University with a major in Marxist theory and ideological and political education, has an in-service postgraduate education and holds the degree of Doctor of Laws. Mr. Xi also studied chemical engineering.

Mr. Xi’s Xinhua biography reveals a long and extensive career in the CPC and in China’s bureaucracy. He filled many roles that his predecessor as General Secretary, Mr. Hu, once occupied. His most high-profile accomplishment, one that likely cemented his recent ascendancy to power, was leading preparations for the Beijing Olympics.

According to according to Zheng Yongnian and Chen Gang of the East Asia Institute, describing Mr. Xi’s work organizing the Olympics:

It was a comprehensive mission that involved not only foreign affairs, but also security, logistics, transportation, media management, environment protection and other preparatory work that needed extensive domestic coordination among the military forces (PLA), police, party, and different governmental bureaucracies and localities. 

The number of terrorist plots by Xinjiang Muslim separatists, the protests along the global Olympic torch relay route triggered by the Tibet violent riots in March, as well as the increasing domestic unrest amidst rising inflation and social inequality in 2008 heaped the Games with such high risks and such great international pressure that it was almost impossible for the organizers to handle. With the Party and people having high expectations for success, there was little room for failure.

In addition to his own political successes Mr. Xi benefitted from his deference to CPC elders as well as his father Xi Zhongxun’s friendship and political alliance with Hu Yaobang, a former chairman and general secretary of the party. According to John Dotson at the US-China Economic and Security Review Commission:

Such reporting as is available paints a picture of a man who is very personable; very politically ambitious, with his eyes on a senior leadership post from an early age; and possessed of a confident belief that the children of the CCP’s revolutionary generation are the natural heirs to rule China.

Mr. Xi was a “fortunate son” as his father Xi Zhongxun served as vice-premier. But Xi Zhongxun eventually fell from grace during Mao Zedong’s rule. He was stripped of all his positions and sent to prison.

Xi Jinping was sent to work in the countryside. In a profile in the Los Angeles Times Mr. Xi explained that he despised the fleas, the farm work and the food, prompting him to run away to Bejing. He was captured and returned to exile, but his time in the countryside is said to have been extremely formative.

In a New York Times profile Mr. Xi noted, “Much of my pragmatic thinking took root back then, and still exerts a constant influence on me.”

It is therefore unsurprising that Mr. Xi is expected to tackle income inequality in China. The country’s Gini coefficient is at a range of 0.45 to -0.49. China’s poor are discontent and are seen as a source of instability. Inequality has hurt consumer spending and prevented China from embarking in earnest on its transition away from an export and fixed-asset investment (FAI) led growth model toward one based on domestic consumption.

Mr. Xi, along with Li Keqiang, is likely to follow through on recent efforts by Mr. Hu and Mr. Wen to foster a sense of security among China’s middle and lower-income classes. Specifically, economic policy efforts will be focused on long-term solutions to housing prices, education expenses and provision of health care to a wider swath of the population.

In a recent column for Bloomberg View Peter Orszag, currently Vice Chairman of Global Banking at Citigroup and formerly Director of the Office of Management and Budget under President Barack Obama, surmised that if China is at the point where workers transitioning from agriculture to manufacturing is no longer translating into economic growth–the so-called Lewis Turning point–Mr. Xi will face “an extraordinary economic challenge, with far-reaching geopolitical ramifications.”

Focusing on the “three mountains” of household economics will smooth this turn. Although rebalancing, evolving into a domestic-demand-led model, rising wage demands, changing demographics–specifically an aging population–on top of a slowing global economy are headwinds for China.

It’s important to note, however, that though it will slow from the rapid, double-digit rates achieved during the 2000s China’s new normal pace of GDP growth will be higher than the US, Europe and Japan. China will continue to lead Asian growth, and that still-emerging continent will in turn drive global growth.

The Roundup

AE Portfolio Conservative Holding Cardno Ltd (ASX: CDD, OTC: COLDF) is under a great deal of selling pressure this week after Managing Director Andrew Buckley announced on Tuesday in Brisbane that the company expects net profit after tax (NPAT) for the first half of fiscal 2013 to be in the range of AUD36 million to AUD40 million.

Cardno posted fiscal 2012 first-half NPAT of AUD36.1 million and fiscal 2012 second-half NPAT of AUD38 million. The first half of fiscal 2012 included an additional week.

In a statement released by the company Mr. Buckley noted that market conditions were more difficult than expected resulting in “softer than anticipated” first-half performance. He also noted, however, that Cardno is “seeing healthy organic revenue growth in the order of 7 percent” but that this improving revenue “is not being reflected in our bottom line.”

Rising competition, pressure on fees for services and increasing costs “have restricted profit performance to date.” Mr. Buckley noted that “Australian conditions are especially difficult with all markets, except the gas projects, showing no growth or negative growth.”

Cardno has also been impacted by Superstorm Sandy in the US Northeast. Although first-half results will likely reflect work stoppages, management expects additional work related to the clean-up to flow through in the second half of the fiscal year. Mr. Buckley also noted that the lead up to the US elections had caused some clients to delay projects.

Cardno has also incurred one-off restructuring charges in areas of the business where conditions have been particularly difficult and required significant reductions in overhead expenses.

Mr. Buckley pointed to Cardno’s 7 percent organic revenue growth and the increasing likelihood of stronger-than-expected GDP growth in North America in 2013 as positive signs for NPAT in the second half of fiscal 2013. He also reiterated the fact that Cardno has a “healthy pipeline” of potential acquisitions.

By comparison, Cardno’s fiscal 2012 revenue grew 16 percent from fiscal 2011 to AUD965.8 million. The company has posted eight consecutive years of record profit and earnings per share growth since it listed on the Australian Securities Exchange (ASX) in 2004.

Cardno may not post another record pace of growth. But it is still on track to grow. And it is in solid position to maintain the dividend level it established in fiscal 2012.

Cardno’s board declared a final dividend of AUD0.18 per share, which was paid Oct. 12, 2012. Last year’s final dividend was AUD0.166523; combined with the AUD0.18 interim dividend Cardno paid AUD0.36 in respect of fiscal 2012, up 5.9 percent from fiscal 2011.

The company has never cut its dividend since listing in 2004. There is AUD161 million outstanding on a loan coming due Jul. 31, 2014, though as of Jun. 30, 2012, there was more than AUD100 million in cash on the balance sheet.

Cardno closed at AUD7.80 on Monday, Nov. 19 on the ASX in Sydney. Following the guidance announcement on Tuesday the stock shed 19.2 percent to close at AUD6.30; it fell another 4.6 percent on Wednesday to close at AUD6.01, down 22.9 percent from its weekly closing high and 29.8 percent from the all-time closing high of AUD8.56 it established Aug. 21, 2012.

There’s no question the market is reacting swiftly and surely to any signs of disappointment in a fraught environment, where the real or perceived troubles of individual operating companies are blown up to match the apocalyptic scenarios of fiscal cliff dives being peddled all over financial infotainment TV.

In a recent presentation prepared for investors Cardno noted that “global market conditions are variable and improving slower than expected” but highlighted its view of an “improving” US economy and that “Australian economic growth” continues to be “bolstered by resources and energy.” So the recent commentary on Australian gas projects is rather disappointing, given the outlook expressed on energy. But overall work in hand as of Jun. 30 was AUD671 million.

And Cardno’s diversity, focus on relatively strong markets and the impact of recent acquisitions provide the ability to ride out difficult conditions.

Now yielding 6 percent in the aftermath of this week’s overzealous selling, Cardno is a buy under USD7.50 on the ASX, which equates to AUD7.25 based on prevailing exchange rates.

Aggressive Holding GrainCorp Ltd (ASX: GNC, OTC: GRCLF) has rejected an AUD11.75 per share all cash takeover offer from US-based agribusiness giant Archer-Daniels-Midland Co (NYSE: ADM).

On Nov. 15 GrainCorp posted NPAT for fiscal 2012 (ended Sept. 30, 2012) of AUD205 million, up 19 percent from AUD172 million in fiscal 2011. Earnings before interest, taxation, depreciation and amortization (EBITDA) grew by 18 percent to AUD414 million.

Managing Director Alison Watkins forecast a profit increase of AUD45 million, or 21.9 percent, for fiscal 2013. Ms. Watkins had previously estimated fiscal 2013 profit would rise by AUD40 million. According to management GrainCorp’s strategic growth initiatives are on track to deliver incremental underlying EBITDA of approximately AUD110 million over the next four years.

GrainCorp’s board approved and management announced dividends totaling AUD0.35 per share, including a AUD0.20 per share final dividend and a AUD0.15 per share special dividend. Total dividends for fiscal 2012 of AUD0.65 per share exceed fiscal 2011’s total of AUD0.55 by 18.2 percent.

The final and special dividends will be paid Dec. 17, 2012, to shareholders of record on Dec. 3. Shares will trade ex-dividend as of Nov. 27.

In a statement Ms. Watkins noted that GrainCorp’s performance was driven by strong volumes, amplified by the substantial progress made in capturing value from the company’s integrated assets and global operations.

GrainCorp’s business is ideally positioned to benefit from the growth in global demand for grain and processed grains, with global trade in the company’s core products expected to double by 2050.

GrainCorp’s Storage & Logistics unit handled receivals of 12.2 million metric tons, compared to 14.9 million in fiscal 2011, on top of the 6 million metric tons that carried over from the prior fiscal year. The company posted record export volume of 10.6 million metric tons, up from 8.1 million a year ago.

GrainCorp Marketing reported another strong result, having traded a record 6.9 million metric ton of grain, including increased international sales of 4.4 million metric tons to more than 80 customers in over 25 countries.

GrainCorp Malt reported an 18 percent increase in earnings, driven by increased sales volumes and effective margin management. Malting sales volumes increased to 1.32 million metric tons, and the company’s malting facilities continue to run at strong capacity utilization of 95 percent.

Allied Mills reported continued earnings growth from increased sales of value-added products and reduced operating costs.

The current eastern Australia harvest was generally proceeding positively, with production forecasts averaging about 18.3 million metric tons. Management noted that fiscal 2013 volumes will be supported by strong export demand and an above-average carry-in of 4.3 million metric tons. GrainCorp Malt has forward-sold 1 million metric tons of fiscal 2013 production.

The recently completed acquisition of businesses that now comprise GrainCorp Oils will also contribute to fiscal 2013 growth. Margins for the unit are expected to be in line with historical performance, supported by firm domestic demand, growing international demand for canola oil and larger crop sizes.

ADM continues to express its interest in GrainCorp, but the latter is not in a mode to sell itself. Ms. Watkins has noted that the company’s assets will continue to deliver benefits for investors for years to come. We agree.

Based on fiscal 2012 results, guidance for fiscal 2013 and the increase in the final dividend of 34.5 percent we’re making GrainCorp a buy again, up to USD12.75 on the ASX, which works out to AUD12.31 based on prevailing exchange rates.

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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