IMF, PMI Elevate Australia

By David Dittman • November 28, 2012 • Pacific Digest

It’s a single paragraph buried deep in a broader report on the need to expand data-gathering capabilities in order to prevent future global financial crises. But it could have important long-term meaning for the Australian dollar.

An International Monetary Fund (IMF) report dated Aug. 28, 2012, but not released until Nov. 14 has concluded that the aussie, along with the Canadian dollar, should be broken out from the group of currencies reported as “other” in an IMF database that keeps end-of-period quarterly data on the currency composition of foreign exchange reserves.

The IMF database–better known by its acronym, COFER–currently identifies the five major world currencies, the US dollar, the euro, the British pound sterling, the Japanese yen, the Swiss francs, and also tracks “other” currencies.

According to IMF data, “other” currencies now rank third overall in terms of official foreign exchange reserves. “Other” surpassed the Japanese yen to take fourth place during the fourth quarter of 2009 and leapt over the British pound for third place in the third quarter of 2010.

The US dollar and the euro remain in first and second place, respectively, but “other’s” share has grown substantially in the 21st century, from 1.49 percent of allocated reserves in 2000 to 5.49 percent in 2011.

IMF data still show, however, that the “overwhelming proportion” of reserves is still held in the five key currencies. Of the 10 “others” only two–the aussie and the loonie–had more than two countries report holdings of them. It is for this reason that the IMF’s 2012 Review of Data Provision to the Fund for Surveillance Purposes concluded that “these currencies are to be considered for inclusion in COFER reporting.”

Foreign central banks and sovereign wealth funds (SWF) have been making concerted efforts to diversify their reserves, with Australian bonds an increasingly attractive alternative.

These foreign purchases reflect some increase in the supply of bonds to finance government budget deficits. But the share of bonds held by foreigners has jumped from 57 percent in 2006 to 84 percent as of June 2012, and some estimates suggest that up to a third of Australian government bonds are held by central banks aiming to diversify their holdings from the US dollar.

Increased demand from foreign entities is recognition of Australia’s strength relative to the rest of the developed world. This demand reflects Australia’s comparatively low public debt (the federal government’s fiscal position is forecast to move back into surplus in the current fiscal year), strong growth, high interest rates and the reduced global pool of AAA- rated assets.

According to the IMF, “Any currency added to COFER reporting should meet the definition of a convertible currency that is freely usable for settlements of international transactions.” What this means is that the aussie and the loonie are growing in importance as foreign exchange reserves climb.

Investors can mimic the behavior of foreign central banks via Aberdeen Asia-Pacific Income Fund (NYSE: FAX), one of only five out of a universe of 106 US closed-end funds with a “Gold” rating from investment research firm Morningstar. This fund is the only one of its kind that enables US-based investors to access developing Asia’s debt markets as well as to Australia’s.

Australian government and corporate bonds account for 42 percent of the fund’s holdings, and the fund’s currency exposure is primarily to the Australian dollar at 44.5 percent.

Aberdeen Asia-Pacific is a compelling option for income-focused investors who also seek some protection from the impact of a deteriorating US dollar. At the same time you’ll get paid USD0.035 per share per month, an annualized dividend rate of USD0.42 per share. That works out to a yield of 5.3 percent based on the fund’s Nov. 28, 2012, closing price.

The aussie has climbed from a closing value of USD1.0376 on Nov. 14 to USD1.0476 as of this writing. But this roughly 1 percent rise likely has as much or more to do with increasing optimism about China’s economy and on the possibility of a global-growth-saving deal that helps the US avoid this melodramatic “fiscal cliff” described by tax-cut expirations and federal spending cuts legislated by Congress to happed on Jan. 1, 2013.

The IMF report’s recommendation is also merely recognition of what’s been happening over the last decade-plus, first as a resource-hungry world turned to Australia and Canada beginning in the late 20th century and continuing well into the first decade of the 21st century and then as these countries relative prudence ahead of the 2007-09 crisis left them in much better fundamental condition vis-à-vis the rest of the developed world and made their assets that much more attractive.

But it does also suggest that the aussie and the loonie–and Australia and Canada–have staying power on the global economic stage.

Flashing Expansion

The HSBC Flash China Manufacturing Purchasing Managers Index (PMI) registered its first “expansion” reading since November 2011, rising to 50.4 in November 2012 from a final reading of 49.5 in October.

Output rose from 48.2 to 51.3, the highest reading for this component since October 2011, and new export orders jumped to 52.4 after wallowing below 50 for six consecutive months. Although new orders declined from 51.2 to 50.2, finished goods inventory rose from 48.4 to 49.5. The new order minus inventory measure declined from 2.8 to 0.7.

HSBC’s PMI reports are based on data compiled from monthly replies to questionnaires sent to purchasing executives for more than 400 Chinese manufacturing companies. The Flash PMI is based on approximately 85 percent to 90 percent of the total PMI’s respondents. A reading above 50 indicates an overall increase in the PMI or in a particular component, or “expansion,” while a reading below 50 indicates an overall decrease, or “contraction.”

HSBC will release its final, unofficial reading for November on Dec. 3.

In a press release announcing the result HSBC’s chief economist for China and co-head of its Asian economic research effort Hongbin Qu noted, “As November’s flash reading of HSBC manufacturing PMI bounced back to the expansionary territory for the first time in 13 months, this confirms that the economic recovery continues to gain momentum towards the year end.”

He also cautioned that “it is still the early stage of recovery and global economic growth remains fragile” and advocated “a continuation of policy easing to strengthen the recovery.”

The official PMI will be released by the China Federation of Logistics & Purchasing and the National Bureau of Statistics on Dec. 1. Manufacturing PMI for October was 50.2, up from 49.8 for September and 49.2 for August.

HSBC’s unofficial sample, which has lagged the official reading for months because it focuses on smaller manufacturers as opposed to the large, state-owned enterprises that dominate the official data, is further confirmation that the world’s second-largest economy has gathered some steam into the fourth quarter.

The Roundup

Here’s what’s happening around the AE Portfolio.

Conservative Holdings

AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY) Managing Director Michael Fraser said in a Nov. 21 interview with Bloomberg that the company’s Macarthur wind farm, a AUD1 billion, 420 megawatt project, will come in on budget and may be ready for operation in February 2013, ahead of the scheduled March 2013 opening.

Macarthur will be the biggest wind project in the Southern Hemisphere and will help extend AGL’s lead as the top renewable energy producer in Australia. That’s a key characteristic as the country’s continues its efforts to limit carbon emissions and moves toward a government goal of deriving 20 percent of its power from renewable energy by 2020.

As of Jul. 1, 2012, Australia is charging about 300 of its largest polluters a fixed price of AUD23 per ton of carbon emitted. The country will transition to a market-based system in 2015. Efforts to export liquefied natural gas (LNG) to Asia at prices linked to the per-barrel price of oil are also putting upward pressure on prices on the east coast of Australia.

Mr. Fraser noted that gas prices there are forecast to double to about AUD8 per gigajoule in about 2016 or 2017 from about AUD4 gigajoule. This could mean the convergence of the cost of gas-fired power stations with that of wind.

AGL Energy is a buy under USD16 on the Australian Securities Exchange (ASX) using the symbol AGK, on the US over-the-counter (OTC) market using the symbol AGLNF or via its US American Depositary Receipt (ADR) which is worth one ordinary ASX-listed share and is traded on the US OTC market.

CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY) boosted its US dollar profit outlook for fiscal 2013, as management now expects net profit after tax (NPAT) to grow by approximately 20 percent in constant currency terms despite increased competition.

In August, when CSL reported NPAT of USD1.024 billion, management guided to fiscal 2013 profit growth of 12 percent.

In a statement Managing Director Dr. Brian McNamee noted that the revised outlook is rooted in strong performance at the company’s CSL Behring unit, including increased sales, a better sales mix and improved efficiencies across the supply chain. CSL also expects higher-than-anticipated royalty income from sales of Gardasil

The stock closed at AUD50.30 on Wednesday in Sydney, or about USD52.70 based on the prevailing Australian dollar-US dollar exchange rate as of this writing. That’s more than 50 percent above our stated buy-under target of USD35.

CSL, one of the first two stocks we added to the AE Portfolio after the introduction of our “Eight Income Wonders from Down Under” in the September 2011 debut issue, has generated a total return of 72.46 percent in US dollar terms since we first recommended it on Oct. 14, 2011. At these levels it is effectively a hold.

Ramsay Health Care Ltd (ASX: RHC, OTC: RMSYF) has posted a 10.73 percent rally on the Australian Securities Exchange (ASX) in November; the stock is up 11.69 percent if you include the impact of a strengthening Australian dollar versus the US dollar this month.

Ramsay, which had been sluggish since we added it to the Conservative Holdings in the September 2012 issue, has now generated a total return of 8.02 percent in US dollar terms as a Portfolio member.

Momentum is based on management’s affirmation of fiscal 2012 earnings growth during the company’s Nov. 15, 2012, annual general meeting. Noting strong industry fundamentals and continuing implementation of its growth strategy, management reaffirmed its target range for core NPAT and core earnings per share growth of 10 percent to 12 percent for fiscal 2013.

Management also noted that AUD20.6 million in new brownfield developments had been approved during the September quarter. Ramsay’s profit growth in recent years has been based on its ability to acquire, update and operate existing facilities while maximizing efficiencies and margins. The stock is a buy under USD26.

Wesfarmers Ltd (ASX: WES, OTC: WFAFF, ADR: WFAFY), a new addition to the AE Portfolio Conservative Holdings as of the November 2012 issue, has had its issuer and senior unsecured long-term debt rating upgraded by Moody’s Investor Service from Baa1 with a “positive” outlook to A3 with a “stable” outlook.

Wesfarmers Finance Director Terry Bowen attributed the upgrade to the company’s “operational performance and continued improvements in (its) financial profile.”

Wesfarmers’ credit rating from Standard & Poor’s remains A- with a “stable” outlook.

Wesfarmers is a buy up to USD36 using the symbol WES on the Australian Securities Exchange (ASX) or the symbol WFAFF on the US over-the-counter (OTC) market.

Wesfarmers also trades as an American Depositary Receipt (ADR) on the US OTC market under the symbol WFAFY. The ADR represents 0.5 shares of the ASX-listed stock. Owning the ADR conveys all the same benefits as owning the ASX- listed WES share or the US OTC-listed WFAFF share, including the effects of a rising Australian dollar. Wesfarmers’ US OTC-listed ADR is a buy under USD18.

Aggressive Holdings

Mineral Resources Ltd (ASX: MIN, OTC: MALRF) Managing Director Chris Ellison hinted that the company will likely spin out its iron ore assets “at some point.”

Over the past 3 years the company has built a substantial iron ore business and expects to export more than 3.7 million metric tons from its Pilbara and Yilgarn operations in fiscal 2013. That figure will rise to 6 million metric tons in fiscal 2014.

But Mr. Ellison, speaking at Mineral Resources’ Nov. 22 annual general meeting, noted that mining services would always be the company’s primary business.

Mineral Resources exports iron ore from both Port Hedland and Kwinana and its primary asset is the Carina iron ore mine in the Yilgarn, which it acquired in its deal for Polaris Metals in 2010. But port space at Kwinana is limited, and Mr. Ellison said the timing of the spin out of its iron ore business could depend on the proposed expansion of the Esperance port.

Mr. Ellison added that he expects Mineral Resources’ production from the Pilbara to rise in January, when its Phil’s Creek mine begins to ship ore.

Against an otherwise gloomy backdrop painted by other mining services companies, Mineral Resources expects a “bumper” year because its build, own and operate model is more attractive to the bigger miners as they pulled back on capital expenditure.

Mr. Ellison also noted that the company will expand its mining services offerings to engineering, procurement and construction management services.

Mineral Resources is a buy under USD13 on the ASX using the symbol MIN and on the US OTC market using the symbol MALRF.

WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY) announced two contract wins in recent weeks, a three-year deal with LukOil Mid-East Ltd to provide project management services for the West Qurna-2 oil field development project in Iraq and, in a joint venture with Abdulaziz Kamel & Partners Co and Alrabiah Consulting & Engineering Services, a general engineering and project management service contract (known in the industry as “GES+”) by Saudi Arabian Oil Company (Saudi Aramco) with a base term of five years with an option for up to three additional years.

WorleyParsons will provide project management, technical and construction supervision personnel to support the West Qurna-2 engineering, procurement and construction (EPC) activities. The company will also develop a project management system to effectively manage and control the project during its execution from design engineering through to commissioning.

The contract covers a number of facilities for the West Qurna-2 project, including central processing facilities, gas treatment facilities, well pads, produced water treatment and all related

offsites and utilities.

Management expects revenue from this contract of USD82 million over the three years.

The scope of the Saudi Aramco work includes all engineering, design and project management and related services, including front-end engineering design (FEED) services, detail engineering design, planning, scheduling, estimating, procurement services and construction management.

All told the work will involve “half a million to a million man-hours per year in services for Saudi Aramco, employing some 250 to 500 people.”

Management didn’t provide a revenue estimate for this contract.

WorleyParsons is a buy up to USD30 using the symbol WOR on the ASX or the symbol WYGPF on the US over-the-counter (OTC) market.

WorleyParsons also trades as an American Depositary Receipt (ADR) on the US OTC market under the symbol WYGPY. The ADR represents one share of the ASX-listed stock. WorleyParsons’ US OTC-listed ADR is a buy under USD30.

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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