The RBA Cuts and the Aussie Rallies

By David Dittman • December 5, 2012 • Pacific Digest

The Australian dollar has settled down a bit in late Wednesday trade after popping on Tuesday in the aftermath of the Reserve Bank of Australia’s (RBA) 25 basis point cut to its overnight interest rate.

It was a rather stunning reaction to a move that further narrowed the RBA’s benchmark relative to those of other major central banks. It’s now at 3 percent, still among the highest in the world but matching the all-time low established during the heat of the Great Financial Crisis in April 2009.

Yet the aussie spiked from an intraday low of USD1.0412 just before RBA Governor Glenn Stevens’ statement on the monetary policy decision was released at 2:30 pm Tuesday afternoon in Sydney, which was 10:30 pm Monday night on the East Coast of the US, to an intraday high of USD1.0485 before eventually closing the day at USD1.0472.

As of Wednesday afternoon in the US the aussie is worth USD1.0454. That’s 7.7 percent above the 2012 closing low of USD0.9701 established Jun. 1 but 3.4 percent shy of the 2012 closing high of USD1.0809 set Feb. 7. The all-time closing high for the Australian dollar versus the US dollar is USD1.1020, which was reached Jul. 27, 2011.

Traders likely bid up the aussie on speculation that this is the last cut a relatively circumspect RBA will make in its 14-month cutting cycle. Mr. Stevens’ statement, in its concluding paragraph, indeed noted that monetary policy “has become more accommodative” over the past year and that there are “signs of easier conditions starting to have some of the expected effects.”

The RBA’s primary concern, quite apart from the economic outlook for Australia, where “most indicators…suggest that growth has been running close to trend over the past year,” is the potential impact of a persistently high Australian dollar on consumers and businesses.

Mr. Stevens pointed out that “the exchange rate remains higher than might have been expected, given the observed decline in export prices and the weaker global outlook.”

In a speech delivered Tuesday in Sydney RBA Deputy Governor Philip Lowe described the aussie as “uncomfortably high,” a condition that wasn’t helped, at least immediately, by the latest in a series of moves that’s shaved 175 basis points off the RBA’s cash rate since November 2011.

Mr. Lowe shed additional light on the aussie’s strength, noting, “Countries that are in relatively good shape and have not seen large-scale expansion of the central bank balance sheet are experiencing stronger currencies than those that are in relatively poor shape.”

The specter of Europe’s debt crisis continues to hang over the RBA’s outlook for global growth, though the threat of a US fiscal cliff-dive also has Mr. Stevens’ attention. Encouragingly, “Recent data suggest that the US economy is recording moderate growth and that growth in China has stabilised.”

At the same time, broader Asian growth “has been dampened by the more moderate Chinese expansion and the weakness in Europe.” Headwinds have combined to drive price for key Australian commodities down by about 15 percent from peak levels, though even here they’re still “historically high.”

Financial market sentiment globally has also improved from mid-2012, though Europe, of course, “is likely to remain a source of instability for some time.”

Mr. Stevens also noted that “capital markets remain open to corporations and well-rated banks” and that “Australian banks have had no difficulty accessing funding, including on an unsecured basis.” Benchmark interest rates around the world remain at historically low levels, making borrowing conditions for large corporations “attractive.”

Inflation in Australia “is consistent with” the RBA’s medium-term target, “with underlying measures at around 2.5 percent.” The RBA anticipates the July 2012 introduction of a price on carbon emissions to continue to impact prices, potentially driving the headline Consumer Price Index above 3 percent “briefly.”

At the same time, labor market conditions are softening and unemployment is on an uptrend, which is working to contain some cost pressures. Consequently, the RBA forecast that “inflation will be consistent with the target over the next one to two years.”

According to the statement on monetary policy posted on its website:

In determining monetary policy, the Bank has a duty to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these statutory objectives, the Bank has an ‘inflation target’ and seeks to keep consumer price inflation in the economy to 2–3 per cent, on average, over the medium term. Controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the longer term.

This, despite the fact that “the full effects of earlier measures are yet to be observed,” is what gave the RBA the scope for further easing it announced this week. The goal is to “help to foster sustainable growth in demand and inflation outcomes consistent with the target over time.”

Data released following the announcement apparently confirms the RBA’s judgment to use the scope available to it.

The Australian Bureau of Statistics (ABS) reported Tuesday in Sydney that third-quarter gross domestic product (GDP) expanded by 3.1 percent year over year, slowing from a revised growth rate of 3.8 percent for the second quarter. Quarter-over-quarter growth was 0.5 percent, slower than the 0.6 percent rate of growth from the first to the second quarter of 2012.

Household consumption rose 0.3 percent in the third quarter, adding 0.2 percentage point to GDP growth after a 0.7 percent gain in the second quarter. This is the weakest consumption growth since the first quarter of 2010. Machinery and equipment investment grew by 6.2 percent, adding 0.4 point to the expansion. Mining, the biggest contributor to growth, expanded 4.5 percent.

Government spending, meanwhile, fell 0.4 percent, subtracting 0.1 point from overall GDP growth.

The ABS will report labor statistics for November on Thursday in Sydney. Australia’s unemployment rate has risen from 5 percent in April to 5.4 percent in October. The participation rate, meanwhile, has dropped from 65.4 percent in May to 65.1 percent.

Analysts expect the ABS to report the unemployment rate for November to 5.5 percent, with the size of the workforce unchanged at 65.1 percent.

The RBA makes interest rate policy decisions 11 times a year, or once every month except January. Its next announcement will come on Feb. 4, 2013.

The Roundup

US-based global agribusiness giant Archer-Daniels-Midland Co (NYSE: ADM) boosted its all-cash takeover offer for AE Portfolio Aggressive Holding GrainCorp Ltd (ASX: GNC, OTC: GRCLF) from AUD11.75 to AUD12.20 on Dec. 3. The total value of the new offer is AUD2.8 billion, 3.8 percent higher than its opening bid.

According to regulatory filings ADM now holds 19.9 percent of GrainCorp. It has received approval for its bid from the Australian Foreign Investment Review Board.

GrainCorp closed at AUD12.32 on the Australian Securities Exchange (ASX) on Wednesday, which at prevailing exchange rates is about USD12.89.

Separately, the Australian Competition and Consumer Commission announced that it won’t object to GrainCorp’s proposal to offer long-term agreements (LTA) to users of its bulk grain export facilities. GrainCorp will allocate up to 60 percent of its port capacity via LTAs to exporters that are willing to commit to minimum export volumes over a three-year period.

The balance of capacity will remain available to all exporters on an annual basis. The LTAs will have minimum and maximum capacity commitments of 300,000 metric tons and 2 million metric tons, respectively, each year for three years.

The ACCC noted that exporters that indicated they would be likely to agree to an LTA have historically accounted for over 90 percent of exports from GrainCorp’s ports.

The company’s revised Port Terminal Service Protocols will come into effect on Dec. 27, 2012, while it will invite nominations for long-term capacity in February 2013.

Also, Australia’s Federal Parliament has passed Wheat Export Marketing Amendment Bill 2012 which will abolish the Wheat Export Accreditation Scheme as of Dec. 10, 2012, and wind up Wheat Exports Australia on Dec. 31, 2012.

The existing open access arrangement will remain in place until Sept. 30, 2014. At that time an access test that will be abolished, on the condition that a non-prescribed voluntary industry code of conduct covering access to grain export terminals is in place.

If a code is approved, the Australian wheat market will move to full deregulation as of Oct. 1, 2014. All aspects of the industry will be subject to general competition law administered by the ACCC and complemented by the code. If a code isn’t approved the access test will continue.

These are critical developments that will help GrainCorp deliver on its Port Flexibility strategy, which is expected to deliver approximately AUD20 million per year of incremental earnings before interest, taxation, depreciation and amortization (EBITDA) by fiscal 2016.

GrainCorp’s ability to implement long-term port access arrangements is a key positive, as it allows the company to manage its freight/shipping logistics more effectively than the current access scheme. The present arrangement limits the ability to plan and invest on a longer-term basis.

The change should allow GrainCorp to invest in its infrastructure with more certainty, leading to greater efficiencies and eventually boosting the competitiveness of Australian grain. This has significant potential to boost earnings.

Use of LTAs will allow GrainCorp to lock in significant capacity potentially three years in advance, boosting earnings and dividend visibility. Booking port capacity on a longer-term basis will also reduce fixed costs in the company’s port operations and earnings exposure to smaller-than-average east coast crop production in any given year.

On Nov. 15 GrainCorp posted net profit after tax (NPAT) for fiscal 2012 (ended Sept. 30, 2012) of AUD205 million, up 19 percent from AUD172 million in fiscal 2011. 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 as of Dec. 3.

Management rejected ADM’s initial offer, on the basis that GrainCorp isn’t 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.

In the Nov. 21 Down Under Digest we moved GrainCorp from “hold” to “buy” with a buy-under target of USD12.75 based on its solid fiscal 2012 earnings, its fiscal 2013 guidance and its dividend increase. Developments since have further justified this move.

In response to the raised ADM offer GrainCorp management stated, “The GrainCorp board will review the revised proposal and will advise the market in due course. GrainCorp has a unique portfolio of integrated, strategic assets and is confident in its outlook and strategy to continue to deliver shareholder value.”

As we said on Nov. 21, we agree. GrainCorp is a buy on dips to USD12.75 or lower.

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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