One of the great attractions of the Australian share market is that it pays, on average, the highest dividends in the world.

And when the Australian dollar is on the uptick, as it’s been for much of the life of Australian Edge since its Sept. 26, 2011, debut, US-based investors enjoy a double pleasure, as a strengthening currency augments share-price gains and the value of dividends paid in respect of underlying shares.

But now we’re experiencing the downside: Prices in the AE Portfolio and How They Rate tables reflect Australian Securities Exchange (ASX) figures adjusted based on the prevailing Australian dollar-US dollar exchange rate.

In other words, the steep, 10.1 percent decline in the aussie versus the buck from April 11 through June 12 has had a profound effect on capital positions for investors who own Australian stocks.

Meanwhile, although it continued chugging higher a month after the aussie began its swoon, from May 14 through June 13 the S&P/ASX 200 Index has posted its own 10.1 percent decline.

A major factor in the aussie’s descent are recent cuts by the Reserve Bank of Australia (RBA) to its benchmark overnight cash rate, which now stands at 2.75 percent.

That’s an all-time low, lower even than it was at the depths of the Great Financial Crisis. Australia’s central bank is trying to engineer as smooth a rebalancing as possible as the country’s resource-focused economy adjusts to new realities, which include China’s transition from an investment-led to a consumption-led economy.

The RBA’s overnight cash rate remains among the highest in the developed world, which means there’s probably more room for the central bank to cut. And there’s probably more room on the downside for the Australian dollar as well.

But policymakers, most notably RBA Governor Glenn Stevens, must also weigh the potential impact easier credit will have on a housing market already perceived to be in bubble territory.

A softer aussie will most likely lead to an increase in exports and a possible offset to mining-sector weakness. But the depreciation we’ve seen probably represents the lion’s share of the move.

On the other side of the equation is the US dollar. Despite the flurry of worry that punctuated May, there is scant hard evidence supporting the conclusion that US Federal Reserve Chairman Ben Bernanke will even taper large-scale bond purchases from the present USD85 billion per month.

The fact that the personal consumption expenditure deflator, the Fed’s preferred gauge of inflation, rose 0.7 percent in April from a year earlier, the smallest increase since 2009, is more persuasive than a line in a speech.

Despite an attention-grabbing and expectations-beating new jobs number of 175,000 for May, the US unemployment rate actually ticked higher, to 7.6 percent from 7.5 percent. The Fed chairman has said that easy monetary policy would continue until the US unemployment rate declined to 6.5 percent.

And the Federal Open Market Committee has indicated it would likely maintain the federal funds rate near zero “at least through 2015.”

Paradoxically, the selling triggered by the mere specter of the end of the Fed’s easy monetary policy invites even more questions about what will happen when the reality of no more quantitative easing hits. It’s unlikely that an outright QE exit is viable at this stage due to the potential deflationary consequences, including the chances of a major market selloff.

That’s to say nothing of a US economic recovery that remains sluggish. We’ve seen another in a long line of weeks characterized by two-steps-one-and-a-half-steps-back data.

Retail sales, for example, rose by expectations-beating 0.6 percent, as auto sales climbed by 1.8 percent. Weekly jobless claims declined for a second straight week, coming in at 334,000 versus expectations of 346,000.

Small-business optimism hit a one-year high in May, according to the National Federal of Independent Business, mortgage applications rose by 5 percent in early June and household debt-to-disposable income hit its lowest level since 2003.

Finally, Standard & Poor’s revised its outlook on US sovereign credit to “stable” from “negative.”

But industrial production in May came in flat versus expectations of a 0.2 percent increase, the second successive underwhelming print for this report. The University of Michigan Consumer Sentiment Index fell to 82.7 in June from 84.5 in May, while capacity utilization declined to 77.6 percent versus expectations of 77.8 percent.

And furniture sales were down for a fifth consecutive month, which suggests buyers can get into houses with rates still historically low but don’t have enough cash to fill them up. This might be the most indicative of all data points, illustrating at once the Fed-driven nature of this still-nascent recovery, what with 30-year mortgage rates only just jumping close to 4 percent but unemployment stubbornly high and wage growth unsatisfactory.

The employment report that spurred the bond selloff that’s driven yields higher in fact holds another key to why QE will likely continue: Occupations paying below-average wages accounted for more than half of last month’s US payroll increase. This dynamic will rein in at may restrain consumer spending and, with it, the economic recovery.

The aussie is languishing right now. But the fundamentals of the Australian economy still look relatively solid.

For those who’ve been with AE from the beginning, stick with us on our adventure Down Under. For new money, this downturn represents a compelling opportunity.

Portfolio Update

It’s been a rough couple months for the Australian Edge Portfolio.

Prices in the AE Portfolio tables reflect Australian Securities Exchange (ASX) figures adjusted based on the prevailing Australian dollar-US dollar exchange rate. In other words, the steep, 10.1 percent decline in the aussie versus the buck from April 11 through June 12 has had a profound effect on capital positions for investors who own Australian stocks.

Meanwhile, although it continued chugging higher a month after the aussie began its swoon, from May 14 through June 13 the S&P/ASX 200 Index has posted its own 10.1 percent decline.

In some cases we’re happy to see share prices back below buy-under targets. That’s how we view recent action in Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY), for example, which has backed off from a five-year high, and in APA Group (ASX: APA, OTC: APAJF), which has come down from an all-time high.

In other cases we’ve seen not only share-price slumps but also more deterioration in sector fundamentals. In one particular case, moreover, we’ve been apprised of yet another guidance update, this one sufficient to finally push us out of the position.

As we detail in this month’s Portfolio Update, our experience with Newcrest Mining Ltd (ASX: NCM, OTC: NCMGF, ADR: NCMGY) is coming to an end.

We detail three other specific cases where share prices have broken down in a way that certainly demands scrutiny. In each of these three cases we find evidence that these companies are not of Newcrest’s ilk, that management is worthy of a level of continuing trust, that financial and operating results will rebound and that dividends will continue at present rates.

At the other end of the spectrum is Conservative Holding Ramsay Health Care Ltd (ASX: RHC, OTC: RMSYF), which recently established an all-time high. We’re raising our buy-under target on the stock in anticipation of another double-digit dividend increase in August.

Portfolio Update has news and developments for our Aggressive and Conservative Holdings.

In Focus

Record profits, higher dividend payout ratios and low bad debts fueled a strong rally in Australian bank shares through April.

But since April 30 through June 12 Australia’s “Four Pillars”–Commonwealth Bank of Australia (ASX: CBA, OTC: CMWAY, CBAUF), Westpac Banking Corp (ASX: WBC, NYSE: WBK), Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANZBY, ANEWF) and National Australia Bank Ltd (ASX: NAB, OTC: NABZY, NAUBF)–declined by an average of 16 percent. This selloff has brought their forward price-to-earnings ratios back into line with global peers.

The type of growth that attracted yield-seeking capital from abroad is likely to slow due to an aging population and slowing mortgage growth.

Results recently reported by the Four Pillars continue to reflect an economy that’s running below growth rates established during the middle stages of what’s now a two-decades-long streak without a recession.

At the same time, however, the Four Pillars are improving their funding mixes, strengthening their balance sheets and continuing to grow dividends for shareholders. And earnings risk is relatively modest, dividends are safe and yields remain attractive.

In Focus takes a look at four high-quality, high-dividend-paying pillars of the Australian economy.

Sector Spotlight

AE Portfolio Conservative Holding APA Group (ASX: APA, OTC: APAJF) has come well back from an all-time closing high of AUD6.95 on the Australian Securities Exchange (ASX) on May 20, its share price declining by 10.8 percent to AUD6.20 as of the close of trading on June 12.

APA earns a perfect “6” under the AE Safety Rating System. Another mark of its high quality: The stock will join the S&P/ASX 50 Index and the S&P/ASX All Australian 50 Index after the close trade on June 21, 2013, as a result of the quarterly rebalancing process.

A payout ratio well within reason given the cash flow it generates from its fee-based services, a more-than-manageable debt burden, a lack of exposure to commodity-price swings, a solid and growing dividend and its inclusion among the biggest of Australia’s publicly traded companies all suggest a stable business worthy of investors of all risk tolerances.

As an invest-to-grow story, APA’s long-term fortunes are tied to its ability to maintain assets and also add pieces to its portfolio. The recent acquisition of Hastings Diversified Utilities Fund (HDF) has already contributed to operating cash flow, and the complementary infrastructure the deal brought to APA’s table looks likely to boost the bottom line as Australia’s gas renaissance matures.

APA Group–currently yielding 5.7 percent–is a strong buy under USD6.50.

Sector Spotlight has more on APA Group.

AE Portfolio Aggressive Holding Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY) might be the most attractive oil and gas target in the world.

When the key Papua New Guinea Liquefied Natural Gas (PNG LNG) comes online, Oil Search’s output will quadruple to 25.6 million barrels of oil equivalent in 2015 from 6.4 million in 2013. And production may reach 35.6 million barrels by 2020. Oil Search owns 29 percent of PNG LNG.

Revenue is projected to rise 234 percent to USD2.42 billion by 2015, from USD725 million in 2012, faster growth than any of the 33 other exploration and production companies with a market value of over USD10 billion for which estimates are available, according to data compiled by Bloomberg. The overall group is projected for average sales growth of 49 percent.

And Oil Search’s estimates, courtesy of Goldman Sachs, don’t include the potential for expansion to a third and fourth train.

Oil Search is a buy under USD8.

The second of June’s Sector Spotlights focuses on Oil Search.

News & Notes

Finding Strength in Weakness: A strong currency has been a major headwind for the Australian economy. Anxious traders have done the country’s central bank a big favor by pushing the currency lower.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced dividend cuts during fiscal 2013 first-half earnings reporting season Down Under as well as those that reduced earnings guidance in recent weeks. It also includes those that cut payouts during their most recent reporting period but that don’t report based on a July 1-to-June 30 fiscal year or a calendar-year basis.

The ADR List: Many Australia-based companies that list on the home Australian Securities Exchange (ASX) are also listed on the New York Stock Exchange (NYSE) or over-the-counter markets as “sponsored” or “unsponsored” American Depositary Receipts (ADR).

Here’s a list of those companies, along with an explanation of what these ADRs represent.

How They Rate

How They Rate includes 111 individual companies and four funds organized according to the following sectors/industries:

• Basic Materials
• Consumer Goods
• Consumer Services
• Financials, including A-REITs
• Health Care
• Industrials
• Oil & Gas
• Technology
• Telecommunications
• Utilities
• Funds

We provide updated commentary with every issue, financial data upon release by the company, and dividend dates of interest on a regular basis. The AE Safety Rating is based on financial criteria that impact the ability to sustain and grow dividends, including the amount of cash payable to shareholders relative to funds set aside to grow the business. We also consider the impact of companies’ debt burdens on their ability to fund dividends. And certain sectors and/or industries are more suited to paying dividends over the long term than others; we acknowledge this in the AE Safety Rating System as well. We update buy-under targets as warranted by operational developments and dividend growth.

In Closing

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David Dittman
Editor, Australian Edge

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