The Surprising Strength of Australia’s Exports

By Ari Charney • October 18, 2013 • Pacific Digest

Australia’s merchandise trade balance for August fell short of economists’ expectations, but the data revealed a couple of promising trends, particularly for investors in the country’s resource sector.

Although Australia’s trade deficit narrowed considerably in August, to AUD815 million from a revised deficit of AUD1.375 billion the prior month, it was still more than twice as wide as the AUD400 million consensus among the 23 economists surveyed by Bloomberg. Australia tends to run persistent trade deficits, with the balance of trade averaging a monthly deficit of AUD323 million over the past five years and an average monthly deficit of AUD1.2 billion over the trailing year.

To be sure, the dollar value of Australia’s exports of goods and services has climbed fairly steadily since its near-term bottom in September 2012, with the latest monthly figure of AUD27.1 billion showing a 13.7 percent improvement from that low. In fact, the precise figure for August is just AUD829 million below the all-time high set back in September 2011.

However, Australia’s demand for imports of goods and services is currently at a monthly all-time high of AUD27.9 billion. That’s effectively masking the strength of Australia’s exports when viewed through the prism of the country’s balance of trade.

In the months ahead, our expectation is that the depreciation of the Australian dollar should give a competitive boost to exports, while reducing domestic demand for imports, since they’ll be more expensive in local currency terms. Though the Aussie fell as low as USD0.89 in late August, it’s rebounded sharply over the past six weeks, in part due to the US Federal Reserve’s decision to continue easing. The currency recently traded near USD0.96, down 9.4 percent from the year-to-date high in January.

The Aussie should weaken further over the medium term, especially once the Fed finally begins to tighten its monetary policy. The consensus forecast among Bloomberg’s survey of economists is for the currency to decline to USD0.89 next year, with a bottom around USD0.86 by 2017.

Although the value of Australia’s overall monthly exports is rising, that may be largely due to demand for services, as the more commodities-dependent merchandise component has declined 5.3 percent on a year-to-date basis, to AUD249.1 billion. That’s likely a reflection of the broad decline in commodities prices, such as coking coal, thermal coal and gold. Indeed, the Reserve Bank of Australia’s (RBA) Index of Commodity Prices has fallen 3.1 percent over the past year.

The good news is that Chinese demand for Aussie commodities has been surprisingly resilient, despite the deceleration of its economy. While the RBA says China’s gross domestic product (GDP) appears on track to achieve full-year growth of 7.5 percent, that’s well below its torrid pace of growth during the preceding decade.

Nevertheless, China is one of Australia’s few trading partners whose demand for goods has actually increased over the past year, up 1.6 percent, to AUD78 billion. China is by far Australia’s largest trading partner and the aforementioned figure accounts for 31.3 percent of the country’s total merchandise exports on a year-to-date basis. In fact, Australia’s merchandise exports to China are currently at an all-time monthly high of AUD8.7 billion, up an astounding 69.4 percent since their near-term low in September 2012 and well above the five-year monthly average of AUD4.8 billion.

A significant factor in this result has been the rise in the price of iron ore, which is Australia’s top export. According to The Steel Index Ltd’s index of iron ore spot prices that prevail in China, while the current spot price near USD134.40 per metric ton is just below the five-year average, it’s up 55 percent since a near-term low in September 2013. There has been some relief for Chinese customers, however, as the spot price is off 15.4 percent from its year-to-date high.

Meanwhile, Chinese steel producers are in the midst of a massive restocking of the raw material. Though the price of iron ore typically crashes around this time each year, Fortescue Metal Group Ltd’s (ASX: FMG, OTC: FSUMF) CEO Nev Power says that Chinese iron ore inventories are at historically low levels, without much room for further destocking. Power believes that should keep prices from slumping for some time.

Indeed, the total monthly value of Australia’s iron ore exports to China hit an all-time high in August of AUD4.8 billion. That’s well above the average monthly value of AUD3 billion over the past five years. China accounted for 73.3 percent of Australia’s iron exports in August, so once its restocking phase ends, prices will likely fall.

Estimates for when that will happen are likely implicit in analysts’ forecasts. Bloomberg’s survey of 14 institutional metals analysts shows an average price forecast of USD118.26 per metric ton of iron ore for the fourth quarter, with prices more or less holding steady at that level until the third quarter of 2014. At that point, the price of iron ore is projected to weaken slightly to USD112.06 per metric ton, and linger near that level for the final half of the year, before rebounding moderately in the first quarter of 2015.

Analysts forecast Fortescue’s full-year 2014 revenue to rise 53 percent year over year, to AUD12.4 billion, while its earnings per share are projected to jump 65 percent, to AUD0.93. Shares of Fortescue are up nearly 14 percent year to date and currently trade near AUD5.30, just 3.5 percent below their 52-week high, which was hit earlier this week. Fortescue is currently rated a buy below USD4.50 in our How They Rate coverage universe.

By contrast, Atlas Iron Ltd (ASX: AGO, OTC: ATLGF), Australia’s other publicly traded pure-play iron ore producer, currently trades near AUD0.99, down 49.1 percent from its 52-week high, due to a substantial decline in earnings. But analysts forecast full-year 2014 revenue will rise 51 percent to AUD1.1 billion, while earnings per share will jump 135 percent, to AUD0.10. Atlas Iron is currently rated a buy below USD1 in our How They Rate coverage universe.

The Roundup

Our analyses of Portfolio companies’ recent earnings reports are linked below.

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