Australia’s economy surprised economists by expanding at its fastest pace since late 2012. During the fourth quarter, the country’s gross domestic product grew by 2.8 percent year over year, beating the consensus forecast by a significant three-tenths of a percentage point.

On a seasonally adjusted basis, the economy grew 0.8 percent versus the prior quarter, a tenth of a point better than forecast. And the prior quarter’s year-over-year growth was revised higher, to 2.4 percent.

These results caused a spike in the Australian dollar, which currently trades just below USD0.90, up about 3.5 percent from January’s three-year low. In its latest statement on monetary policy, the Reserve Bank of Australia (RBA), which held short-term rates at their all-time low of 2.5 percent, observed that the exchange rate remains high by historical standards.

In other words, the central bank believes a further decline in the aussie will be necessary to spur economic growth. At the same time, the economy’s stronger-than-expected fourth-quarter performance could keep the RBA in a holding pattern on short-term rates, though according to The Australian economists say the central bank will also be focusing on domestic final demand, which fell 1.2 percent over the past year.

For the full year, the economy grew by 2.4 percent, a marked deceleration of nearly 1.2 percentage points from the prior-year, during which the country’s growth was fueled by the resource boom. Last year should be the trough of the current cycle, as private-sector economists forecast economic growth will rise by 2.8 percent and 2.9 percent in 2014 and 2015, respectively, figures which largely comport with the RBA’s estimates.

Though those numbers are still below Australia’s long-term trend of 3 percent annual growth, they would still mean the next two years will be among the strongest since the Global Financial Crisis.

As we detailed in last month’s issue, export growth, particularly for resources such as iron ore, continues to be a big part of the story. In fact, net exports contributed the most toward GDP growth, with exports of goods up 2.7 percent on a seasonally adjusted basis.

Among industries, mining, real estate services, and manufacturing were the key contributors to growth. However, the continuing economic uncertainty is underscored by the decline in gross fixed capital formation, which includes business investment in fixed assets, such as property, plant and equipment.

On a seasonally adjusted basis, this activity dropped by 2.4 percent year over year and 1.2 percent quarter over quarter. Private-sector spending on fixed assets fell 2.3 percent sequentially, driven lower by an 8.8 percent decrease in spending on machinery and equipment, which followed the prior quarter’s 3.5 percent decline in this area.

While business confidence has fallen from September’s post-election high, National Australia Bank’s February survey of business confidence shows that sentiment remains near a three-year high. But that clearly hasn’t translated into growth-oriented capital spending as of yet.

As evidenced by the contribution of real estate services toward GDP, the one area where the RBA’s monetary policy is clearly having an effect is in the real estate market, with January building approvals up 6.8 percent month over month and 34.6 percent year over year.

Given historically low interest rates, we’ve been saying for some time that the housing sector would be the most likely source of economic strength now that the resource boom is on the wane. But we’d also like to see other non-mining sectors drive growth, especially since a number of economists are concerned that a real estate bubble could be forming.

But it can take from 18 to 24 months for the full effects of monetary policy to flow through to the economy. So outside the resource space, we’ll have to content ourselves for now with growth being driven by the sectors most sensitive to interest rates.

Portfolio Update

Aggressive Holdings constituent Ausdrill Ltd (ASX: ASL, OTC: AUSDF) has been on probation for much of the period since we first added it to the Portfolio in March of last year. In making our original recommendation, we assumed the fact that the contract driller had greater exposure to the production side of the resource sector, instead of the far riskier exploration side, meant that it would be well positioned to endure the ensuing decline in mining investment.

At the time, the stock was already a value play, as its shares had fallen 31.6 percent, to AUD2.92, from its all-time high in April 2012. Unfortunately, sometimes what seems to be a value play can be more akin to catching a falling knife.

In this case, Ausdrill’s shares proceeded to plunge nearly 74 percent, finally bottoming near AUD0.76 in early December. The shares have since risen to AUD0.90, for a current market capitalization of just AUD282.6 million. At these levels, the firm trades at roughly one-third of its book value.

But given the resource sector’s boom-and-bust cycle, Ausdrill has been here before, to some extent. Just prior to the onset of the Global Financial Crisis, the company’s shares had an interim peak near AUD2.53 in mid-2008. By March 2009, the stock had fallen 71.3 percent, to AUD0.725. About three years later, they hit an all-time high of AUD4.27, nearly six times the price of the earlier low.

Of course, we initiated our position at a much higher price point. But if the eventual mining rebound takes shares back at least that high, it would still represent a gain of 46.2 percent, not including dividends collected or reinvested along the way.

The steep decline in Ausdrill’s share price and the corresponding jump in yield, to double digits, has caught the attention of some income-hungry investors. However, when earnings per share drop by about 47 percent, as they did in calendar-year 2013, that’s not a recipe for dividend growth. The firm’s total payout in 2013 declined about 17.2 percent from the prior year, and the interim payout of AUD0.025 scheduled for later this month is 54.5 percent lower sequentially and 61.5 percent lower than a year ago.

For the first half of fiscal-year 2014, which ended on Dec. 31, Ausdrill reported AUD424.2 million in revenue, down 26.9 percent from a year ago, though in line with earlier guidance. Earnings per share fell 70.5 percent, to AUD0.0463. However, cash flow from operations rose 24.3 percent to AUD65.7 million.

Given the challenges facing its business, the company is pursuing a strategy of deleveraging, while restricting its capital expenditures. During the past six months, Ausdrill pared debt by AUD48.5 million, and total long-term liabilities now stand at AUD481.4 million, along with AUD56.8 million in cash on its balance sheet. It also limited CAPEX to AUD32 million, down by almost half from the previous six-month period. Finally, management cut the number of employees by nearly 30 percent, to 4,536.

With the curtailment of the industry’s exploration investment, Ausdrill is focused on production-related activities, including drill and blast, contract mining services in Africa, equipment hire and waterwell drilling, which accounted for about 66.1 percent of revenue. Revenue from providing services to gold and copper miners accounted for 65.5 percent of that amount, while services to miners of iron ore, Australia’s largest export, contributed 30.1 percent. By contrast, drilling related to exploration contributed just 9.8 percent toward total revenue.

Although management says iron ore projects coming into production in Western Australia’s Pilbara region, along with higher gold prices, should drive production-related revenue, exploration spending is likely to remain subdued.

Guidance for the full fiscal year through the end of June projects net profit after taxes and before any significant items of AUD35 million on revenue of AUD825 million.

Analyst sentiment is evenly split among the three possible outlooks, with five “buys,” five “holds,” and five “sells.” Three analysts lowered their ratings in the wake of Ausdrill’s earnings release. EVA Dimensions reduced its rating to “overweight,” from “buy,” though for sentiment purposes the new rating is still treated as equivalent to a “buy.” BBY Limited downgraded the stock to “underperform,” or “sell,” from “buy.” And JPMorgan lowered its rating to “underweight,” or “sell,” from “neutral,” or “hold.”

The consensus 12-month target price is AUD1.07, which suggests potential appreciation of 16.3 percent above the current share price. Analysts forecast fiscal-2014 revenue to decline by 25 percent, to AUD849.1 million, while earnings per share are expected to fall by 64 percent, to AUD0.11.

However, moderate sales growth of 6 percent and 3 percent is expected in fiscal 2015 and 2016, respectively. And earnings per share are projected to jump 46 percent next year, to AUD0.16 and another 18 percent the following year, to AUD0.19. But even the latter result is a far cry from the heady results posted during the resource boom. For now, Ausdrill remain a hold.