In this month’s In Focus feature I discuss a potential rebound for the Australian retail sector, signs of which can be found in solid retail sales for January and a fantastic employment report for February, both of which provide reason for optimism despite apparently deteriorating consumer confidence Down Under.

It may be that a media emphasis on “bad news,” including announcements of major job cuts by several prominent manufacturers based in or with significant operations in Australia, is simply obscuring “good news” from consumers view.

The same survey that showed “pessimists” outnumber “optimists” regarding feelings about the next 12 months found that two-thirds of respondents had heard mostly “negative” economic news.

It should be noted too that the survey was conducted before the Australian Bureau of Statistics reported the second-largest monthly gain of full-time jobs on record for February 2014. Of course the unemployment rate is still hovering around a 10-year high of 6 percent.

But this elevated level is at least due in part to a rise in the labor force participation rate–in other words, more Australians are looking for work, and that’s a good thing.

Australia also posted 2.8 percent gross domestic product (GDP) growth in 2013. Although this remains below the long-term trend rate, growth in December 2013 was 0.8 percent, or 3.2 percent annualized.

The Reserve Bank of Australia has committed to an accommodative monetary policy for the foreseeable future, and the Australian federal government won’t impose an “austerity” budget that would suck some juice out of the economy.

But there are clouds gathering, and they’re looming to Australia’s north.

Renewed fears of a slowing Chinese economy hit global equities markets late this week, exacerbating tensions aroused by Russia’s incursion into Ukraine’s Crimea region.

China’s industrial output, investment and retail sales cooled more than analysts expected in January and February, signaling an economic slowdown that could make the government’s 2014 growth target harder to reach.

According to the National Bureau of Statistics, factory production rose 8.6 percent in the two-month period compared to the prior corresponding period, the weakest start to a year since 2009. Retail sales grew by 11.8 percent, the slowest pace for the period since 2004. And a 17.9 percent increase in fixed-asset investment was a 13-year low.

Previously released data for February showed exports unexpectedly plunged by 18.1 percent, the steepest decline since 2009, during the Great Financial Crisis, producer-price deflation deepened and credit growth trailed estimates.

And other data released by the National Bureau of Statistics showed that the value of homes sold fell 5 percent from the same two months in 2013. That compared with a near doubling of sales in the first two months of 2013 compared to 2012.

The Middle Kingdom is the Land Down Under’s biggest trading partner.

The sense of a slowing China sent the price of iron ore, a key Australian export, to near USD105 per metric ton midweek, while copper suffered another steep leg down.

It’s likely that the Chinese government will find this current slowdown to be too drastic to tolerate, meaning some form of credit easing is soon to follow.

Concerns about China, along with the US Federal Reserve’s tapering of its bond-buying program, are expected to weaken the dollar, but the aussie held up well this week, trading above USD0.90 for the most part.

It’s likely that global markets will continue to be buffeted by ebbs and flows of Chinese data, with volatility exacerbated by the still-evolving situation on the Black Sea.

But there are longer-term plans being made that point to a robust trading relationship between Australia and China in the 21st century.

According to China’s ambassador to Australia Ma Zaoxu, every Australian household is more than AUD13,000 better off each year thanks to trade with the Middle Kingdom.

China’s investment last year in Australia stood at around AUD19 billion. Mr. Ma noted in his address to a Perth business lunch this week. Over the next five years China plans to spend approximately AUD555 billion in outbound foreign investment.

And as China undertakes a broad range of economic reforms, its leadership is eager to speed up negotiations for a free trade agreement with Australia.

Prime Minister Tony Abbott hopes to make significant progress on those negotiations when he visits North Asia in early April.

Negotiations have stretched over several years, but during a recent address Chinese Premier Li Keqiang vowed to accelerate the deal.

Mr. Abbott’s government has said a free-trade agreement with China will bring billions of dollars Australia’s way but will also likely mean making domestic concessions.

One of the Chinese government’s chief concerns after a long period of capital investment and infrastructure buildout is food security. Last week, during the opening session of the National People’s Congress, public reference was made to the Australia-China free-trade agreement, a clear signal that Australia offers a significant part of the answer.

This bodes well for the success of Mr. Abbott’s trade and business mission to China in April, during the landmark Australia in China Week. A free-trade agreement with China is coming soon. Under the right circumstances, it could even be signed the next time President Xi Jinping visits Australia.

But Australia must be prepared for potentially uncomfortable economic developments arising from a comprehensive agreement with China, including joint ventures, outright takeovers of Australian companies, the import Chinese agricultural machinery, huge China-funded infrastructure projects and an influx of Chinese workers.

These are all generally positive in the context of economic development. But there will be some discomfort for Australians.

A 2011 KPMG study of Australia-China trade relations noted that “Chinese investors see the benefit in securing land assets, notably the source of food production.”

In a June 2013 McKinsey report on the Chinese upper middle class said business strategies needed to reflect China’s new constellation of rising incomes, shifting urban landscapes and generational change, since “millions of Chinese are trading up and becoming more picky in their tastes.”

Australian exporters stand to benefit from a more vigorous, formalized trade relationship with China. And an agreement will likely become reality during the life of the Abbott government, because signing it is now as much in China’s national interest as it is in Australia’s.

But Australia will certainly benefit from beefed-up bilateral trade with a nation of 1.3 billion people.

Portfolio Update

Fiscal 2014 first-half earnings reporting season has come to an end Down Under, with generally solid results for AE Portfolio Holdings.

In fact seven Aggressive Holdings announced increased interim dividends. And 12 of the 14 individual Aggressive Holdings–we hold one fund, Aberdeen Asia-Pacific Income Fund (NYSE: FAX)–are paying higher fiscal 2014 interim dividends than they did a year ago.

We are making three moves in the Portfolio this month. JB Hi-Fi Ltd (ASX: JBH) is joining the Aggressive Holdings. And we’re moving on from two Aggressive Holdings that broke down under extremely difficult operating conditions, Ausdrill Ltd (ASX: ASL, OTC: AUSDF) and SMS Management & Technology Ltd (ASX: SMX, OTC: SMSUF, ADR: SMSUY).

highlight dividend-growth and earnings details for AE Aggressive and Conservative Holdings that underlie the Portfolio’s recent outperformance.

We also address the status of a major merger among two Conservative Holdings, APA Group (ASX: APA, OTC: APAJF) and Envestra Ltd (ASX: ENV, OTC: EVSRF), and the acquisition by another Conservative Holding, AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY), of significant power-generation assets in New South Wales.

Portfolio Update highlights dividend-growth and earnings details for AE Aggressive and Conservative Holdings that underlie the Portfolio’s recent outperformance.

We also address the status of a major merger among two Conservative Holdings, APA Group (ASX: APA, OTC: APAJF) and Envestra Ltd (ASX: ENV, OTC: EVSRF), and the acquisition by another Conservative Holding, AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY), of significant power-generation assets in New South Wales.

In Focus

Australia’s retail sector has suffered over the past couple years as mining-boom-driven growth has slowed. Record-low interest rates and a strengthening employment situation may provide the fuel for a durable rebound.

It’s still too soon to say the Australian economy has turned the corner. Some recent data suggest things are getting better, but consumer confidence remains subdued.

But consumers actually spending money is a more reliable indicator of confidence than a reaction survey to a run of excessively hyped up job losses.

And retail sales climbed 1.2 percent during January 2014 from December 2013, the Australian Bureau of Statistics reported on March 5, the strongest monthly gain in 11 months and far exceeding 0.4 percent growth expected by economists. Annual spending growth is now at a four-year high.

It may also be a bit early to say the retail sector has emerged from a long period of weakness. But economic indicators suggest a durable recovery is within sight.

In Focus takes a look at top picks among Australian retail stocks, solid dividend-paying businesses with good track records of performance through the cycle.

Sector Spotlight

JB Hi-Fi Ltd (ASX: JBH, OTC: None) has a proven track record of successfully entering new categories to continually grow and expand its business. The next frontier, following the successful rollout of a web-based presence, is the AUD4.6 billion home appliances market.

New growth areas were significant contributors to comparable sales growth during the six months ended Dec. 31, 2013, as online revenue grew at double-digit rates, its share of total revenue rising by 10 percent.

And the nascent expansion into refrigerators, washers, dryers, dishwasher, ovens and other, smaller convenience items has exceeded management expectations, with strong comparable sales numbers for stores converted to the “JB Hi-Fi Home” concept.omeHom

Continuing growth is rooted in JB Hi-Fi’s success at leveraging its brand and adapting to an ever-changing retail landscape.

And JB declared an interim dividend of AUD0.55 per share, up 10 percent from an interim dividend of AUD0.50 for fiscal 2013.

We have more on JB Hi-Fi in this month’s first Sector Spotlight.

Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY) reported another weak result for its Energy Markets business for the six months ended Dec. 31, 2013.

Origin’s retail transformation and cost-reduction program should drive better operating performance in the Energy Markets business. But fiscal 2014 will likely be tough for energy retailers. We expect to see reals signs of a turnaround in fiscal 2015 and a return to healthy levels of earnings growth in fiscal 2016.

Origin is Australia’s largest vertically integrated energy retailer. Its diverse operations span the energy supply chain, from oil and gas exploration and production to power generation and energy retailing. Its 37.5 percent stake in the Australia Pacific Liquefied Natural Gas (AP LNG) project, which is expected to make first delivery of cargoes in mid-2015, is expected to drive growth for its Exploration and Production unit.

The bottom line is Origin Energy offers compelling long-term value at these levels.

This month’s second Sector Spotlight focuses on Origin Energy.

News & Notes

Australia’s Economy Regains Momentum: Australia’s economy appears to have finally turned a corner, though China’s weakening growth could be a near-term headwind, notes AE Associate Editor Ari Charney.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced reduced dividends during fiscal 2014 first-half earnings reporting season Down Under.

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 113 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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