The first quarter of 2014 is in the books.

Australian stocks, as indicated by the S&P/Australian Securities Exchange 200 Index, posted fair-to-middling results, with a total return in local terms of 2.1 percent.

Accounting for the gain in the Australian dollar versus the US dollar, the S&P/ASX 200 is up 6 percent.

Both return numbers best the S&P 500 Index’s 1.8 percent and the MSCI World Index’s 1.4 percent.

The Australian Edge Portfolio has fared well in this environment, with an average total return of 5.4 percent in US dollar terms.

Our 15 Conservative Holdings have set a solid pace, posting an average gain including dividends of 8 percent, while the 15 Aggressive Holdings, including recently sold Ausdrill Ltd (ASX: ASL, OTC: AUSDF) and SMS Management & Technology Ltd (ASX: SMX, OTC: SMSUF, ADR: SMSUY) and recently added JB Hi-Fi Ltd (ASX: JBH, OTC: JBHIF), are up an average of 2.8 percent.

Ausdrill, with a loss of 17.1 percent, and SMS, with a loss of 6.4 percent, had been obvious drags on the Aggressive Holdings since well before the first quarter of 2014.

JB Hi-Fi, buoyed by another solid reading on Australian retail sales, has generated a total return of 13.5 percent in the four short weeks it’s been a member of the AE Portfolio. But for the first quarter the electronics retailer posted a loss of 6.7 percent. The early 2014 selloff was one of the reasons we finally pulled the trigger and added the stock to the Portfolio.

Top longer-term Aggressive Holdings during the first three months of the year include Amalgamated Holdings Ltd (ASX: AHD, OTC: None), with a total return in US dollar terms of 12.3 percent also enjoying the benefits of a resurgent Australian consumer.

Sydney Airport (ASX: SYD, OTC: SYDDF) actually posted the top first-quarter total return performance among Aggressive Holdings at 14.5 percent. Spark Infrastructure Group (ASX: SKI, OTC: SFDPF), subject of one of this month’s Sector Spotlights and a “best buy” for April, still has considerable upside despite a 12.8 percent US dollar total return from Dec. 31, 2013, through March 31, 2013.

WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY), which this week announced a restructuring designed to improve margins and operational performance, posted a first-quarter loss of 3.4 percent.

The leading Conservative Holding for the first quarter was private hospital owner/operator/developer Ramsay Health Care Ltd (ASX: RHC, OTC: RMSYF), with a total return of 16.4 percent. Australand Property Group (ASX: ALZ, OTC: AUAOF), supported by takeover speculation, posted a total return of 13.8 percent. Fellow A-REIT GPT Group (ASX: GPT, OTC: GPTGF), coming off a 14.9 percent loss in 2013 and looking like a good value, posted a gain of 11.8 percent.

Engineering and environmental consultant Cardno Ltd (ASX: CDD, OTC: COLDF), continuing its comeback after a difficult 2013, was up 11.7 percent for the first three months of the year. Cardno is the subject of this month’s other Sector Spotlight, which means it’s one of our two top picks for new money right now.

Pipeline owner/operator APA Group (ASX: APA, OTC: APAJF), held up in its attempt to buy the 33 percent of fellow natural gas infrastructure company and Conservative Holding Envestra Ltd (ASX: ENV, OTC: EVSRF), generated a total return of 11.3 percent during the first quarter.

Transurban Group (ASX: TCL, OTC: TRAUF) was the sixth and final Conservative Holding to post a double-digit first-quarter total return, at 10.2 percent. And this week the toll road owner/operator/developer reported proportional toll revenue growth of 12.7 percent for the quarter ended March 31, 2014.

Conglomerate Wesfarmers Ltd (ASX: WES, OTC: WFAFF, ADR: WFAFY) was the only Conservative Holding to post a negative total return in the first quarter, with a loss of 0.9 percent.

China’s Syndrome

The possibility that growth will come in below the government’s stated target has inspired another round of policy movies designed to support growth in China.

In early April the Chinese government introduced  a new set of stimulus measures, including incentives for spending on railways and other construction projects, as evidence mounts that the Middle Kingdom wont’ meet Premier Li Keqiang’s 7.5 percent gross domestic product (GDP) growth target for 2014.

The State Council announced a plan last week to sell USD24 billion of US Treasury holdings to build railways in the underdeveloped central and western regions of China. It also plans a USD35 billion fund dedicated to rail financing as well as an increase in financing to build low-cost housing.

The Asian Development Bank recently issued a report estimating that Chinese GDP grew by 7.7 percent during the fourth quarter of 2013 but would slow to 7.5 percent in 2014, even amid higher social spending.

GDP is forecast to decline again to 7.4 percent in 2015, even though the rest of the world is expected to recover and increase its demand for Chinese goods.

China’s manufacturing purchasing managers’ index (PMI) rose to 50.3 in March from 50.2 in February, according to the National Bureau of Statistics and the China Federation of Logistics and Purchasing.

The March PMI was just above a consensus forecast of 50.2. Any figure above the 50 mark indicates expansion of manufacturing activity, while anything below 50 signals contraction.

The rise in the official PMI contrasts with a weak preliminary reading of the HSBC Flash PMI, which dropped to an eight-month low of 48.1 in March.

China will also extend a preferential tax policy to more small companies and increase investment in its program to replace shantytowns with more stable housing. Accelerating shantytown transformation and getting millions of residents into modern buildings should drive investment and promote consumption.

The government has allocated more than CNY1 trillion (USD178 billion) this year to redeveloping shantytowns.

Railways are a priority to link underdeveloped regions to the booming coastal cities and boost growth in central and western China. The State Council announced plans to build more than 6,600 kilometers of new rail lines this year.

This is not quite a repeat of previous occasions when China stimulated growth, as the scale of the stimulus is modest, likely aimed at smoothing GDP growth at around the 7.5 percent target.

These efforts are aimed at balancing growth and jobs in the short-term, boosting long-term growth prospects and mitigating financial risks.

Any expectation of a stimulus package similar in magnitude to the kind China unleashed following the 2008 Global Financial Crisis/Great Recession is unlikely to be met.

Nevertheless, the mini-measures introduced last week should provide some support for industrial resource prices, including iron ore, copper and coal.

Up the Aussie

The Australian dollar surged to a 2014 high on April 10 after the Australian Bureau of Statistics (ABS) reported that the unemployment rate Down Under declined to 5.8 percent in March from an upwardly revised 10-year high of 6.1 percent in February. Economists expected a 6.1 percent jobless rate in March, though the better-than-expected figure is likely, at least in part, a function of the workforce participation rate declining to 64.7 percent from 64.9 percent in February.

The number of new jobs created across the economy since January grew to 88,000 in March.

The Australian dollar rose by more than USD0.005, touching a fresh 2014 high of USD0.9444, up from USD0.9372 just before the ABS employment report was released.

Reserve Bank of Australia Governor Glenn Stevens noted last week that “green shoots” in the economy were only just beginning to emerge.

With the outlook in China, Australia’s biggest trading partner, also uncertain the RBA is likely to keep its benchmark rate at the current record-low level of 2.5 percent through 2014.

Portfolio Update

AE Portfolio Aggressive Holding BHP Billiton Ltd (ASX: BHP, NYSE: BHP) continues to adjust to the end of the global commodity super cycle and a slower rate of growth.

The world’s largest mining and resource company remains well positioned to generate strong revenue, earnings and cash flow that will support a stepped-up capital management program.

As new CEO Andrew Mackenzie continues to focus on cutting costs and reducing capital expenditures, investors will likely benefit from a more aggressive dividend policy.

According to multiple reports, the process of establishing a leaner company is likely to accelerate.

On the chopping block are aluminum, manganese and nickel assets. The end result would be a company focused on four core resources, iron ore, petroleum, coal and copper, and a potential long-term “fifth wheel,” potash.

Management confirmed the essentials reported by financial media in an April 1 statement, noting that “the simplification of our portfolio is a priority.”

BHP also stated that a portfolio “focused on our major iron ore, copper, coal and petroleum assets would retain the benefits of diversification, generate stronger growth in free cash flow and a superior return on investment.”

The share price has responded extremely well, as BHP has surged to above USD72 on the New York Stock Exchange as of midday April 9, 2014, from below USD64 in mid-March.

In other Portfolio news, GrainCorp Ltd’s (ASX: GNC, OTC: GRCLF) relationship with Archer Daniels Midland Co (NYSE: ADM) may yet have a serious future.

Mineral Resources Ltd (ASX: MIN, OTC: MALRF, ADR: MALRY) has raised its iron ore output forecast for fiscal 2014, while fellow Aggressive Holding WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY) is restructuring its business.

APA Group (ASX: APA, OTC: APAJF) may take a new tack in its approach to acquiring all of fellow Conservative Holding Envestra Ltd (ASX: ENV, OTC: EVSRF), AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY) is still in the game to acquire Macquarie Generation from the New South Wales government and Australand Property Group (ASX: ALZ, OTC: AUAOF) may be the target of a takeover offer from a fellow A-REIT.

Portfolio Update details all that and also provides a brief overview of our monthly “Aggressive Technicals” and “Conservative Technicals” tables.

In Focus

Two years ago the Australia liquefied natural gas (LNG) story was about a “golden age,” during which the Land Down Under would super-cool vast volumes recovered from coal seams onshore and from immense offshore fields and meet demand from fast-growing emerging and reaccelerating developed Asian economies.

Today, although the country is poised to shoot up the rankings of LNG exporters to heights now occupied by world No. 1 Qatar, the tale is far more prosaic.

A recent report from the International Energy Agency (IEA) underscored the reality that Australian gas producers will face increasing pressure from the US and Canada as it lifts exports to Asia.

But all is not lost for Australia’s LNG industry.

New plants for exporting LNG from the US have been held up by regulatory delays as government agencies have failed to assess issues such as environmental impact as quickly as the projects’ backers had hoped. The conflict on the Black Sea over Russia’s claim to Ukraine’s Crimea region may generate additional political will to accelerate US LNG exports, but the lead time from final project approval to first gas is a long one.

And the Canadian projects are of the “greenfield” variety–as opposed to largely “brownfield” conversions of LNG import terminals in the US–and will therefore entail a much longer time horizon until they reach the production phase.

In Focus details the substantial window of opportunity for Australia-based companies with projects already producing LNG cargoes and for those who will get on the market in 2014 and 2015.

Sector Spotlight

AE Portfolio Aggressive Holding Spark Infrastructure Group (ASX: SKI, OTC: SFDPF) closed at AUD1.82 on the Australian Securities Exchange (ASX) on Feb. 25, 2014, having surged from a Dec. 10, 2013, 12-month closing low of AUD1.54 despite a challenging demand environment and rising interest rates and bond yields.

By mid-March the stock was trading around AUD1.66 on the ASX, laid low after management reported a 26 percent decline in statutory net profit after tax (NPAT) for 2013 to AUD128.4 million, as the company absorbed a AUD16.2 million settlement with the Australian Tax Office (ATO) and a higher tax bill from deductions that have now been disallowed.

The impact of the continuing ATO dispute is well reflected in Spark’s share price. The current yield of 6.5 percent is ample compensation for investors as the market revalues it based on its solid assets, cash flow generation and distribution growth

We have more on Spark Infrastructure in this month’s first Sector Spotlight.

On March 17, 2014, AE Portfolio Conservative Holding Cardno Ltd (ASX: CDD, OTC: COLDF) announced largest acquisition in its history, the purchase of Houston, Texas-based PPI Group for USD145 million.

Cardno operates across multiple sectors in North America and Australia. Its strategy is to pursue organic and acquisition-driven growth to build out engineering and consulting capabilities across multiple geographies. It’s well diversified by sector and geography, with more than 50 percent of sales now generated in the US.

Cardno is well placed to benefit from a broad-based US recovery, and it should also benefit from a weaker Australian dollar, though a weaker aussie may also impact its purchasing power as it seeks to acquire businesses in international markets.

That hasn’t happened yet, however, as management continues to make big deals.

This month’s second Sector Spotlight focuses on Cardno.

News & Notes

Australia Makes Progress on Multiple Fronts: The domestic economy is showing increasing signs of life, while the latest free-trade deal has expanded its export market, notes AE Associate Editor Ari Charney.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that have recently announced profit warnings as well as those 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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