Australian policymakers are hoping to create the conditions necessary to help the non-mining sectors assume leadership of the country’s economy.

Although the resource sector will continue to play a huge role in Australia’s economy, it’s now entering a new phase of the business cycle, where investment in new projects has peaked and is now on the decline.

At the same time, a glut of new supply is hitting the commodity markets amid depressed prices, as new projects initiated during the resource boom finally come on line. That means there must be sufficient demand in the global markets, particularly in the fast-growing Asia-Pacific region, for higher volumes to offset lower prices.

In addition to the housing and retail sectors, both of which have exhibited strength over the past year, the manufacturing sector has also started to gain traction. Naturally, the former have also helped boost the latter.

According to the ACCI-Westpac Survey of Industrial Trends, which is the longest-running business survey in Australia, the country’s manufacturing sector just posted its third consecutive quarter of expansion.

The survey’s Actual Composite Index held steady at 51.0 for the June quarter, based on a survey of 352 manufacturers over a period of about one month that concluded on June 9. Readings above 50 indicate expansion, while readings below 50 signify contraction.  

This three-quarter streak of expansion is the longest such run since 2011. Among the factors contributing to the sector’s performance are strengthening consumer spending, an increase in housing construction, and a rise in exports.

As per usual, given economics’ reputation as the dismal science, not all of the data are rosy. Indeed, some of the responses indicate significant challenges ahead for the sector.

Business confidence is subdued, with companies turning from optimism to mild caution, as concerns persist about the strength and duration of the current rebound. Profit expectations are now slightly negative for the coming year.

Sentiment has weakened despite the fact that both new orders and export deliveries experienced modest rises during the quarter.

The sudden strength of the Australian dollar may be contributing to this gloomy outlook, particularly among exporters. The aussie currently trades near USD0.94, up about 8.2 percent from the three-year low in late January.

Even with the recent rise, the country’s exchange rate is still about 14.5 percent below this cycle’s high in mid-2011.

But it’s likely that the Reserve Bank of Australia still regards the present level of the exchange rate as uncomfortably high, as it would prefer to see the aussie trade in the low-to-mid USD0.80s. That’s the level it deems necessary for Australia’s exporters to effectively compete against their peers.

Though business sentiment has deteriorated, investment intentions for spending on plant and equipment remain positive, albeit just barely.

And while 12 percent of firms expect to reduce their head counts in the near to medium term, there is still plenty of demand for labor, as evidenced by the increase in overtime in recent months. In fact, this was the third consecutive quarter in which overtime hours had increased.

The Labor Market Composite Index, which is an important indicator of future employment growth, weakened moderately from the prior quarter, but is still above the levels that prevailed over the two-year period that ended in September 2013.

In fact, the labor market has tightened in recent months, and Westpac believes this could mean the country’s unemployment rate may have already peaked. The unemployment rate was recently at 5.8 percent in May, after hitting a high of 6.0 percent for this cycle back in February.

One area of concern, however, is the anticipated deceleration in wage growth, with 25 percent of respondents expecting to raise wages at a slower pace than in previous years.

While a broader employment base will spur consumer demand, some of that improvement will be offset by slackening wage growth.

And consumer demand is what usually triggers the virtuous cycle of a rise in hiring and business investment, which begets more demand, then more hiring and more investment. Fortunately, Australia is not solely dependent on domestic demand and is in proximity to nearby emerging markets.

Overall, despite the mixed data, the main takeaway from this survey should be that the manufacturing sector is in a modest expansionary mode.

While business sentiment can be an important economic indicator, it relies on respondents to extrapolate the future from the recent past. We’d rather see how actual events transpire.

Portfolio Update

Aggressive Portfolio Holding Woodside Petroleum (ASX: WPL, OTC: WOPEF) will be undertaking a massive USD2.68 billion buyback in the coming weeks in conjunction with oil giant Royal Dutch Shell Plc’s (NYSE: RDS-B) sell-down.

Prior to the deal, Shell held a 23.1 percent stake in the Australian energy exploration and production company, a legacy position from a failed takeover bid back in 2001.

Shell previously sold a 10 percent stake in Woodside in November 2010, and has long signaled its intent to further reduce its holdings in the firm. So this latest move should not be seen as a reflection of Woodside’s growth prospects.

The first phase of this latest sell-down occurred earlier this week, with Shell selling 78.3 million shares of Woodside, or 9.5 percent of shares outstanding, via underwriters to financial institutions at AUD41.35 per share. That left Shell with a 13.6 percent stake in Woodside.

Woodside then intends to buy back 78.3 million shares from Shell for USD2.68 billion, based on a share price of AUD36.49, a 14 percent discount to the recent share price.

The selective buyback agreement is subject to approval by Woodside’s shareholders at an extraordinary general meeting scheduled to take place in August. The buyback will be funded by cash and existing credit facilities, and Woodside plans to cancel the shares rather than hold them in its treasury.

Following the series of transactions, Shell will retain a stake in Woodside no higher than 4.5 percent of shares outstanding, a threshold at which the Anglo-Dutch firm will no longer be considered a material shareholder.

Woodside’s management believes the buyback helps optimize the company’s capital structure by bringing gearing in line with its long-term target range of 10 percent to 30 percent.

Additionally, the buyback is expected to be accretive to earnings and dividends per share by approximately 6 percent, thanks in part to the aforementioned discount.

The sell-down also removes the considerable uncertainty that comes from knowing that one’s single largest shareholder is anxious to unload their position, while not knowing whether it will occur in an orderly manner. And it improves the stock’s overall liquidity in the market.

Management has also stressed that the buyback will not deter the company from undertaking its current growth plans, nor alter its dividend policy or credit rating.

In fact, the company has said the substantial cash flows generated by its operations afford it the financial flexibility to continue pursuing growth via mergers and acquisitions, as well as by investing in its existing business.

Analysts were largely supportive of the agreement.

Woodside is a buy below USD42.