Two thousand thirteen was a rough year for the Australian dollar and for US-based investors who were long dividend-paying Australian equities.

Share-price gains were offset by currency declines, losses were exacerbated and payouts were crimped.

From a broader perspective, it appeared that the end of the 21st century mining boom signaled a wholesale retreat from Australia, with little to recommend the country beyond its iron ore. No longer would capital flow into the Land Down Under.

At the same time, the US and Europe were showing sure signs of economic durable economic rebound, and they looked much better relative to Australia.

But Australia, though its economic growth slowed considerably, still hasn’t suffered a recession in more than two decades.

And efforts by the Reserve Bank of Australia, including a series of interest-rate cuts that’s taken its benchmark to an all-time low, appear to bearing fruit in the form of strength in domestic construction and for the country’s export industries.

And, lo and behold, global investors, including central banks, sovereign wealth funds, pension funds and institutions, are putting money back to work in Australia.

That’s reflected in the 5.3 percent rise in the Australian dollar versus the US dollar from Dec. 31, 2013, through July 18, 2014.

What Australia has to offer, to big, smart money and to individual investors like you and me, is yield.

In early January the yield on Australia’s 10-year government bond was 4.3 percent, particularly attractive given the fact it’s one of the few remaining developed countries with triple-A credit. High demand coupled with the RBA’s low benchmark–itself indicative of a still-struggling economy–have pushed the 10-year Australian government yield to 3.4 percent.

But the 10-year US Treasury yield is still just 2.5 percent. The comparable UK note pays 2.6 percent, Japan’s 0.5 percent.

Japanese pension firms and insurance companies are at the forefront, buying Australian federal bonds, state-government debt, Australian corporate debt and so-called kangaroo bonds, foreign bonds issued in the Australian market by non-Australian firms and are denominated in Australian dollars.

US and European institutions, in the aftermath of the European Central Bank’s recent rate cut, are also finding a decent rate of return Down Under.

According to Japan’s finance ministry, Japanese investment in Australian bonds reached the highest level in almost two years in April 2014 at AUD3.3 billion. That compares with a monthly average of AUD1.9 billion in the first quarter of 2014.

Although Australian economic growth has slowed, it’s still relatively good in light of weaker-than-expected growth rates in the US and Europe.

And the dynamic will likely persist for the long term–stable but slower growth around the Atlantic, which means monetary policy for the US Federal Reserve and the ECB will likely remain relatively accommodative in an historical context.

As Goes the Middle Kingdom…

China’s second-quarter growth was slightly stronger than economists had expected, suggesting the world’s second-largest economy–and Australia’s most important trading partner–may have stabilized after a slowdown earlier in 2014.

In early 2014 the Chinese government stepped up its efforts to create more credit as well as its spending on infrastructure.

According to the National Bureau of Statistics, gross domestic product (GDP) in the Middle Kingdom expanded by 7.5 percent from the prior corresponding period, accelerating from 7.4 percent year-over-year growth in the first quarter.

Industrial output in June and fixed-asset investment in the first half of the year both beat expectations. But home sales during the six months ended June 30, 2014, a sign that China still faces headwinds.

The government is likely to continue its “targeted easing” measures to sustain the growth during the second half of the year, with selective cuts in the reserve requirement ratio for banks and the central bank’s relending facilities likely to be adopted to pump liquidity into the economy.

China’s recovery remains fragile, and measures to support the housing market will be limited to removal of housing purchase restrictions. But if there’s any deterioration Beijing will take additional measures to boost demand in the property market and the broader economy. 

Portfolio Update

The Australian Parliament voted this week to repeal the country’s carbon tax law, which took effect on July 1, 2012.

Because the carbon price fell most directly on the power sector, its removal should produce long-term benefits in that industry, save for the hydro plants and wind farms which operate at near-zero emissions.

But coal-fired power producers have been stoked with billions of dollars in compensation to ensure they absorbed the carbon hit. The government gave almost 100 percent free permits to the generators, who were allowed to bank the cash. They’ve charged consumers for the cost of the carbon and taken the difference as a profit.

AE Portfolio Conservative Holding AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY), in a statement released on July 17, 2014, said the repeal of the carbon price would reduce fiscal 2015 earnings before interest and taxation (EBIT) by about AUD186 million.

Aggressive Holding Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY), Australia’s largest electric and gas utility, also acknowledged the tax’s repeal but highlighted the savings for households through lower customer bills and didn’t mention an earnings impact.

Portfolio Update looks at the carbon tax repeal from the perspective of Portfolio power producers, assesses Rio Tinto Ltd’s (ASX: RIO, NYSE: RIO) first-half production report and rounds up recent progress on relevant acquisitions and other important developments for Conservative and Aggressive Holdings.

In Focus

A solid rebound for the Australia dollar has helped first-half total return figures for US investors who are long Australian equities, as the S&P/Australian Securities Exchange 200 Index (ASX) outpaced the S&P 500 Index and the MSCI World Index from Dec. 31, 2013, through June 30, 2014.

The aussie appreciated by 5.8 percent versus the US dollar over the first half of the year, from USD0.8917 at the end of 2013 to USD0.9433 as of June 30, 2014. CurrencyShares Australian Dollar Trust (NYSE: FXA), and exchange-traded fund (ETF) that tracks the aussie, was up 6.5 percent for the period.

Meanwhile, the S&P/ASX 200 was up 3 percent in local terms, including dividends. Accounting for the strengthening aussie, the Australian benchmark was up 8.8 percent versus 7.1 percent for the S&P 500 and 6.5 percent for the MSCI World Index.

The 28 companies that make up the AE Portfolio produced an average half-year total return in US dollar terms of 11.6 percent. The 15 Conservative Holdings’ average was 14.1 percent, the Aggressive Holdings’ 8.6 percent.

For reference sake, iShares MSCI Australia Index Fund (NYSE: EWA), an Australia-focused ETF populated with large-capitalization stocks, was up 8.8 percent including dividends. The small-cap-focused IQ Australia Small Cap ETF (NYSE: KROO) was up 6.2 percent.

Aberdeen Asia-Pacific Income Fund (NYSE: FAX), which includes fixed-income securities issued primarily by Australian and Asian sovereigns and which is an AE Portfolio Conservative Holding, was up 12.9 percent for the first half of the year, as international investors return to aussie-denominated assets.

In Focus takes a look a sector-by-How They Rate sector look at what worked and what didn’t over the first six months of 2014, with an emphasis on Portfolio Holdings but including selective reviews of companies with bright or dim prospects for the balance of the year, into 2015 and beyond.

Sector Spotlight

Transurban Group (ASX: TCL, OTC: TRAUF) suffered a rather rough road in the early days of its US expansion, undertaken via its interest in the DRIVe joint venture with Australia-based specialty infrastructure investment firm CP2.

In 2012 Transurban wrote off its AUD138 million investment in the Pocahontas 895 toll road near Richmond, Virginia, as hoped-for development along the route fell victim to the Global Financial Crisis/Great Recession.

And traffic on the 495 Express Lanes near Washington, DC, which opened in November 2012, was initially much lower than expected. A third project in the US, the 95 Express Lanes, also near the Capital Beltway region, is currently under construction.

But the demonstrated resilience of Transurban’s overall portfolio, the importance of its roads to local transportation networks in Sydney and Melbourne and the relative stability of the Australian economy support revenue, cash flow and dividend growth for what remains a solid, defensive investment.

And though the DRIVe portfolio currently makes up a very small part of Transurban’s proportional earnings, a strengthening economy in the Capital Beltway region is translating to accelerating traffic and toll revenue growth on the 495 Express Lanes.

A solid foundation in Australia coupled with improving prospects in the US make for a good defense and opportunistic offense.

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

APA Group (ASX: APA, OTC: APAJF) is an original member of the AE Portfolio, one of the “Eight Income Wonders from Down Under” that comprised our lineup of top recommendations in our September 2011 debut issue.

APA, which owns and operates two-thirds of Australia’s onshore pipelines, utilizes its interconnected networks to transport approximately half the gas used domestically. Its assets include 14,120 kilometers of transmission pipelines as well as underground and liquefied natural gas (LNG) storage facilities.

It also owns and operates approximately a third of Australia’s gas distribution networks, with 25,000 kilometers of pipelines serving 1.2 million customers.

APA has also developed and acquired complementary energy infrastructure, including gas and wind electricity generation and gas processing and electricity transmission assets.

APA’s interconnected grid on Australia’s east coast is opening up a new range of services and providing shippers with new flexibility in how they manage their upstream and downstream portfolios.
Management continues to optimize the use of APA’s existing assets and to develop infrastructure and services in response to customer and market requirements.

APA is well positioned to benefit from rising domestic production and consumption and the export of natural gas in and from Australia.

A quintessential invest-to-grow story, APA consistent expansion of its fee-for-service asset base translates into reliable dividend growth for investors.

This month’s second Sector Spotlight focuses on APA Group.

News & Notes

The Big Picture Remains Bright: Despite disappointing economic data as of late, Australia’s economy is still expected to continue strengthening, 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 112 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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