Australian Prime Minister Tony Abbott is off to India next month for meetings that should lay the foundation for a comprehensive economic cooperation agreement between the two countries.

His visit comes at a time when India is struggling to reestablish momentum after two lackluster years of gross domestic product (GDP) growth.

Mr. Abbott will sure bear in mind the benefits Australia has reaped from its trading relationship with China.

At the same time, the prime minister will take with him the knowledge that diversity of export markets is an all-around positive for a country such as the Land Down Under that, despite the recent resource downturn, remains exceptionally dependent on commodities for its economic viability.

India, 30 years ago, stood on equal ground with China in terms of GDP per capita. But now the Middle Kingdom dwarfs the Subcontinent, a result of aggressive policy action designed to turn the former into the world’s manufacturer and of concomitant leadership failures coupled with inherent difficulties of governing a disparate country for the latter.

In Prime Minister Narendra Modi Mr. Abbott will find a pro-business, pro-growth leader focused on helping India discover its economic potential, to in fact lead a Chinese-style infrastructure boom that will drive increased living standards for Indians.

As it was with China, Australia, because of its geographic proximity, will certainly play a significant role in helping India achieve its goals.

We have more on Australia’s relationship with India, which is more potential than payoff at this stage, in this month’s In Focus feature.

Back to the Middle Kingdom

The Southern Autumn-Northern Spring China Resources Quarterly (CRQ), a joint report of the Australian government’s Bureau of Resources and Energy Economics and Westpac Banking Corp (ASX: WBC, NYSE: WBK), recently reported that the Chinese economy grew at a rate close to but slightly below its potential in the first half of 2014, supported by easier fiscal policy, firmer exports and the conclusion of the negative phase of the short-run inventory cycle.

As a result, China’s resources and energy use continued to be strong across most commodities.

Against a backdrop of rising concern about its economic growth and construction, China’s steel production was a record 209 million metric tons in the second quarter of 2014, up 4.7 percent on the prior period, contributing to record iron ore imports of 235 million metric ton during the three months ended June 30.

Australia was a major contributor to this growth, with China sourcing 138 million metric tons of iron ore from the Pilbara region of Western Australia during the period, up 35 percent compared to the second quarter of 2013.

The value of Australia’s iron ore exports to China increased by 19 percent year over year to AUD14.6 billion.

Australia also exported some 11.5 million metric tons of metallurgical coal during the second quarter, up 18 percent on the prior corresponding period, with a total value of AUD12.77 billion.

Thermal coal imports from Australia were up 13.5 percent compared with the second quarter of 2013, to 12.8 million metric, worth an estimated AUD869 million, while oil imports decreased by 10.8 percent to 712,000 metric tons and gas imports decreased by 7 percent to 904,600 metric tons.

Gold imports from Australia also declined by 10 percent to 40 metric tons, while nickel imports declined by 41 percent to 112,000 metric tons due to reduced production from Australia.

The CRQ noted that while commodity prices were soft during quarter, lower prices had been driven largely by increased supply rather than any material change in demand.

“Competition to supply China’s demand for mineral and energy commodities is growing with new low-cost mineral regions emerging around the world following the wave of international investment of the past five years,” the report concluded.

Australian mineral and energy commodity producers have had to review operations, trim costs, scale back projects and improve productivity to remain profitable.

But Chinese demand remains strong.

Portfolio Update

Earnings reporting season is well underway in Australia, where the typical financial year runs from July 1 through June 30. So for most companies, including our AE Portfolio Conservative and Aggressive Holdings, we’re seeing fiscal 2014 results.

Over the past month we’ve also had separate takeover attempts of two Conservative Holdings, Australand Property Group (ASX: ALZ, OTC: AUAOF) and Envestra Ltd (ASX: ENV, OTC: EVSRF) progress to the end game.

For Australand, whose acquisition by Singapore-based Frasers Centrepoint Ltd (Singapore: FCL) is on track to close on Aug. 21, we’re going to book a US dollar total return of approximately 81 percent.

Envestra, an original member of the AE Portfolio, is set to be acquired by a Cheung Kong Group consortium on Aug. 21.

The natural gas transmission and distribution company checks out of the Portfolio with a total return in US dollar terms of 137.4 percent.

As for Portfolio recommendations that reported financial and operating results since the July 2014 issue was published, highlights include four dividend increases on top of the boost that we reported last month for Conservative Holding Transurban Group Ltd (ASX: TCL, OTC: TRAUF).

Numbers for the 10 companies whose reports we break down below have been largely positive, though we have made note of some early fiscal 2015 weakness for JB Hi-Fi Ltd (ASX: JBH) and casino operator Crown Resorts Ltd (ASX: CWN, OTC: CWLDF, ADR: CWLDY).

Portfolio Update has the latest on acquisitions of Portfolio Holdings, earnings reports from four Aggressive Holdings and six Conservative Holdings and dividend increases from four Holdings.

In Focus

India is the third-largest economy on a purchasing power parity basis and has the world’s second-largest population, according to World Bank data.

It’s a major engine of growth in Asia and is deepening its trade and investment flows within the region.

The value of Australia-India trade fell from AUD20 billion to AUD15 billion Australian dollars in 2013, as elevating relations to a “strategic partnership” has clearly not achieved one of the desired results, which is deeper economic engagement.

But there are significant opportunities for Australia in India.

According to a feasibility study conducted as part of free trade agreement negotiations between the two countries, Australia would gain AUD43 billion in real gross domestic product (GDP) in net present value (2008) terms.

Infrastructure, financial services, food security, agriculture, water management, education, tourism, health care and information technology are other longer-term sectors where Australia-based companies can establish meaningful operations in India.

But the most immediate impact of a stepped-up Australia-India trade relationship will be felt by Australia-based commodity producers.

In Focus takes a look at Australia’s opportunity to diversify its export end-markets by establishing closer economic ties with a fantastic prospect in close geographic proximity.

Sector Spotlight

Conservative Holding M2 Telecommunications Group Ltd (ASX: MTU, OTC: MTCZF), which we added to the AE Portfolio in December 2011, has posted a remarkable record of growth over the past decade, its expansion driven primarily by acquisitions of smaller competitors on the Australian telecommunications space.

Recent reports suggest management is considering an acquisition outside its “wheelhouse,” as it seeks to extend a remarkable history of double-digit sales, earnings and dividend growth.

M2 is Australia’s fifth-largest provider of fixed-line broadband ­services, with brands such as Dodo and iPrimus. It’s spent more than AUD500 million to buy more than 20 rivals over the past six years.  

But the market is now largely consolidated, and “second tier” telecoms are on the hunt for new sources of revenue and profit growth.

Lumo Energy, Australia’s fourth-largest natural gas and electricity retailer, could be M2’s answer.

M2 does have experience with adding energy retailing operations. In May 2013 it completed the acquisitions of smaller telecoms Dodo and Eftel for a combined AUD248 million. 

Dodo, a hybrid telecom-energy retailing business, brought with it a customer base of 53,000, which grew to 69,000 by the end of the first half of fiscal 2014.

The primary attraction is Lumo’s 500,000 customers, all of whom could be sold extra phone and Internet services to keep them locked in and loyal to M2.

We have more on M2 Telecommunicaionts in this month’s first Sector Spotlight.

By all measures our experience with Aggressive Holding WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY) has been negative.

Since we added it to the AE Portfolio in February 2012 the stock of the Sydney-based engineering services firm has generated a total return of minus 41.9 percent in US dollar terms.

Worley’s energy and mining work in Australian and Canadian and to a lesser extent its operations in Latin America and the Middle East tailed off due to the global slump in resource CAPEX that began in 2012.

So why are we recommending Worley again as a “best buy” for new money following recommendations in February 2012, when we added it to the Aggressive Holdings, and in February 2013, at a time when its operating and financial performance was on the wane, and why now?

The short answer is that Worley has a clear path to medium-term earnings growth, supported by management’s cost-cutting program as well as momentum from recent contract awards. The balance sheet is strong, with low overall debt and total maturities coming due before Dec. 31, 2016.

And, with a current dividend yield of 5 percent investors will be well compensated for the risk they’ll take on.

This month’s second Sector Spotlight focuses on WorleyParsons.

News & Notes

Australia’s Economy Still in Transition: Despite a difficult job market and falling commodities prices, the country’s economy is expected to grow by 3.1 percent this year, 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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