A part of me completely understands and appreciates where Reserve Bank of Australia Governor Glenn Stevens is coming from.

A growing dividend is as sure a sign of underlying business health as there is.

At the same time, sustaining and laying the foundation for further growth requires investment.

Good management teams actually earn their stripes by effectively and efficiently allocating cash flow, establishing a functional capital structure, limiting costs, spending to drive expansion and rewarding shareholders with reliable income.

In a late August appearance before a committee of Australia’s Parliament Mr. Stevens questioned capital management moves by large cap companies such as AE Portfolio Holdings Wesfarmers Ltd (ASX: WES, OTC: WFAFF, ADR: WFAFY), Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY) and Rio Tinto Ltd (ASX: RIO, NYSE: RIO) to return cash to shareholders in the form of stepped-up dividends and share buybacks rather than invest in growth initiatives.

After cutting the RBA’s overnight cash rate target to an all-time low of 2.5 percent Mr. Stevens is pretty much out of monetary tricks. “I’ve allowed the horse to come to the water with cheap funding,” said Mr. Stevens. “I can’t make it drink.”

The central banker indicated that any further cuts to the cash rate may be of little use. Since the RBA last cut its cash rate to 2.5 per cent in August 2013 easing of margins by banks had cut the cost of borrowing a further 0.15 percentage points.

At the end of the day, plans for growth that management teams might have filed away remain hostage to uncertainty about the future pace of demand.

It’s a pretty clear lesson that monetary policy can only smooth fluctuations, perhaps prevent absolute deflationary disasters. It can’t drive demand.

Mr. Stevens may question companies’ capital management strategies, but the market clearly appreciates dividends and share buybacks.

Five years into the recovery from the Global Financial Crisis, Australia is struggling to negotiate lofty heights that have seen it avoid recession for more than two decades, even as most of the rest of the world suffered through the worst economic downturn since the Great Depression.

A business-led recovery would see a surge in capital spending drive jobs creation, which in turn would support demand growth, as more people working equals more people spending money.

But management teams are cautious, perhaps too cautious, but better to reward shareholders–or even hoard cash–than rush into a spending spree on assets or projects that may not fit, with no clear idea of how output will be absorbed by consumers, simply because the cost of capital is low and/or there’s a big pile of cash burning a hole in your pocket.

We explore these issues in the context of fiscal 2014 reporting season and dividend growth for the AE How They Rate coverage universe, with an emphasis on Portfolio Holdings, in this month’s In Focus feature.

We advocate a certain discipline when it comes to allocating investment funds: Focus on companies with Safety Ratings that fit with your risk tolerance, pay attention to buy under targets, exercise patience, both before establishing positions and after you’ve bought a business.

As we note in Portfolio Update, the strategy we advocate is to build wealth over time by collecting dividends, benefiting as well from dividend growth and concomitant capital appreciation.

Tactically, we focus on high-quality, easily understood businesses, primarily in essential-service industries, with clearly identifiable cash flows.

When we buy a company we intend to stick with it for the long term, conceiving of ourselves as small business owners, with the type of commitment to stick it out through cycles.

We use the AE Safety Rating System to establish quality, buy-under targets to establish value.

From time to time we’ll take profits off the top of positions, maintaining our original investment, in order to generate funds to establish new positions for diversification purposes or for other uses that suit your particular needs.

It’s a “broad front” approach, as opposed to quick, concentrated methods such as day trading, seeking out hot momentum stocks or piling into initial public offerings.

This is no sprint, but a marathon.

And eventually the cycle will turn for the better.

Jobbing Jobs Reports

Data from the Australian Bureau of Statistics (ABS) showed 121,000 jobs were created Down Under during the month of August. It’s the largest single-month increase since the series began in 1978, and it dwarfed expectations for a 12,000 increase.

The unemployment rate declined to 6.1 percent, reversing most of July’s unexpected jump to 6.4 percent.

Most of the gains came in part-time jobs, which surged 106,700, while more people went looking for work as the participation rate jumped to a 16-month peak of 65.2 percent.

But jobs numbers–in Australia, Canada and the US–are notoriously volatile, subject to numerous revisions and susceptible to a great deal of statistical noise.

After an initial bounce the Australian dollar resumed a week-long down-spiral, and skeptics ruled the spin war on a data set that was probably skewed by the introduction by the ABS of a new methodology for the labor force survey ahead of the August version.

Note too that there have only been seven occasions since 1993 where the month-to-month change in total employment has been greater than 80,000.
Mr. Stevens appeared to be at his wit’s end during his Parliamentary testimony. This jobs report will only add to his miasma.

Portfolio Update

A combination of weak retail demand, a significant acquisition in the context of soft wholesale power markets and the repeal of Australia’s carbon tax has sunk the share price of AE Portfolio Conservative Holding AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY).

Australia’s second-largest integrated utility posted a 3.9 percent decline in underlying net profit after tax, as revenue dipped 1.8 percent. Underlying earnings per share were down 5.2 percent.

Gearing was up 1.9 percentage points but remains well within the “Very Safe” range defined by the AE Safety Rating System. And AGL did boost its final dividend by 4.4 percent

AGL faces near-term challenges, primarily a weak wholesale power market. In time, however, it will benefit from the ongoing deregulation of Australia’s power markets as well as the tightening of wholesale generation markets.

AGL continues to invest in asset growth, extend market dominance, fine-tune customer-retention efforts and establish a basis for long-term earnings and dividend support and growth.

Portfolio Update examines the current state of a struggling Conservative Holding that was one of the first eight recommendations in the AE Portfolio, ties up loose acquisition ends and highlights a couple key earnings reports.

In Focus

Back in my broker days a client who happened to be the heaviest hitter in the book of business managed by my partner and me once asked, in response to my partner’s comment that a relatively small sum would be swept into his cash account, whether he’d ever heard the one about the man peeing in the ocean.”

“Every little bit counts.”

And even just a little bit more is much better than a little bit less.

So it goes, of course, with the recently concluded earnings reporting season Down Under that we have to talk about the downside of dividend growth.

Generally speaking, there’s no better indication of a healthy underlying business than a rising payout. Myriad factors may drive short- and medium-term market moves. But over the long term growing a dividend is a sure way to grow a share price.

That’s the basic distillation of the philosophy informing not just Australian Edge but Canadian Edge and Utility Forecaster as well.

At the same time, it’s axiomatic that dividend growth is best accomplished by a growing business. And growing a business requires capital investment.

In Focus takes a look at dividend growth in Australia during the recently concluded earnings reporting season, including companies from the How They Rate coverage universe and Portfolio Holdings, and what it means for investors with a long-term perspective.

Sector Spotlight

On April 22, 20124, Stockland (ASX: SGP, OTC: STKAF) offered AUD4.20 per security for the 80.1 percent of fellow Australian real estate investment trust (A-REIT) and AE Portfolio Conservative Holding Australand Property Group (ASX: ALZ, OTC: AUAOF).

Australand rejected Stockland’s bid but subsequently struck a deal to be acquired by Singapore-based Frasers Centrepoint Ltd (Singapore: FCL).

Stockland will net approximately AUD80 million on its Australand position. 

Stockland took a disciplined approach to its investment in Australand, with a clear strategic intent and view of value. Although it didn’t come out ahead in this particular bidding process, over the long term Stockland will still be able to make progress on management’s strategic objectives due to Australand.

It will reap a solid profit that will fund its growth plan rather than overpay for an asset.

We’re adding Stockland to the AE Portfolio Conservative Holding because of management’s demonstrated restraint, because its residential business will enjoy favorable market conditions well into fiscal 2015 and beyond, because it has a fortress balance sheet and because it pays one of the highest yields among A-REITs.

Once a suitor for Australand, Stockland, a buy under USD4, is now effectively replacing its fellow A-REIT in the Portfolio.

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

Recent headwinds in one of its key markets, questions about the real stability of its domestic franchise and concerns about the impact of an aggressive capital expenditure plan on the balance sheet have weighed on AE Portfolio Aggressive Holding Crown Resorts Ltd (ASX: CWN, OTC: CWLDF, ADR: CWLDY) hit an all-time closing high of AUD18 on the Australian Securities Exchange (ASX) on Jan. 21, 2014.

The initial reaction to a fiscal 2014 earnings report that showed the domestic portfolio is performing better than expected and included a shareholder-friendly revision to the dividend policy was positive.

But the share price has come back again to approach its 52-week low of AUD14.59. As of Sept. 11, 2014, Crown Resorts was trading at AUD14.98 on the ASX, 15.97 times forecast fiscal 2015 earnings.

And that spells opportunity to go all in on a high-quality global gaming name with a stable foundation in Australia and lucrative opportunities for growth at home as well as in Asia and North America.

Take advantage of recent share-price weakness.

Crown Resorts is a buy up to USD16.50 on the ASX using the symbol CWN and on the US OTC market using the symbol CWLDF.

Crown Resorts’ ADR, which trades on the US OTC market under the symbol CWLDY and is worth two ordinary, ASX-listed shares, is a buy under USD33.

This month’s second Sector Spotlight focuses on Crown Resorts.

News & Notes

Steady Growth and Then a Sudden Surge: The Australian economy posted a respectable performance during the second quarter, but its August’s stunning jobs report that’s got everyone talking, 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 the recently concluded 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 111 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