The third quarter was a rough one for Australian equities.

It was particularly difficult for US-based investors long dividend-paying stocks from Down Under, as a 7.3 percent decline in the Australian dollar versus the US dollar exacerbated what was actually modest underperformance versus major global equity benchmarks.

It would be most accurate to identify September as the cruel month among the three at issue.

Indeed, from July 1 through Aug. 31 the S&P/Australian Securities Exchange 200 Index actually outperformed the S&P 500 Index and the MSCI World Index in US dollar terms, 4.1 percent to 2.6 percent and 0.7 percent, respectively.

The aussie was only modestly lower versus the buck through the end of August, down 1 percent.

But since Sept. 2, when the S&P/ASX 200 reached a post-Global Financial Crisis closing high, geopolitical tension, concern about global growth and a concomitant flight to safety have drawn red from the Australian stock benchmark.

The Australian dollar’s otherwise controlled descent has spiraled since early September, the risk-on currency shedding 6.7 percent of its value versus the US dollar from Sept. 5 through Sept. 30.

The aussie made a new 12-month low of USD0.8675 on Oct. 3, a decline of 10.6 percent since Oct. 22, 2013.

Although the Reserve Bank of Australia (RBA) would prefer it even weaker, the impact of its recent slide on US investors who are long Australian equities in recent months has been decidedly negative.

The RBA would like a softer currency because it would make Australian exports more attractive to foreign buyers and thus provide some economic offset against a weaker mining and resources sector.

At the same time, managers of foreign currency reserves, primarily central banks, continue to accumulate Australian dollar-denominated assets, establishing a strong floor.

Recent communications from the Federal Reserve suggest as well that the US central bank is equally concerned about the impact of a strong currency on the domestic economy. Concern about global growth is another factor that could delay the Fed’s next rate hike.

Still backed by strong fundamentals, the aussie has bounced off its Oct. 3 low in recent days. Its reputation as a “commodity currency” will leave it susceptible to perceptions about global economic growth prospects.

That means short-term volatility.

We have more on the Australian dollar in this month’s In Focus feature.

As for the third-quarter performance of the AE Portfolio in this context, let’s start by pointing out total return numbers for the three main benchmarks we regularly reference.

The S&P/ASX 200 Index was down 7.8 percent in US dollar terms, 0.6 percent in local terms during the three months ended Sept. 30, 2014. The S&P 500 Index gained 1.13 percent, while the MSCI World Index lost 2 percent.

Including Conservative Holdings Envestra Ltd and Australand Property Group, the acquisitions of which have now been completed and the ASX-quoting of which ceased as of Sept. 12, as well as recent addition Stockland (ASX: SGP, OTC: STKAF), the AE Portfolio generated an average total return in US dollar terms of negative 5.9 percent.

In Australian dollar terms we were up 1.3 percent.

The Aggressive Holdings posted an average US dollar total return of negative 9.5 percent. The local number was negative 2.2 percent.

Every Aggressive Holding posted a negative total return in US dollar terms. The top performer was October Sector Spotlight Amalgamated Holdings Ltd (ASX: AHD) at negative 2.4 percent.

Significant outperformance versus the broader S&P/ASX 200 during a down market and the ability of its cinema exhibition business to do well throughout the business cycle are two reasons why Amalgamated Holdings is one of our “best buys” for new money this month.  

The Conservative Holdings, meanwhile, were down 2.9 percent in US terms but gained 4.2 percent in Australian terms.

M2 Telecommunications Group Ltd (ASX: MTU, OTC: MTCZF), one of our “best buys” in the August 2014 issue, was the top performer with a 22.1 percent total return in US dollar terms. Biopharma company CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY) was No. 2 at 4.3 percent.

Private hospital operator Ramsay Health Care Ltd (ASX: RHC, OTC: RMSYF), another October Sector Spotlight, posted a third-quarter total return of 3.1 percent.

Its global footprint in an industry backed by solid long-term fundamentals and an outstanding record of dividend growth recommend Ramsay as a “best buy” this month.

For purposes of comparison, IQ Australia Small-Cap ETF (NYSE: KROO) lost 8 percent during the third quarter. iShares MSCI Australia Index Fund (NYSE: EWA) was down 8.4 percent.

Aggressive Update

“Curtailing production would simply create a void that would be filled by other producers and new starters.”

That’s Andrew Harding, the head of AE Portfolio Aggressive Holding Rio Tinto Ltd’s (ASX: RIO, NYSE: RIO) iron ore unit, explaining why his company will stick to a plan to increase production by almost 25 percent to 360 million metric tons over the next couple years.

Rio Tinto reported a USD20.40 per metric ton cost of production for the first half of 2014, which means its biggest profit center is still profitable even after the price of iron ore on the spot market is down 40.4 percent during 2014 to a five-year low around USD80 per metric ton.

In fact the world’s biggest iron ore producers will continue to boost production in the face of falling prices, because they can, and because it means greater share of a market that will continue to be driven by demand from emerging and urbanizing Asian economies such as China and including India.

Fellow Aggressive Holding and top rival BHP Billiton Ltd (ASX: BHP, NYSE: BHP) announced its own plan to lift capacity by 65 million metric tons to 290 million a year by June 2017 by maximizing efficiencies at existing operations.

The biggest mining company in the world by market value will keep digging more tons of iron ore out of the ground, even as the steep drop in prices pushes smaller rivals to the brink of extinction.

And it will use driverless trucks to keep mines operating round the clock. Other moves will result in cost-saving jobs cuts.

BHP plans to cut production costs to less than USD20 per metric ton from USD27.50 for fiscal 2014 in a bid to become the lowest-cost miner in the world.

BHP insists its program is not directed at any competitor or competitors in particular; the focus is on maximizing margins and value from its own business.

Other big producers are also ramping up capacity, like Rio and BHP looking to capitalize on efficiencies of scale.

Brazil-based Vale SA (Brazil: VALE5, NYSE: VALE)–the world’s biggest producer–is on track to boost annual output to approximately 450 million metric tons by 2018 from 306 million metric tons in 2013.

Vale’s production cost is about USD22 per metric ton.

Australia-based Fortescue Metals Group Ltd (ASX: FMG, OTC: FSUMF, ADR: FSUGY) recently noted that it may ship 160 million to 170 million metric tons in fiscal 2015, up from 155 million during fiscal 2014.

Fortescue posted a production cost of USD34 per metric ton for fiscal 2014 and is tracking to USD31 to USD32 per metric ton for fiscal 2015.

BHP has no major iron ore projects under construction, having recently completed its Jimblebar mine in the prolific Pilbara region of Western Australia. Existing assets are sufficient to support current operations for three decades.

Rio Tinto and Vale, meanwhile, will continue to invest in expanding operations at their main iron ore mines in Australia and Brazil.

Some observers expect the iron ore glut to more than triple from 52 million metric tons this year to 163 million tons in 2015, as slowing Chinese growth eats at demand.

A drastic reduction in capital spending in the resource space–from about USD1 trillion in 2012 to less than USD700 billion so far in 2014–could lead to supply shortages. Price and cost pressures are also sidelining Chinese producers.

About half of China’s annual production of 400 million benchmark-equivalent tons has either already left the market or will be shuttered. Rio Tinto expects 125 million metric tons of high-cost global output will exit the market this year.

The market for the steelmaking material is in the midst of a dramatic upheaval that’s squeezing high-cost producers and will probably halt development of major new mines. Rival iron ore miners will be among the biggest casualties as the largest suppliers increase low-cost production and exacerbate a global glut.

That includes Aggressive Holding Mineral Resources Ltd (ASX: MIN, OTC: MALRF, ADR: MALRY), which in addition to its core mining services operations now has significant iron ore production capacity.

We’re cutting Mineral Resource to a hold due to its production vulnerability as well as the slowdown in resource sector spending.

BHP Billiton and Rio Tinto can still materially grow cash returns, despite the slide in iron ore prices.

Accounting for current iron ore prices and including the assumption that capital discipline holds, both companies should still be able to generate significant free cash flow before dividends, Rio Tinto USD4 billion to USD5 billion and BHP approximately USD10 billion.

That should be sufficient to support both management teams’ plans to boost dividends and potentially buy back shares over the next 12 months.

Both have indicated significant boosts are coming in February, with Rio in particular promising to deliver “materially increased” cash returns to shareholders.

We are reducing our buy-under targets on both stocks.

Rio Tinto is a buy under USD54 on the ASX using the symbol RIO.

Rio Tinto is dual-listed on the London Stock Exchange. Its New York Stock Exchange (NYSE) listing is an American Depositary Receipt (ADR) that represents one share of the company’s London listing. The London listing and the New York listing both represent the same underlying business as the Australia listing.

Rio’s NYSE-listed ADR–which also trades under the symbol RIO–is a buy under USD54.

BHP Billiton is a buy up to USD40 on the ASX using the symbol BHP.

BHP’s NYSE listing is an ADR that represents two ordinary shares traded on the ASX. Buy BHP on the NYSE using the symbol BHP up to USD66.

Conservative Update

Longtime AE Portfolio Conservative Holding APA Group (ASX: APA, OTC: APAJF) was recently defeated in the bidding war for Envestra Ltd by a consortium including Cheung Kong Infrastructure Holdings Ltd (Hong Kong: 1038, OTC: CKISF, ADR: CKISY), Cheung Kong Holdings Ltd (Hong Kong: 0001, OTC: CHEUF, ADR: CHEUY) and Power Assets Holdings Ltd (Hong Kong: 0006, OTC: HGKGF, ADR: HGKGY).

But APA still has ample opportunity to add assets and grow its already-dominant Australian natural gas infrastructure business.

A critical factor is the coming maturation of Australia’s liquefied natural gas (LNG) export industry on the east coast.

Queensland’s AUD70 billion LNG export industry will drive a fundamental change in energy markets. Although the Queensland market is currently oversupplied with gas and power, that’s set to change progressively over a period of about 12 months once BG Group Plc’s (London: BG/, OTC: BRGXF, ADR: BRGYY) Queensland Curtis Island LNG (QC LNG) project starts production at the end of 2014.

Queensland’s coal-seam gas (CSG) resources will be the major source of supply for these LNG projects, though some of the gas required is likely to come from the Cooper Basin and other regions, which have historically been a significant source of supply for the domestic market.

It is possible that the Gladstone LNG projects may further de-risk gas supply from their CSG developments by contracting additional third party gas if available.

To the south, the stalling of CSG development in New South Wales and a moratorium on onshore drilling in Victoria is plaguing producers. A continuation of this stalemate–which could trigger AUD2 billion of pipeline investment–would actually benefit pipeline developers such as APA.

APA is among the last few remaining bidders for the pipeline related to BG’s QC LNG project. The structure of the sale–with a price tag that’s expected to approach USD4 billion–means that the winner will only invest in the project; it won’t manage the asset.

APA could be pitted once again against Cheung Kong Group.

BG expects to finalize the sale before the end of 2014.

The 540 kilometer pipeline will carry coal-seam gas from the Surat Basin to a processing plant on Curtis Island near Gladstone.

APA is also weighing three potential options for a pipeline to link Northern Territory gas field to Australia’s east coast through the Moomba processing station.

The Northern Territory government estimates that there is in excess of 270 trillion cubic feet of conventional and unconventional gas resources in its midst, both onshore and offshore.

If the proposed link proves viable it would create an interconnected system of over 9,000 kilometers of gas pipelines, which would join APA’s two existing Northern Territory pipelines to its east coast grid.

APA’s first option is a 620 kilometer pipeline linking the 1,629 kilometer Amadeus gas pipeline–which is owned and operated by APA in Northern Territory–with the mining town of Mount Isa in Queensland, where the 840 kilometer Carpentaria gas pipeline runs from to Ballera in southwest Queensland.

The second APA option is a 1,100 kilometer pipeline from the southern end of the Amadeus gas pipeline to South Australia’s Moomba, the main processing plant for gas from the Cooper Basin.

The third option is a 700 kilometer pipeline that starts about 150 kilometers south of Northern Territory’s Tennant Creek to the Carpentaria pipeline.

Feasibility studies are expected to be completed during fiscal 2016 at a cost of AUD2 million.

APA Group–which is yielding 5 percent–is a buy under USD7.

Transurban Group (ASX: TCL, OTC: TRAUF) posted another strong quarterly result, boosted by the performance of its Sydney toll roads.

During the three months ended Sept. 30, 2014, Transurban posted proportional toll revenue–the most accurate reflection of the performance of Transurban’s portfolio–of AUD375.2 million, an increase of 36.5 percent from the prior corresponding period.

Statutory toll revenue was up 63.9 percent to AUD364.7 million.

Transurban’s Sydney network again delivered outstanding numbers during the quarter, driven largely by traffic growth in the northwest corridor as a result of the M2 upgrade completed in August 2013.

Average traffic growth across Westlink M7, Hills M2 and Lane Cove Tunnel was 7.9 percent for the quarter.

In the US, Transurban’s average workday toll revenue for the quarter grew 74.1 percent versus the first quarter of fiscal 2014 to USD116,673.

Transurban, along with its bid partners, reached financial close on the acquisition of the Queensland Motorways assets and concessions on July 2, 2014, and assumed ownership of the asset from this date. Transurban’s proportional ownership is 62.5 percent.

The acquisition will drive long-term growth.

Transurban also reached agreement with the Victorian government on Oct. 6, 2014, to deliver the CityLink Tulla Widening project. The project will add additional lanes to the Tullamarine Freeway from Melrose Drive in the north, along CityLink to the Bolte Bridge.

Additional lanes will also be added to the Westgate Freeway eastbound between the Bolte Bridge and Power Street.

Major construction on the project, and the East West Link/CityLink interface, is expected to start in October 2015, with the CityLink Tulla Widening finished in early 2018 and the interface work shortly after.

Standard & Poor’s reaffirmed Transurban’s A- rating but revised its outlook to “negative” from “stable” due to the magnitude of the company’s recent expansion efforts and the potential strain on the balance sheet.

For its part, Transurban management “remains committed to maintaining the group’s current credit worthiness.” And there’s been no change to Transurban’s strategic objectives of growing distributions to securityholders and creating long-term value through a combination of greater operational efficiencies and enhancement activities on its road networks.

The capital expenditure requirements of Transurban’s development projects, including the CityLink-Tulla widening project in Melbourne, remain consistent with those objectives.

S&P’s change in outlook has no impact on Transurban’s existing funding arrangements or its distribution guidance.

Management’s fiscal 2015 distribution target is AUD0.39 per security, which represents an 11.5 percent increase compared to fiscal 2014. Since 2009 Transurban has grown its distribution at a compound annual rate of 10 percent.