PORTFOLIO POINT: Many companies will be referring to challenging conditions in the current reporting season. The big challenge for them is to communicate clearly to shareholders.
The coming of the 2011-12 reporting season may be compared to the “silly” season of Christmas.
Some commentators are suggesting that the market is in waiting for a storm of negative earnings reports. Time will tell, but shortly we will be dealing with facts rather than speculation. It will certainly give me the opportunity to critically analyse the companies that reside in our growth portfolio.
One “adjective” that will be flogged to death in the coming weeks will be the word “challenging”. “The past year was challenging, the present is challenging and the outlook appears challenging.”
Those business environment conditions may be used by executives to justify an increase in remuneration. The shareholders, who actually own the business, may well conclude that these conditions actually justify a reduction in salaries!
The other things to look for in coming weeks from the reports of our major companies are as follows:
- Will the decline in BHP Billiton’s (BHP) profit be offset by a more sensible approach to capital management and dividends? During the three years to 2011, BHP lifted earnings by 400%, whilst the dividends to shareholders hardly moved. The share buyback of 2011 was a massive positive for the shareholders who sold (mainly pension funds) and a disaster for the Australian government’s tax collections. Hopefully, we will see some sense by the BHP board, dividends lifted and shareholders treated like owners. Maybe BHP will give us some clarity over its mooted non-payment of the Mineral Resources Rent Tax. Click here to read MyClime’s recent research report on BHP Billiton.
- The Commonwealth Bank (CBA) result should confirm low earnings growth and a slight increase in dividends. There will be the usual analysis of margins and cost bases but the key focus will be on return on equity. I suspect that the ROE may lift slightly and really confirm that Australia’s banks are among the best in the world. Unfortunately, the peer group residing in Europe makes anyone look good in comparison.
- Telstra’s (TLS) result has been flagged and low-digit growth is expected. The dividend is known and so the real consideration will be the operating cash flow report. Does the TLS depreciation charge exceed the capital investment and thus, is free cash flow growing quicker than profits? Further, some clarity over the receipt of National Broadbank Network payments would be helpful. How much is likely to be received in 2013 and 2014? Maybe it is challenging for TLS to shed light on this question, but it is vitally important information.
- Woolworths (WOW) should also disclose low single-digit earnings growth before its provision for Dick Smith. Its dividend should rise slightly. Of more interest will be the analysis of its hardware joint venture to determine its investment so far, and the dilutionary effect on WOW’s ROE.
I do not doubt that the current economic and business conditions are most challenging. However, it is at times like these that we should look for companies to be clear in their communication, in their strategy and in their capital management.
The “challenging” environment
Currently, the poor equity market returns and the price volatility seem to magnify the issues of offshore economies. The debt crisis of Europe is a constant and stifling problem for the world and Australia. So too is the anaemic recovery in the United States and the risk of decelerating growth in China. These are all issues that are hampering the Australian economy and profit growth. However the bigger issues, in my view, are the strength of the Australian dollar and the political impasse that is hampering the growth potential of this country.
Specifically, the actions of offshore central banks, sanctioned by their governments, are anti-competitive in their effect on Australia. The massive quantitative easing programmes of Europe, the US and the UK have resulted in the revaluation of the $A to levels that destabilise many of our industries. Further, the policy settings of China, our largest trading partner, have resulted in a significant revaluation of the $A against the yuan. Sure, we have a trade surplus with China but it would be larger if our currency was correctly valued. A bigger surplus would ensure the growth of Australia.
Thus, overseas policy settings demand a thoughtful reaction from our government and central bank. Lowering interest rate settings is an obvious reaction but it should not be taken to stupid levels. The low cost of debt helps with the repayment of debt, but it does not encourage consumption nor does it necessarily stimulate growth. The current overseas economic policy settings seen in the US and particularly in Japan show this clearly to be the case.
A more dynamic response
What Australia needs is a more dynamic response to offshore events and their effects on the local economy.
At a Commonwealth government level there could be policies that support Australian exporters via equity or loans rather than by grants. For instance, the Australian car manufacturing industry is being destroyed by cheap imports caused by the high $A. If foreign-owned manufacturers want to close their manufacturing operations then maybe the government should consider buying them. That is exactly what the US government did during the GFC.
The provision of grants to pay retrenchments is hardly good policy. The Australian government should acknowledge that our currency is being manipulated by offshore policies and so it will be a transitory environment. If Australia closes much of its manufacturing capacity on the hope that the $A stays strong forever, and that China will never revalue, we will be sadly exposed. Future generations may well question the vision of our current leaders.
Similarly if the major world economies are undertaking quantitative easing and benefitting from low bond interest rate costs, then why does Australia not consider raising substantial cheap long-term debt with Reserve Bank of Australia intervention in bond markets? Surely major infrastructure works should be funded and fast tracked with cheap long-term debt with 10-year bond yields at 2.8%.
The RBA could actively buy assets from our banks to increase bank liquidity and take the strain off their funding requirements. Further, major projects could be taken away from public/private partnerships and become fully publicly owned so that infrastructure is not provided by inflation-based revenue equity models.
The outward bound trading engagement with China must be broadened from its focus on resources. Australia should develop value-added food production industries. If cheap long-term government debt is available, then this could be accessed so that developments move forward quickly.
Frankly, Australia is in a unique position on many fronts but our political quagmire and leadership vacuum are simply stiffing forward momentum in our economy. We can blame Europe and the US but our economy is growing despite their problems. Australia could grow faster on a sustainable basis if our politicians had vision and the intestinal fortitude to rise to the occasion.
The good news is that the political quagmire will end at some point. The unknown is what the next government, whoever it is, will do and how quickly it will move.
Australia has a superior economic outlook, and therefore a superior investment case, than many overseas countries. The non-performance of the equity market has created an opportunity for long-term investors. Should our economic policy become more considered and lateral then our equity market is indeed good value.
Growth Model Portfolio
|Clime Model Growth Portfolio (prices as at July 26, 2012)|
Purchase Price ^
FY 2013 Value
|The Reject Shop|
|* Market prices as at close July 26, 2012. ^ Purchase price as of close June 30, 2012|
Weighted Portfolio Return
Since Inception: -5.72%
Since June 30, 2012: 1.39%
Average Yield: 7.70%
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