|Summary: Australian business confidence is falling and growth is slowing. With corporate earnings set to rise at a much faster rate in the US than Australia, and the dollar remaining high, now is a prime opportunity to gain offshore exposure.|
|Key take-out: As we head into our new financial year, it is time to make sure that a worthwhile proportion of your local shares have a substantial content of overseas exposure or, alternatively, you take a greater direct investment.|
|Key beneficiaries: General investors. Category: Investment strategy.|
Sometimes a communication passes your desk, which really starts you thinking about what is really ahead for Australia.
This week the Roy Morgan ANZ Group produced their monthly business confidence report for June, which was prepared after interviews with 1,240 business groups across Australia. This was a large survey.
Below is the graph that was produced, which shows business confidence fell a further 5.4% in June and is now an incredible 20.7% below the peak in 2013 following election of the Abbott Government.
Business confidence is at the lowest level since June 2012. In short, the businesses told Morgan Research that they do not believe the Australian economy is going to materially improve over the next five years and they are beginning to relook at their business investment. In due course that will affect employment far more than the rise to 6% in June. It’s always dangerous to place too much emphasis on surveys, and indeed the NAB business confidence survey is far more optimistic. But longer term, consumer and business confidence show the same trends and both Morgan and Westpac consumer surveys are in line with Morgan’s business confidence survey and my anecdotal experiences.
However there is a small pick-up in consumer confidence, so we are not looking at a disaster but rather much slower growth. Accordingly I am seeing a number of analysts beginning to suggest that growth rates in the next five years in the US are going to be much higher than those ahead for Australia.
And, of course, that is the absolute reverse of what we have seen in the last five years. The compound annual revenue growth rates over the next five years projected for large US companies tend to be around the 7% to 7.5% mark. The equivalent Australian projections are in the 3.2% to 3.4% range — the US is more than double Australia. That means American earnings are likely to rise at much faster clip than Australia.
If that is what happens then the Abbott Government will struggle at the next election, given current opinion polls. And indeed the only person in the Abbott Government that has a vision for this country is the Trade Minister Andrew Robb, who is opening up vast trade opportunities in Korea, Japan and perhaps later China as a result of trade agreements. This will take time to materialise. Robb is also preaching northern development. So where does that leave investment strategy? For some time now I have been suggesting that the higher Australian dollar represents an opportunity for long-term investors to increase their proportion of overseas investments. For the most part, Australian investors particularly.
Self-managed funds have been reluctant to substantially lift their overseas content, and usually they have been right because overseas market rises have been offset by the higher Australian currency and the Australian market’s performance.
Earlier this week, Eureka Report added international equities investor Clay Carter to its team (see Eureka brings the world to your doorstep), who noted that investing in international shares remains underdeveloped in Australia.
There are a number of ways to invest directly overseas, including via listed investment companies like Templeton (the way I do it). But many Australians have actually adopted another way of adjusting portfolios to take advantage of better trading conditions overseas. In the last decade there has been an incredible increase in the amount of revenue generated by Australian-based companies offshore. Indeed, many of our self-managed funds say they don’t need to invest directly offshore because their local listed companies are performing the task.
And when you look down the list of Australian companies there has been a considerable rise in overseas exposure, particularly if you adjust for the higher local dollar.
According to Macquarie, if you exclude banks and resource companies there are now more than 40% of Australian companies generating more than 30% of their revenue overseas.
Macquarie say the shift to offshore is more apparent at the smaller end (ex 100 Industrials), where 27% of companies are now classified as ‘International’ (more than 30% of revenue generated outside Australia) compared to just 15% in 2000.
Similarly, the proportion of companies outside the top 100 with no international exposure has more than halved to 33%.
There is now a long list of companies that have increased their overseas investment in recent years including CSL, Amcor, Brambles, GrainCorp, Computershare, Worley Parsons, Ramsay Healthcare, Sonic Healthcare, Ansell, Seek, Flight Centre, Aristocrat, Navitas, Domino’s Pizza and Breville Group. Some have disappointed, while others have succeeded.
If we see a fall in the Australian dollar then the profits from that expansion and the value of it will explode. So I think, as we head into our new financial year, it is time to make sure that a worthwhile proportion of your local shares have a substantial content of overseas exposure or, alternatively, you take a greater direct investment.
Australian shares are looking fully valued in many areas, including banking. As I pointed out last week, PayPal and Ebay are likely to enter the Australian space and compete with some of our Australian companies including banks.
Ebay’s value in price earnings terms is not that much higher than the Commonwealth Bank. Australian banks are going to face considerable competition from overseas technology-based companies that have substantial customer bases.
Now, of course, just because Australian domestic revenue growth rates are likely to fall to the low 3% annual rates, and personal income growth is also falling, does not mean that there will be plenty of local success stories. There will be a large amount of infrastructure investment, but again companies like Leighton are going to find it very difficult to comply with the Government’s labour rules. And, as always, we will see companies that pick market niches doing very well.
Overall it is going to be tough going, and if your portfolio is completely dominated by banks and the local market I would advocate a greater degree of diversification.
You will notice that I haven’t included Telstra in that general commentary. Telstra looks like they have the government fairly well cornered and will do very well out of fibre to the node. But, in addition, Telstra has an ambitious plan to be a much larger overseas player, particularly in China. I know that Telstra is seen as a purely income stock, but it actually has substantial growth ambitions and will use some of the money that comes out of the NBN to fund those ambitions.
When you look at your company’s profits in the next month or so ask the question, has management prepared for a much slower Australian growth rate? Have they already expanded offshore, and how successful have they been? Are they preparing to expand offshore? Remember that it is not easy to expand offshore, and those that have done it and succeeded are much better placed than those that are just starting.