Three opportunities from the G20

The leaders’ summit will create opportunities in infrastructure, energy and dairy.

Summary: The G20’s emphasis on boosting global growth includes a plan to mobilise investment capital into infrastructure projects, which will offer more investment choices in coming years. In terms of energy, as the world becomes more energy efficient, a surplus of energy will depress prices. In agriculture, dairy will be the biggest beneficiary of the FTA with China that was signed after the G20.

Key take out: Low-cost energy producers will use cash flows to pay high dividends, meaning BHP could become an income stock.

Key beneficiaries: General Investors. Category: Economics and investment strategy.

Enormous volumes of words and film came out of the G20 meeting and its aftermath. For Eureka readers I want to focus on the three themes that caught my attention because they are going to require a continual monitoring of investment strategies.

I can’t imagine counting the number of times people referred to the proposed 2.1% increase in global growth without mentioning how it was to be achieved. Let’s look at part of the growth plan, because investment opportunities will be created which will require evaluation.

The second theme is carbon. The carbon conscious journalists placed enormous emphasis on energy generation. How will that affect companies like BHP Billiton?

Finally, we are going to have a boom in dairy and other agricultural areas. Again, there will be opportunities for investors. 

Investing in infrastructure

The one thing we know is that simply flooding the world with money does not make any significant difference to growth or employment generation. All it does is push up asset prices and create a frenzy of speculation. What creates growth is projects or business investment and/or consumer spending. 

And so in the US the combination of attractive labour, technology and an abundance of low-cost energy via fracking has created enormous stimulation to the US. Many US manufacturing enterprises are leaving China and coming home. Politicians can encourage that sort of growth but they can’t drive it.

At the G20 a key growth plan was to mobilise investment capital into infrastructure projects around the world. That plan, if it can be implemented, would indeed create a lot of growth because the world’s savings are not yielding good returns in interest-bearing securities. On the other hand they are being boosted by the speculative activity created by money printing. 

The problem with infrastructure is that the easy part is getting the capital. The hard part is getting projects where the users of the new facilities are prepared to pay a sufficient amount to give the provider of capital a return.

Using Australia as an example, people much prefer to drive on roads where there are no tolls; they can object to power prices that are pitched to give a return to the various capital providers in the network and if fares on public transport rise too far there are also protests.

In Australia these “angry moments” fade away. But in developing countries, where many of these ‘toll’ infrastructure projects are planned, the income of the population is depressed and so these projects carry considerable political risk. 

A change in government, perhaps one that is democratically elected, may well change the rules in the face of public protest. Where there is political risk, capital will require a greater return, which increases the risk of backlash. We may see larger countries provide an element of guarantee but that also can be very dangerous. So if the growth the G20 foreshadowed is to be achieved then there will need to be a much greater understanding among the users of the infrastructure that this infrastructure must be paid for.

In Australia there is currently a Victorian election campaign where one of the issues is a proposed toll road called the East West Link. The mistake that the Victorian Coalition made was not to gather support for that project by raising capital from the local community. So as to avoid the BrisConnections mistake, that capital had to be raised with a level of government guarantee. It is only by bringing the community benefitting from the project into the capital raising process that some level of security can be achieved. This was the main conclusion of the ADC summit on infrastructure earlier this year but the Victorian government ignored it and, according to opinion polls, will pay the price.

The whole infrastructure thrust is a work in progress but one way or another there will be a lot more infrastructure investment choices in coming years.

Considering carbon

When it comes to carbon we are headed into a very different era. The green commentators are focused on fossil fuels and the way we generate energy.

Those who think a little deeper are beginning to realise that the way we generate power is only part of the story – possibly the minor part. There is enormous scope for our world to use energy far more efficiently. For example in large residential or office towers new technology enables a 20% to 30% reduction in energy usage. The outlays to achieve the energy usage reduction can be recouped quite quickly, in say, three years. My prediction is that in the developed world we are going to see very little if any rise in energy usage and in some areas we may see significant falls as enterprises and assets become more efficient.

In that context we are going to have a surplus of energy, which will depress prices. We are already seeing that happen although the current price falls are more closely related to the fact the suppliers of coal, oil and gas have flooded markets. And, in terms of energy demand falls, we are looking at a trend that is not short term. And so to be economic, new alternative energy sources will need to be very efficient unless governments/consumers are prepared to subsidise them. That totally transforms the outlook for stocks like BHP and Rio Tinto. They are not going to be growth stocks because the products they produce will be in abundance and demand will be restrained in developed countries. In China, India and emerging countries there will be growth but energy efficiency will also affect demand in those countries. 

Among the resource companies we will see emerging a series of low-cost producers who will make a lot of money. They will not spend a lot of money on exploration and it will be efficiency and more efficiency. The international oil companies are starting to look like this. BHP will be a leader of the new breed and to use its cash flows to pay high dividends in Australia and buy back shares to please the London institutions. I never thought I would ever see BHP as an income stock. But it is coming and the G20 was a signal.

The approaching dairy boom

Dairy will be the biggest and immediate beneficiary of the free trade agreement with China which was signed just after the G20. It will be some time before services will really boom. But dairy is set to double in five years. But the industry will need capital. New plants need to be installed that are efficient and clean and designed for export rather than the local market.

The overseas groups that are big players in Australian dairy processing will need either to invest or sell. Murray Goulburn, which is a cooperative and the biggest enterprise in the industry, is planning to invest $500 million in new plant to supply China. Next year it will issue securities where the dividend returns will be linked to the milk price and not to profits.

This will be a totally new concept and will represent an interesting opportunity for investors to participate in the dairy industry. Australian dairy herds need to be substantially increased and that will take at least three years. Right now most of the dairy farmers are full of debt and need equity. Murray Goulburn is mobilising the large institutional superannuation funds to buy dairy farms and then lease them back to share farmers. I am trying to encourage them to widen that offer so that at least the larger self-managed funds will have the opportunity to participate.

Like all agriculture, dairy will go up and down but the milk price is set to rise substantially assuming the Russian bans on dairy imports from Australia and Europe is ended. That requires peace in the Ukraine. 

And so we see a new set of opportunities in global infrastructure, a totally new outlook for our large miners and opportunities in dairy.