Where Has All The Growth Gone?

Is there climate change? I think the answer is affirmative the investment climate has changed dramatically in years past. This has occurred on the back of significant changes in global financial and economic dynamics.

For investors in the Australian share market, this has not proved a positive development. The Australian economy is admired worldwide for its resilience and its underlying strength, while the Australian dollar has risen to the top of many performance tables, but the Reserve Bank has been forced to keep a tight lid on inflation while the once-in-a-lifetime resources boom has sucked the life out of everything else. A survey conducted earlier this year showed exactly why the Australian share market has not been the safe haven so many believed it to be: 90% of all profits in the year to June 2011 have been generated by the Big Four banks plus the major resources companies.

All the other circa 190 companies combined that make up the ASX200 index thus only generated the remaining 10%. It is common for many a market commentator to make references to the general economic trend when making predictions about potential returns from equities, but the real issue at hand is whether those individually listed companies can generate any growth in profits. Earnings growth is what keeps investors in the share market excited, but over the past five years most of the growth achieved in the Australian share market has remained confined to miners and oil and gas companies, and those who service them.

Unfortunately for investors, both banks and miners have experienced a relentless de-rating on the back of global risk aversion. This now raises a few interesting questions as we are yet again on the cusp of finishing off on another disappointing year: how are we positioned for next year?

If we can rely on current consensus estimates, the immediate outlook is for a continuation on the same theme. There's a screaming absence of earnings growth in Australia. In the US analysts and investors are worried now that consensus forecasts for the current quarter (Q4 2011) have fallen to 10%. Ten percent. It may seem like a warning signal for a market that has become accustomed to double digit advances, plus positive surprises as a bonus each reporting season, but in Australia growth in earnings per share (EPS) has been far, far less. If current estimates are confirmed in February and August next year, 10% will again remain well beyond Australia's reach.

On FNArena's calculations, the average projected lift in EPS for the 200 members of the ASX200 this year sits below 5% and mind you, the trend remains to the downside. Equally interesting is what is currently being expected from those few companies that kept up the average last year. Below are consensus forecasts for the largest and most popular banks and resources companies in the Australian share market (year 1 and year 2):

• BHP Billiton (BHP)) 3.1% / 8.7%
• Rio Tinto ((RIO)) 13% / 7.7%
• Woodside Petroleum ((WPL)) 7.4% / (-1.9%)
• Santos ((STO)) (-1.3%) / 4.1%
• Fortescue Metals ((FMG)) 98.3% / 9.4%
• Newcrest Mining ((NCM)) 47.5% / 27.1%
• ANZ Bank ((ANZ)) 2.4% / 5.4%
• Westpac ((WBC)) 1.2% / 5.8%
• CommBank ((CBA)) 0.2% / 4.5%
• National Australia Bank ((NAB)) 8.1% / 5.8%

Note that Year 1 for Rio Tinto, Woodside and Santos means this year to December. So Rio in 2012 is only looking at single digits, and falling, while Woodside sits in negative territory and Santos is anticipated to go backwards this year, with only a small advance in store for next year. Equally, the largest bank in Australia, Commbank, is not expected to grow this year. The current margin is so small ( 0.2%) it may well turn out negative by August next year.

Herein lies exposed one of the obvious weaknesses of the Australian share market: there's no Apple, no Nike, no Microsoft, no Unilever, No McDonald's, No Colgate-Palmolive and no Anheuser Bush Inbev to sustain growth, and those companies that do keep growing profits for shareholders in Australia are too small to make a difference.

What about the world's largest miner, BHP Billiton?

Interesting question. About every commentator, stockbroker and financial planner in the country believes BHP Billiton should be in every investor's long term investment portfolio. No questions asked. Yet, the share price today is unchanged (net) from mid-2009 (more than two years ago) and if consensus forecasts can be relied upon, there will be hardly any growth for shareholders in the two years ahead. Note that at least three stockbrokers who updated their projections in November now forecast negative growth for both FY12 and FY13. BA-Merrill Lynch, to date the most bearish forecaster on BHP in Australia, is forecasting no growth for three years ahead, starting with the present one.

Admittedly, there are others. Deutsche Bank is still forecasting some big numbers and UBS agrees this year will probably be a negative one for BHP, but UBS also maintains that FY13 should see a jump in the Big Australian's profits. Which just goes to show how much the company's underlying dynamics are levered to global economic growth and to price forecasts.

Probably the most important observation in this regard was printed in a recent report by analysts at Macquarie who, incidentally, are on the same song sheet as UBS: negative growth this year, followed by a pick-up in growth in FY13. Macquarie analysts point out current spot prices for most commodities are below market expectations for the years ahead. Were today's prices to be extended into 2012 and 2013 the impact on BHP's projected earnings per share for both years would be a further reduction by 11% and by 27% respectively.

In other words: BHP shares today look cheap, but only if prices for iron ore, coal, crude oil, copper, nickel and others do not stay at present levels. They have to rise and if they do, a whole new environment opens up for the company and its peers.

If, however, sustainable growth in prices proves illusory a whole new set of dilemma's will be awaiting BHP's board and daily management. Some analysts have already started to question the rationale behind the intention to spend US$80bn in capital expenditure in FY12-15 given cost blow-outs and marginal returns on investments made, such as the Caval Ridge/Peak Downs coking coal project. Analysts at JP Morgan recently mentioned the unthinkable: could the sector be on the verge of entering a period of "value destructive growth"? The longer prices remain below expectations, the more such questions will be raised.

It's probably no surprise then both BHP and Rio Tinto are examining potential divestments of non-core operations?

Note that present expectations for EPS growth in Australia are for a robust looking 13.8% in FY13, but these projections have to be taken with extra caution given the downward trend in expectations overall.

However, it should hardly surprise anyone that, when measured on two years growth expectations ahead, the list of most promising looking stocks in the Australian share market is predominantly made up by resources stocks, with Carnarvon Petroleum ((CVN)), Kingsgate Consolidated ((KCN)) and Mount Gibson Iron ((MGX)) leading the pack.

Sifting through the rankings (see R-factor on the FNArena website) the following industrials look extremely cheap too, on the condition that present forecasts are not completely out of whack with reality:

• Virgin Blue Holdings ((VBA))
• Boart Longyear ((BLY))
• Macquarie Atlas Roads ((MQA))
• Insurance Australia Group ((IAG))
• Bank of Queensland ((BOQ))
• OneSteel ((OST))
• Emeco ((EHL))
• TPG Telecom ((TPM))
• Macmahon Holdings ((MAH))
• Sims Group ((SGM))

Admittedly, growth projections for companies such as Monadelphous ((MND)), Campbell Brothers ((CPB)), Domino's Pizza ((DMP)), Reckon ((RKN)) and Ramsay Healthcare ((RHC)) carry a lot less question marks and risks, but their share prices have already priced it all in, plus some more.

By Rudi Filapek-Vandyck, Editor FNArena

Note: FNArena subscribers have access to daily forecasts and other data that allows them to conduct similar analysis as I did for this story.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)