A stock that is one of the ‘haves’

Chief Investment Officer and founder of Aitken Investment Management
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While Treasurer Wayne Swan continues to bring unwanted negative attention to Australia with his personal attacks on Australian business people, perhaps he should be more focused on the rapidly deteriorating economic data on the east coast of Australia.

Treasurer Swan believes the right course of action for Australia is the largest fiscal contraction in Australian spending in over a decade – right at a time when east coast Australia is clearly suffering from Dutch Disease.

I realise Treasurer Swan believes he will achieve some sort of economic credibility by delivering a surplus, but not only will he be incapable of delivering that surplus as tax receipts collapse, but his brand of fiscal austerity will lead to growth in Australian gross domestic product (GDP) and company profits being lower than otherwise achievable. It will also lead to unemployment being higher than expected.

Tax change?

I just can’t help but think some of Swan’s recent jibber is softening us all up for a change to the Mining Resource Rent Tax (MRRT) to fill his growing budget revenue hole. The big miners should be sceptical of their agreement with Canberra and I believe some of BHP and RIO’s recent heavy underperformance is based on valid fears of revisions to the MRRT deal.

There was a series of data released in Australia early this week that confirm my genuine concerns about East Coast Australia this year. The most concerning was the Australian Industry Group-Commonwealth Bank Performance of Services Index (PSI), which dropped 5.3 points to 46.7 in the month. The retreat below the 50-point level indicates services contracted in the month. New orders dropped to their lowest level in 12 months in February, down 8.5 points to 45.6.

But not only is the services sector physically going backwards, the data is showing Australia business is holding more inventory. Australian inventories rose by 1.4% in the fourth quarter of 2011 compared with an expected 0.3% rise, which saw Australian profits fall 6.5% in the quarter.

East coast struggling

That AI Group PSI reading for February is absolutely accurate in my view. The east coast economy is facing very serious headwinds that are translating to economic activity contraction. The mining and mining investment boom that is underpinning the Aussie dollar and high interest rates in Australia is damaging east coast Australia. It’s that simple and that is why I continue to believe this is going to be a difficult year in east coast Australia, at least until the Reserve Bank of Australia works out that its implied ‘high dollar policy’ is an unmitigated disaster.

And this is all happening before Australian industry has to deal with the world’s highest carbon tax from 1 July. You can see why I am running a ‘selectively bullish’ Australian equity strategy, focusing on the ‘haves’ and trying to avoid the ‘have nots’.

Until I see a genuine change of policy from both the Federal Treasury and the Reserve Bank of Australia, which may come later this year after the damage is done, I will maintain our conservative approach to all this and I will keep using the term “Dutch Disease” because it’s exactly what the east coast of Australia is suffering from. The first thing we all need to do is admit we have a problem.

So let’s look at the ‘haves’.

February was another strong month of iron ore export shipments from the ‘haves’ across at Port Hedland. Normally February is the weakest month of the year given it has less shipping days and Chinese New Year. But this year, more ore was moved than in January. Clearly the cyclone would have impacted January’s number, but good to see some catch-up is being made with similar volumes to what was going through in October and November last year. Keep in mind, 74.4% of Port Hedland iron ore exports went to China, reminding you that demand from China remains a record high.

Emeco Holdings (EHL) – Buy

Emeco is one of the ‘haves’. It is trading on 10.3-times its fiscal 2012 offering, is plus-20% earnings per share (EPS) growth and has a 5% yield. The company is cheap and leveraged to the mining investment boom. This is one mid-cap growth industrial stock with yield support that I would be adding to portfolios.

Arguably the easy money is made in stocks like Emeco when utilisation rates in the existing fleet approaches 90-95% (effective capacity). In the case of this company, this has already been achieved in the Australian business and with global utilisation averaging 85% through to the first half of 2012 (currently 92%) the upside looks somewhat confined to further investment. However, we believe there is still some significant upside in the Indonesian and Canadian businesses, where we see the shift in fleet to core production as lagging the turnaround already visible in Australia.

We continue to see value in Emeco. The continued repositioning of the portfolio to production-based revenues (approaching 90%), increasing contract tenures, with higher minimum hours and capital investment support our forecast for 15% per annum compound EPS growth to fiscal 2014. We retain our Buy rating with our target unchanged.

  • 12-month target price: at $1.39
  • Wednesday’s close: $1.06

Go Australia, Charlie

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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