Last week the RBA surprisingly cut Australia’s benchmark cash rate, to 2.75%, the lowest since record keeping began.
The rate cut was unexpected. Positive retail sales from January to March suggested a cut may not be needed (in Q1 2013 retail sales rose 2.2%, compared to 2.6% for the entire year 2012). Yet cut they did.
One reason for the cut is the stubbornly strong Aussie dollar. Treasurer Wayne Swan notes that the high Aussie dollar is “putting pressure on all sectors of the economy”. Declining commodity prices should have weakened the dollar but the dollar has remained firm. Concerns over the mining bloom slowdown should have hurt the dollar, but it hasn’t.
From 1990 to 2006, the Aussie dollar averaged $0.85 against the US dollar, reaching a high of $1.10 in 2010. Our dollar has now been above parity with the US dollar for ten months. The following chart tracks the AUD/USD since the GFC:
The big question is: how will this impact your investments?
Implications for Investors
In theory, there are four trends that could present buying opportunities:
• Lower term deposits could push investors into high yielding equities
• Lower credit costs, especially mortgages, could put more money in consumers’ pockets, benefiting retailers.
• If the AUD falls substantially below parity with the USD, ASX listed companies that get paid in US dollars should benefit.
• Decreased purchasing power from a lower AUD could benefit Australian retailers suffering from online competition as well as Australian tourism and leisure stocks.
Big dividend paying stocks should benefit from a lower dollar, as seen in the following chart:
Term deposit rates will fall, possibly as low as 3%. Furthermore, the RBA could cut again, by 0.25%, in June. A cash rate of 2.00% by the first quarter of 2014 is not out of the question.
Lowered savings rates almost certainly lead to investment dollars flowing into high-yielding equities. The big banks have agreed to pass the full cut so mortgage rates should correspondingly fall.
Will Consumers Spend?
Lower rates may increase consumer spending and credit demand, but not necessarily. Recent trends suggests Aussies may use the rate cut to save more and pay off debt. Indeed, the rate cut may not have the desired effect on consumer spending.
Will the Dollar Fall?
Hedge fund managers have been calling the Aussie dollar down for quite some time now. Again just last week Stanley Druckenmiller, connected to George Soros, says investors should bet against the Australian dollar. “We think the Australian dollar will come down and will come down hard,” Druckenmiller reportedly said at a New York conference. “It’s expensive.’
GDP growth forecasts for 2013 and 2014 have been downgraded by Treasury to 2.75%; Resource rich Canada has also lowered its 2013 GDP forecast to 1.5%.
However on the flipside Australia is one of a handful of industrialised countries still holding a coveted AAA credit rating with a stable outlook. And while our cash rate may be at a record low, it’s high relative to most other economies. The table below shows benchmark interest rates around the world:
Key Interest Rate
Swiss National Bank
3 Month Libor Rate
Bank of Japan
Overnight Call Rate
Federal Funds Rate
European Central Bank
Bank of England
Bank of Canada
O/N (Overnight) Lending Rate
Sweden Central Bank
The Norwegian Central Bank
Sight Deposit Rate
Reserve Bank of New Zealand
Official Cash Rate
Reserve Bank of Australia
Our cash rate is still among the highest in the world. South Korea just lowered their benchmark rate to 2.50%. Australian bond yields are also among the best in the world.
Australia’s 10-year bonds yield around 3.17%, compared to 1.80% for the 10 year yield on US government bonds and 1.82% for Canada. The only industrialised countries with higher yields than Australia are Spain, Portugal, and Greece!
The key to a lower AUD is not interest rates here so much as interest rates elsewhere, especially in the US.
Even at 2.00% our cash rate still betters the US Federal Funds rate, who are waiting for jobs data to improve before they stop their bond-buying program.
Stocks to Benefit
We found five stocks currently out of favor in the midst of this bull rally. All stand to benefit from the RBA rate cut. We looked for “blood in the streets” and right now there really isn’t that much.
52 Wk Share Price % Change
Forward P/E (2014) vs. Sector P/E (Current)
11.42 vs. 10.56
Incitec Pivotec Ltd
10.48 vs. 10.56
15.1 vs. 10.56
Noni B Ltd
7.78 vs. 15.16
Oroton Group Ltd
16.16 vs. 15.16
Orica Limited (ORI) reported Half Year results on 06 May, the day before the rate cut. Results were moderately positive but fell short of some broker expectations.
The company provides blasting systems and explosives to infrastructure and mining companies globally, with eight separate geographic market segments. The second largest by revenue is North America. First half revenue from the company’s Asia/Pacific market was $99.78 million while revenue from North America was $743.9 million. The 5 Day share price chart shows market reaction:
The timing of the two announcements makes it impossible to tell which benefited the share price more, but this is a company that would benefit should the AUD drop below parity with the USD. Major Australian brokerage houses like the stock, with only Citi maintaining a NEUTRAL recommendation following the results release. Macquarie, UBS, CIMB Securities, Deutsche Bank, Credit Suisse, JP Morgan Chase, and BA-Merrill Lynch all have BUY or OUTPERFORM recommendations on Orica. The dividend yield may not be attractive enough for some investors as it is only partially franked, at 44.4%.
Incitec Pivotec (IPL) is another materials sector provider that has suffered from weakening demand as well as from the high AUD. In its dismal Full Year Results release back in November 2012 company management claimed IPL sustained a loss of $40 million from falling commodity prices and $41 million from the high AUD. The company makes fertilizers and other chemicals for the agricultural sector and explosives for the mining sector.
The company is expanding in China and India and is building an ammonia manufacturing facility in the US. Analyst opinion on IPL is mixed; with BUY or OUTPERFORM recommendations from Credit Suisse, UBS, Macquarie, and CIMB Securities. Citi, BA-Merrill Lynch, Deutsche Bank, and JP Morgan Chase have HOLD or NEUTRAL ratings.
The company’s share price rallied for a few days following the rate cut. Here is its 5 Day chart:
Incitec’s dividend yield is partially franked at 75% but considering its exposure to exchange rate differences, this stock is one to watch should the AUD fall substantially.
Sims Metal Management (SGM) buys and processes scrap metal.
The company saw a 25% revenue decline in the Half Year 2013 results along with a 76% drop in underlying NPAT after significant items. This company is heavily exposed to US markets with 60% of revenue from North America and 24% from Europe.
Despite this, major analysts are positive on the company’s prospects due to cost control efforts and management efficiencies. In late April BA-Merrill Lynch upgraded the stock to a BUY citing growing evidence of a US recovery.
On 01 May Credit Suisse upgraded the company from UNDERPERFORM to NEUTRAL due to valuation reasons. Sims is high risk as even a falling dollar might not compensate for continued drops in the price of iron ore and steel. In addition, the company recently cancelled its dividend payment.
However, the stock is trading below book value with a P/B of 0.92 along with an attractive P/EG of 0.81. The share price has improved since the RBA rate cut was announced. Here is the 5 Day chart:
The final two companies are high end niche retailers that could benefit if the dollar falls enough to drive consumers out of their easy chairs and into the stores. Both have online sales operations as well.
The companies are the Oroton Group Ltd (ORL) and Noni-B Ltd. (NBL). Oroton sells leather goods and fashion accessories under its own brand as well as under the Ralph Lauren label. Competition from online discounters has hurt and now the company is losing its rights to the Ralph Lauren brand at the end of June 2013.
Noni-B sells high fashion women’s wear under its own brand and the Liz Jordan label. Half year results showed a 19% decline in NPAT. The company has brand recognition and 219 stores across Australia and management is committed to increasing online sales. As such, the company could benefit if online competition from offshore retailers drops due to a falling dollar.
Although both Oroton and Noni are high risk propositions, note the high dividend yield from each, both fully franked.
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