There is a growing chorus of market experts predicting lower sharemarket returns for the years ahead based on the current record highs and seemingly stretched valuations of most major sharemarkets. This is a sentiment that we agree with, as we believe monumental changes lie ahead for the global economy. We are in the midst of a synchronised normalisation of interest rates from all-time lows, unwinding of inflated balance sheets, slowing commodity demand, increasing inequality, protectionist trade policies and volatile currency markets.
So as investment advisers, what should we do in this situation?
In an increasing interest rate environment, we are simply not comfortable ‘buying the index’ via an exchange traded fund, as these investments are always fully invested and perform the worst during market downturns. What we seek to do at Wattle Partners, is to identify emerging themes that can generate long-term outperformance for investors even in poor markets. Rather than looking globally for growth, which has been our preference in recent years, we thought it worth considering where the future lies for the Australian economy.
Australia – Today
In order to understand where the future is for the Australian economy, it is important to consider where we are today. Whilst the general views of economic commentators and ‘expert’ forecasters remain positive, with trend growth and inflation to return soon; the data suggests all is not as rosy as it seems. The S&P/ASX 200, which is a leading indicator of the strength of the economy, has actually lost ground over the last decade, to the tune of -1.33% per annum in price terms. When all dividends are reinvested, the return is marginally better at 3.20% per annum; not quite the 10% per annum most of us expect from sharemarkets. Interestingly, the growth in the ASX 200 has closely mirrored the growth of Australia’s GDP per capita, or person. In 2006, our GDP per capita was $50,952, in 2016 it had increased to $55,670. That’s an improvement of just 10% over the same 10-year period. Whilst we remain among the richest countries in the world, it seems the last decade of ‘GDP Growth’ has actually come from increasing the size of our population, and has not resulted in any improvement of the wealth of the population. Interesting, given we experienced both a commodity export and property construction boom for the ages.
In our view, Australian’s have become far too infatuated with investing into residential property, supported by various tax benefits, and this is having negative implications on the economy. Recent statistics indicate that property now makes up close to 60% of the value of the assets of Australian’s and the property market is substantially larger than the sharemarket, which includes businesses that employ the majority of Australians. When you combine the preference for property with retiree’s obsession for franking credits, the result is a corporate sector starved of capital for investment into research and development, expansion and innovation. We believe it is these reasons that are now seeing wage growth at its lowest level in 20 years, at just 1.9% in 2017, and three consecutive months of negative or zero growth in retail sales.
Australia’s trend growth for the period 1992 to 2016, was close to 3.3% per annum, yet we now sit at just 1.8%, slower than Europe, 2.5%, and the US, 2.3%. Consumption continues to be the primary driver of Australia’s growth, representing 56%, however, the threat of increasing interest rates is putting pressure on household budgets and may see us experience the first recession in two and half decades. We are seeing the end of an era in Australia as the final remnants of our past, including smelting plants, vehicle and basic manufacturing are closed down, replaced by cheaper overseas imports. The performers of the last decade, our commodity producers, are beginning to recover, yet they remain cyclical and profitability is determined by the whim of the Chinese Government and their fiscal spending. This is certainly not a sector we should be banking on to improve the wealth of Australian’s for the years to come.
It isn’t all bad news…….
There are definitely reasons to be negative on the future of the Australian economy; but there are also plenty of reasons to be positive on the outlook for Australian businesses. Australia has consistently fought above its class to the benefit of the population, with our ranking as the 13th largest economy, just behind Russia, but ahead of Spain, and its 46 million people. Australia has just recently achieved its 26th year of consecutive economic growth, albeit at a slowing pace, and remains a successful service driven economy with a history of being ahead of our competitors in a number of specialised areas, which will be discussed below.
Australia – Tomorrow
Yes, it’s true that the companies of yesterday are closing down or leaving our shores. To be honest, this probably should have happened earlier given the borderless, globalised world we live in. The concept of competitive advantage suggests that in a connected world, countries should focus on producing what they are best at, or that which they can deliver at a lower cost than their trading partners; as one of the wealthiest countries in the world there is simply no chance we can compete with the likes of Asia or Africa for basic manufacturing. So, where will the growth come from? Where should we invest?
It isn’t all doom and gloom, at this juncture Australia has two options, to move along the advanced or value added manufacturing path of Germany and Japan, or transition towards an even more service driven economy. Given the multi-decade head start already afforded to Germany and Japan, we believe our future is in the latter. And more specifically, the increasing export of our services, expertise and experience to our closest neighbours in the north; Asia, China and India. Over many decades, Australia has built a reputation of world leading knowledge and success in several key areas (Why Australia? Benchmark Report 2017) that we believe have the potential to benefit investors in the future. They are:
- Resources and energy – including renewables;
- Agribusiness – including land and technology;
- Financial services – including insurance, pension and investment management;
- Education – including tertiary and vocational; and Tourism.
In addition to these, we also see opportunities both domestically and globally in the following:
- Technology and digital media;
- Health and aged care; and
In the sections that follow, we will quickly touch on what we believe to be the opportunities for investors in each of these sectors and a number of implementable ideas. In addition, there are a number of additional articles within this issue, including an analysis of opportunities in the advanced manufacturing space, by microcap investors, Acorn Capital, and a look at Australian success in the online application space, courtesy of Roger Montgomery.
Resources and Energy
Australia was blessed with an abundance of easily accessible commodities that form the basis of the today’s world. In terms of our future, we do not believe it lies in the iron ore, coal or oil sectors, but rather in cleaner energy, mining technology and power storage. We think investors should be seeking exposure to cleaner energy sources, such as natural gas, solar, and uranium. Companies involved in these sectors include, Santos (STO) and Origin Energy (ORG), or Energy Resources of Australia (ERA) for those seeking an exposure to uranium production ahead of a possible approval in Australia. In terms of the future, which we believe will be based around power storage and renewable energy, Australia is well positioned to benefit from both of these booms. Australia has an enviable number of commodity producers specialises in lithium, which at this stage appears to be the core component of most battery technologies. Australian lithium producers are only minnows on a global scale, but given the well highlighted shortage of supply likely to occur as petrol powered cars are banned in various countries, the likes of Orocobre (ORE), Galaxy Resources (GXY) and Mineral Resources (MIN) stand to benefit exponentially.
It is increasingly evident for anyone that commutes into the CBD’s of Melbourne or Sydney, that following years of steady immigration, there has been an inadequate level of investment in our infrastructure. The daily commute seemingly gets longer every year, whether by public transport or car, contributing to an inefficient economy and disgruntled workforce. The continued sprawl of our cities has yet to be met with similar expansion or infrastructure, yet the tide appears to be turning; with Government’s showing some bipartisanship and improving an increasing slate of infrastructure projects. These include new roads andfreeways, schools, hospitals and telecommunication networks, as well as bridges, public transport expansions, level crossing removals and tunnels. There is an extensive selection of companies and sectors that will benefit from this trend, some more than others. They include contracted construction companies, like Cimic (previously Leighton Holdings) and Lend Lease or raw material input producers, like cement and gravel (Adelaide Brighton, Boral and Brickworks). Our picks for this burgeoning sector are Lend Lease, given its globally renowned brand, and Boral, which has less exposure to the cyclical mining sector than Adelaide Brighton.
In 2016, Australia was the 11th largest market for international tourism, generating $29bn in associated receipts which represented some 23% of GDP. International tourists remains infatuated with the natural beauties of our country, from the diverse and rare flora and fauna to world-class travel destinations in every state. An increasing number of tourists are choosing Australia over the likes of Europe and the US, with 1.2m Chinese visiting Australia in 2016 and that number expected to hit 3.3m in 2026, as the country’s wealth continues to grow.
Unfortunately, there isn’t a great selection of opportunities to access this exploding trend, with most airports, outside of Sydney, privately owned or held by institutions. Embattled theme park operator, Ardent Leisure (AAD), and Event Hospitality and Entertainment (EVT), which owns cinemas and hotels offers exposure to the younger generations, whilst casino and resort owners, Star Entertainment (SGR) and Crown Resorts, to the wealthier groups. One for the risk seekers is Experience Co Ltd (EXP) which provides adventure experiences like sky-diving, ballooning and white water rafting. Our exposure of choice remains Sydney Airport (SYD) which essentially has a monopoly over arrivals due its proximity to the Opera House, Harbour Bridge making it the first port of call for most international travellers. The airport stands to benefit from increasing capacity, efficiency improvements and continued growth in Asian tourists.
As it stands, Australia is the third most popular destination for students choosing to study overseas, attracting more students than the likes of France, Germany and Japan or 6.2% of the global total. Education services are one of Australia’s leading exports, whether in the form of accepting international students, offering online education, or using our expertise to expand offshore. Interestingly, the increasing unrest in the countries like the United Kingdom and the US, are expected to benefit Australia by attracting more students to our comparatively stable and safe economies. There are a number of listed education investments, including Navitas which has expanded globally and teaches some 80,000 students and IDP Education, which provides international student placements and has been expanding into the operation of English language schools in Asia. An alternative option to access the exponential growth in students, maybe to invest into one of Blue Sky Asset Management’s Student Accommodation Property Syndicates, which either manage or develop properties focused on attracting international students.
As a small country in terms of population, Australia has seemingly done something right when it comes to the provision of pensions and retirement benefits. Australia’s $2tn pension system is the fourth largest in the world and a major driver behind our globally recognised funds management industry; this is expected to at least double to $4tn in the next 10 years.
Australia houses some of the world’s most successful professional equity investors, with the likes of Kerr Neilson, of Platinum Asset Management (PTM), and Hamish Douglass, of Magellan Financial Group (MFG), building businesses from scratch and increasing attracting investment capital from offshore. These are two of our preferred exposures to the world-class funds management sector. At the other end of the spectrum are ANZ Banking Group (ANZ) and AMP (AMP), both of which have been expanding aggressively into China and the Asian region. ANZ has sought to diversify its risk away from the Australian property market by continuing its institutional and corporate banking operations through Asia, whilst AMP has entered several joint ventures in China and Japan that are focused on sharing their expertise with superannuation, pension and annuity management. It’s not surprising that financial services make up close to 10% of our $1.6tn services sector when you consider the quality of the businesses we have just identified.
One of the most important sectors, in our view, for the future of Australia, is agricultural and the production of food. We continue to be viewed as a high quality producer of food, with a commitment to safety, animal welfare and security of supply, however, this can quickly change. Our largest agricultural exports in recent years have been beef, other meat, wheat milk and barley. At Wattle Partners, we believe an investment in agriculture can be in two ways; the lowest risk ownership of producing property, or the ownership of the production or distribution companies.
In terms of production companies, we prefer those with the ability to differentiate and charge a premium for their products for one reason or another. A2 Milk (A2M) has been a market darling in recent years, however, in our view the growth trajectory could easily be reversed with an improvement in Chinese dairy and milk production in the years ahead. Bega Cheese (BGA) stands to benefit from the changing diets of the Asian region, with its spread of both milk, cheese and other dairy products likely to benefit. Select Harvests (SHV), as one of the only listed almond producers in the world, is likely to see continued growth as healthy eating spreads from the developed to the emerging markets. Costa Group (CGC) is the largest horticultural company in Australia, producing berries, mushrooms, tomatoes, citrus and avocadoes among others. It has substantial market share in the majority of its sectors. The company is also investing into global expansion by entering joint venture to grow its various commodities in Asia and the Middle East, a positive in terms of reducing the cyclicality of their Australian business.
Australia has an enviable track record in inventing technologies or software that become ubiquitous in the modern age; it all began with the CSIRO discovering wifi in the 90’s. Unfortunately, we haven’t always been good at monetising these opportunities. The future of the global economy, as proven by the likes of Google, Amazon, Facebook and Alphabet, lies in digital media and data services. Fortunately, there are no barriers to entry for global competitors and Australia houses some of the world’s best programmers and designers. The Australian Government has been a strong supporter of venture capital investment, providing research and development incentives to Australian companies, which bodes well for the future. These are a few of the more interesting opportunities today:
- Afterpay (APT) – Which is growing substantial market share offering a ‘lay-by’ arrangement for the digital age.
- Altium – Which provides design software for the construction of circuit boards central to increasing computing power;
- Freelancer – (FLN) – Which is a crowdsourcing marketplace allowing people to post jobs and collate quotes for consideration in various service sectors;
- Aconex (ACX) – Which has revolutionised the construction industry via its web-based project management platform.
Health and aged care
As a major beneficiary of the 40’s and 50’s baby boom, Australia’s population will become increasingly tilted towards the older generations in the years ahead. The continued improvements in modern medicine will mean people are living longer and surviving with chronic pain as they may not have been able to in the past. We believe two key sectors will benefit from the ageing population, private hospitals and aged care homes. It is becoming increasingly difficult to improve healthcare outcomes via increased Government funding, as a result we expect a transition to more efficient providers and the outsourcing of additional tasks to the private sector. Healthscope (HSO) and Ramsay Healthcare (RHC) stand to benefit from the increasing regularity and severity of illnesses. On the other hand, the likes of Estia Health (EHE), Regis Healthcare (REG) and Japara Health (JHC) are well positioned to benefit from a boom in older Australians transitioning into some level of assisted living. These companies have been exposed in recent years due to some inappropriate policies and the gaming of Government funding, however, the future is clear. The Federal and State Government’s simply cannot be relied upon to fund the sector as demand continues to grow, and these represent just a few of the companies that have the ability to raise capital and provide services more suited to the expectations of the Baby Boomer generation.
We hope this article has gone some way to provide you with an insight into the many opportunities in the future Australian economy; something that will be important for investors as well as the employees of tomorrow. Australia has a strong history in world changing technologies, from the invention of wifi and the Black Box recorder on every plane, to the technology supporting Google Maps, Spray on Skin and cervical cancer vaccine, Gardasil. We suggest investors keep this in mind when times get tough in the years ahead, as they typically do.