Winners If The Australian Dollar Falls

August, 2016

Karl Siegling Photo

This article was written by Karl Siegling was originally published in the August ASX Newsletter.

Currency and interest rates are currently playing a large role in the world economy, which should be no surprise because we are covering new ground in terms of record low rates and subsequent currency fluctuations. At present, 40 per cent of the developed world’s interest rates are negative.

By contrast, Australia has one of the highest official cash rates. The consequence of this is the risk that the Australian dollar remains disproportionately strong compared to other developed countries’ currencies and damages our competitiveness.

Although good for taking overseas holidays, a strong Australian dollar makes exports less competitive, encourages imports and tends to lead to current account deficits and large government debt. This is why the Reserve Bank of Australia is monitoring the situation so closely. The bond market is predicting a high chance the RBA will cut rates in Australia again this year and an even chance of another cut in the New Year.

A fall in interest rates would put downward pressure on the Australian dollar, which in turn would improve export competitiveness, curb imports and ultimately balance Australia’s budgets again.

The Australian dollar has already fallen from around US$1.10 to US$0.75, a fall of around 32 per cent since the Australian dollar reached its most recent high. A further fall of around 32 per cent would take it to historical lows of US$0.50.

We believe this would require interest rates falling significantly from the current 1.75 per cent, or the Australian current account deficit growing significantly.

This scenario is not the current one being painted by economists and business commentators. A more measured scenario is predicted where the Australian dollar is benign, or falling more gradually. In our view, this is a more likely outcome.

Investment considerations

The investment implications of this are that we need to look for domestic stocks that benefit from falling interest rates, a gradually falling Australian dollar and beyond these two conditions, stocks that can display more than one string to their bow in terms of the likely earnings outcome over a period where interest rates and the Australian dollar fall.

Some examples of stocks that fit this category are Macquarie Group Limited, Henderson Group Limited, Select Harvests Pty Ltd and selective resource stocks, in particular gold stocks, and as a consequence, mining services providers such as Monadelphous Group Ltd.

Here is a brief synopsis on how these benefit when interest rates and the Australian dollar are falling and what could make them special.

Macquarie Group (MQG)

The company started in Australia in 1976 and 40 years later has reported a record profit of $2.1 billion. Macquarie is now the largest infrastructure fund manager in the world and has a very large global funds management business, as well as an emerging global investment bank. Threequarters of MQG’s earnings come from offshore and two-thirds of all earnings are now of a recurring nature as a result of the funds management business.

Falling interest rates are beneficial for diversified financial services businesses in general, and a falling Australian dollar would increase the value of the 75 per cent of MQG’s earnings that are from overseas. Beyond the direct benefits of falling interest rates and a falling Australian dollar, MQG also has a history of significant earnings growth over 40 years and through many market cycles.

Henderson Group (HGG)

Henderson is a spin-off from AMP in Australia which has grown significantly and is now a global funds management business with a large portion of funds being managed on an absolute returns basis. Ninety-five per cent of earnings come from overseas and the business has grown funds under management and earnings significantly over nine years.

In an environment where the Australian dollar is falling relative to overseas currencies, HGG earnings will go up in Australian dollars.

At the time of writing, the Australian dollar has actually appreciated dramatically in a short time against the British pound because of the Brexit vote. But in our view, no matter how the Brexit situation is resolved, HGG will still be a global fund manager and expand its business. Brexit actually might create an opportunity for potential investors.

Select Harvests (SHV)

The agriculture company is a world-scale producer and distributor of almonds. During falling interest rates and a falling Australian dollar, domestic almond producers would have the double benefit of lower capital costs to plant orchards and higher income, because almond prices are predominantly sold in US dollars.

Select is also interesting because the almond price suffered an exogenous shock last year and fell dramatically below its long-term average, severely affecting the SHV share price. Almond prices are now recovering to more normal levels and SHV’s volumes are being significantly increased with new plantings. SHV has essentially three strings to its bow in terms of earnings growth.

Resources and gold stocks

All exporters become more competitive with a lower Australian dollar. Falling interest rates would improve capital costs and in the case of gold, we could see a situation where, as currencies become increasingly vulnerable, people buy gold for certainty and the US-dollar price increases.

The Australian-dollar gold price would go up more, and the cost of mining gold in Australia would effectively fall. Australia would be capable of producing more gold than can be mined cost-effectively at the moment, and at higher margins.

Should resources become more competitive exports because of a lower dollar, many mining services companies which experienced significant growth in the last mining boom but have since contracted, may win new contracts as resource companies look to open new, or expand existing, production.

In summary, falling interest rates and a falling Australian dollar could benefit a selection of companies listed on ASX. These factors could be a big positive for many investments and might currently present a significant opportunity for long-term investors.

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