Record low interest rates mean an acquisition can kick start your growth

I’m sure you’re all familiar with the term ‘acquisition’ but have you ever seriously considered it a viable component of your growth strategy? At a difficult time in the economic cycle surviving rather than growing is probably your most pressing issue. But acquisitions can be, and have long been, an excellent way to quickly increase revenues, expand products or service offerings, improve market reach and increase enterprise and shareholder value. That all sounds good but what does it really mean?

When defining an acquisitions strategy, smart companies always start with a fine-tuned business strategy. Once that business strategy is defined, they then look at acquisitions as a potential tactic that can help them achieve that strategy.

A fundamental part of every business strategy is growth, which can be achieved in a multitude of different ways. By examining key rationales for acquisition activity, it may become more evident why including acquisitions in your growth strategy warrants a closer look. The following list of acquisition benefits is not comprehensive, but it is a good start.

Scale. Greater scale provides opportunities for profit enhancement across many aspects of the company and its operations.

Market share. Control a greater percentage of the total available market. Anecdotal evidence and economic theory suggest that long-run profitability increases with market share as it gives you the opportunity to be a price maker not a price taker.

Economies of scale. Decreased per unit cost occurs as output increases. By consolidating and eliminating duplicative departments, job functions and certain processes, thereby lowering costs relative to the same revenue stream, significant improvement in margin can be realized.

Distribution channels. New or additional channels for distribution can be more quickly acquired than developed. Established distribution channels can take years to develop and are usually not easily penetrable.

High cost of excess capacity. Excess or idle capacity is a killer on margins. Every unit of excess capacity carries with it an incremental piece of overhead. Zero excess capacity equates to the lowest cost per unit.

Convergence. Products or services that incline towards each other, rather than ones that run parallel, present unique opportunities.

Cost synergies. Significant savings are generally found in production and procurement, but also present in marketing and advertising.

Intellectual property. Firms in need of IP as part of their strategy can often acquire it more quickly and less expensively than developing it.

Countercyclical balance. Firms in cyclical businesses may seek to acquire businesses that are countercyclical to absorb excess capacity or idle production.

Resource transfer. Resources are unevenly distributed across companies and the interaction of the target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.

Vertical integration. Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers.

So if you believe acquisition should be part of your overall growth strategy, is now a good time? Mergers and acquisitions (M&A) deal activity has taken a precipitous drop over the last few years from the previous all-time highs. Economic factors are the key drivers behind reduced deal volume, particularly the severe tightening of the credit markets.

Although the global recession and constrained credit markets may make completing acquisitions more challenging, significant opportunities remain for well-positioned companies. Firms in stable, mature industries with strong balance sheets have opportunities not seen in decades. Lower valuations, together with fewer competitors capable of making acquisitions, indicates the time for making acquisitions couldn’t be better. Interest rates are at record lows and credit is still available for strong companies making the right acquisitions for the right reasons.

Start the new year off by giving growth-by-acquisition a serious look. First and foremost, know your strategy and take into careful consideration whether the cultural aspects of an acquisition, and the affect it will have on your employees, will be beneficial to your firm’s long-term viability.

Economic update : the state of the economy and the markets leading up to the Federal Budget

The budget is coming.  With just two weeks to go it looks like, the Government will deliver a budget with a strong long term outlook and an amount of short-term pain including the introduction of a debt levy. Not surprising really given the state of the domestic economy and the sheer number of baby boomers that will leave the workforce in coming years.  

Over the last three months, our economy has behaved with relative stability.

The last quarter, and in particular, the last month has seen the Australian dollar rise adding more pressure to rebalance the domestic economy. On the flip side, housing prices have continued to rise over the quarter combined with an increasing level of building approvals showing confidence is certainly in place.

Interest rates have remained unchanged throughout the quarter at 2.50% and RBA Governor, Glenn Stevens has commented that further rate cuts are unlikely in the short term. The board appear more comfortable with the global outlook and are predicting a reasonable pick-up this year. In Australia, the housing market has rallied in recent months and household spending has continued to increase, encouraged by our historically low interest rates.

In international markets, the US and Euro Regions have shown improvements in recent months. The US Federal Reserve made the announcement in March to reduce asset purchases by a further $10 billion a month to $55 billion. Following on from this announcement, US 3-year and 10-year Government Bond Yields rose by 0.07% and 0.32% respectively.

Overall International Bonds outperformed global equities in March, with the Barclays Global Aggregate (Hedged) $A Index increasing by 0.31%. Treasury stocks and corporate bonds gained by 0.35% and 0.36% respectively for the month.

Australian equities posted modest gains in March, with the ASX 300 rising 0.21% for the month. Commodity prices declined by 2.0% for the month in terms of Australian dollar terms, largely coming from the fall of iron ore, coking coal and steaming coal. On a market capitalisation basis, large company stocks performed better than smaller companies. The S&P / ASX 50 Leaders Index increased by 0.33% in March, while the S&P/ASX Small Ordinaries Index posted a loss of 1.16%.

On a sector basis, Financials (ex-Property) was the best performing and gained 2.92% in March. All the big four banks also recorded another round of strong gains in March. Materials and Healthcare were the weakest sectors declining by -2.89% and -2.07% respectively.

While residential dwelling investments continue to expand, commercial properties (office buildings and large shopping centre investments) declined over the month. The Australian Listed Property Market posted a loss of -1.58%.

In international equities, the Fed’s further decision to taper and indication that quantitative easing could end earlier (possibly within the next 6 months) has resulted in a more optimistic growth outlook. The MSCI North America (Local Currency) Index posted a small return of 0.68% in March.

The best performing region was India with 4.75% over the month due to political optimism. Japan was one of the worst performers losing -7.51% in the first quarter of 2014 due to the sudden 3% sales tax threatening to endanger their recovery.

China lost -1.74% and Europe reversed its previous months strong position and lost -0.65% in March.

Global resources performed poorly in the month with the FTSE Gold Mines Index and HSBC Global Mining Index declining by -11.14% and -5.42% respectively.

Over the coming three months we expect, if there are no sudden changes to the global environment….

1. A Federal Budget that takes some positive steps to reduce the deficit, cutting welfare payments to those not working and incentivising mothers into the workforce; and

2. A stable interest rate environment that is supportive of business and consumer confidence.

Green Shoots

The Federal Election has come and gone, leaving the result most business owners and investors were expecting but will the confidence instilled by a more stable Government bring the green shoots Australia needs?

In the week leading up to the election when our Nation’s fate looked sealed firmly in blue tape, the consumer confidence number started to climb, rising by 4.7% in September from August and sitting at 110.6, above the 100 level where optimists outnumber pessimists.

The business confidence numbers also strengthened significantly in this period, with the index rising in August to its highest point since May 2011.  The consecutive cuts in the cash rate may have helped, but seemingly more important were the anticipated political changes.

Nationally, housing is also providing a badly needed sign of life in our economy, with six consecutive weeks of 80%+ auction clearances in Sydney at the time of writing, and Melbourne achieving their highest rate since 2010, at 76% .

Equities, which were struggling under the weight of the Syrian crisis and the end to quantitative easing in the US in August, seem to have lifted their tone with the news that Russia and America plan to do everything they can to avoid full blown conflict.

Could these be the green shoots of Spring in our economy that so many are looking for to invest?

Over the coming three months we are looking for three shifts in the market:

We expect the USA will continue down the forewarned path of reducing its quantitative easing, bringing to fruition something the market already expects.  This could cause some market instability around announcements.

We see the continued weakness in commodity prices and Asian markets driving a gradual and painful weakness across the mining economy in Australia and a continued flow through to other sectors.

And the handbrake coming off Australian business confidence, as the Liberal Government starts to make their policy changes.

One big hope we all have is that the recent reduction in the $A dollar will act as a natural stimulus improving investment and export growth that stimulates our business economy.

Doom and gloom or the roaring bull?

While interest rates may need to fall a bit further, green shoots of recovery suggest we are at or near the low and more importantly, point to an improvement in economic and profit growth over a 12 month horizon, according to Dr Shane Oliver, Chief Economist from AMP.

“All I hear is doom and gloom… All is darkness in my room”

Dr Shane Oliver opened his Economic Update for our Sydney office last week with a riff from the new Rolling Stones song “Doom and Gloom” released this year.

His pragmatism was clear, despite the recent rise in equity markets that has occurred since December 2012, he wants investors to retain cautious optimism and look forward to more growth.

Many of the worst-case scenarios that economists predicted for 2012 didn’t happen:

  • Italian and Spanish bond yields fell when many expected them to rise,
  • The US didn’t have a double dip or fall off the fiscal cliff,
  • The Australian dollar traded within a narrow range all year; and
  • The world didn’t end on December 21, the end of the Mayan calendar.

Many of the issues that people were concerned about last year can now be seen receding and Shane Oliver himself says he is feeling more sanguine with the world’s economic prospects.

In 2012, listed REITs were the star performers, enjoying a return of 30% in Australia and 27% globally.  Cash on the other hand achieved only a 4% return.

In 2013, he expects the world to grow steadily.  He predicted that China will grow 7.5-8% and that the tail risks in Europe will continue to recede.  “Europe is still in recession right now, but the economy is showing signs of growth,” he said.  “All is starting to look OK in the US, with retail sales motoring along, the fiscal cliff now resolved, and housing starts are picking up.  We are also impressed to see that US debt to GDP ratios has fallen from 11% at the height of the GFC to 6% today.”

According to Dr Oliver, Japan finally seems to be getting it right too with the election of new Prime Minister Abe who has won the election on inflation friendly policies that make it look like it will go down the same recovery track as the USA.

Australia, he says is showing signs of green shoots, despite our determination as a Country to be pessimistic.   Retail sales were up in January, job ads were up in January, and new home sales and auction clearances are looking up too.

“Mining is moving into a cyclical decline, which will force our economy to be more dependent on the non-mining sectors over coming years for stability.  Whilst this presents concerns, the reserve bank is supporting growth and consumer confidence is rising, with it up over 15% in the last year.  Political risks remain and are likely to hang around until we have removed the hung parliament and returned certainty to our Government in September.

He believes that the seven cuts in interest rates we have seen over the last eighteen-month period are starting to be felt right across the Australian economy and that we may now be nearing interest rate lows.

“I believe interest rates are near the bottom of the cycle.  With Banks offering 4.99% on fixed term loans, it simply cannot get much better.”

Dr Oliver was optimistic that the equity market has entered another cyclical bull market.  Our equity market in Australia has been rising since November 2011, about 18 months.  But research by AMP shows that most cyclical bull markets last approximately 47 months, leading him to suggest that there should be more good times ahead.

Equity markets are up 22% in the year to February, primarily due to some growth in company profits.  This has driven up price earning multiples making some of the equities in our market look a little expensive, or indicating potentially that profits might be about to rise as often happens at this point in a cyclical bull market.

What makes him think it can go higher?

“When cash rates get below about 6% people usually start moving out of cash and seeking out risk.  There is about 14% of our Superannuation system currently sitting in cash at the moment in Australia, giving us a strong pool of money that may be tempted to enter the market given a continued improvement in confidence.”

To finish off the evening, Dr Oliver highlighted the risks, which looked a lot less threatening than recent years:

  • Instability in Europe, with many watching Italy for any distress after their recent elections;
  • Any slippage in Chinese growth;
  • Any further ratings downgrades for the US; and
  • Continued softness in Australia’s non-mining economy which we will become more and more dependent on.

Article by John Manuel, Director, Prosperity Wealth Advisers Pty Ltd.  John and our other Advisers provide Financial Planning and Family Office services to our clients from offices in Brisbane, Sydney and Newcastle.

Is the Australian Mining Boom Over?

Reading the newspaper, one could be forgiven for thinking that the Australian Mining economy had stopped cold.  Just a week ago, the Reserve Bank came out with their minutes from the September meeting that spoke of weakening commodity prices and more general concerns around the mining sector.  This was the key reason behind the central bank’s decision to cut rates.
“It seemed likely that mining investment would peak a little earlier and at a somewhat lower level than had previously been forecast,” the RBA said.

But is the mining boom over, or are the dynamics of the mining boom just changing?

Over the last two years, the cost of mining construction has skyrocketed throughout Australia as miners charged in willy-nilly looking to confirm production figures, build facilities and lock in supply contracts before their competitors.  High commodities prices across the board for over a decade led a race to production that has caused many companies to get a little carried away.  We can see this in their willingness to pay way over benchmark prices for unskilled labour and supply.  This didn’t matter too much while commodity prices remained high.   But recent weakness in the price of iron ore and coal, both of which fell over 30 per cent in August and September before recovering slightly, has led firms to review their costs, operations and plans for viability.

Behind the boom
Let’s look at the facts that sit behind the boom.

It is just over a year since resource commodities prices peaked in the second half of 2011, around a decade since the resource boom began.

According to the September 2012 report from the Bureau of Resources and Energy (BREE), the latest forecasts of volumes and prices show two distinct trends. Firstly, the prices of many resources have moderated from historic highs in 2011 and further declines are expected over the medium term in US$ terms. Second, Australian export volumes, especially in terms of bulk commodities, have grown rapidly and are expected to hold these levels for several years to come. The net result is that the value of resource and energy exports in 2011–12 are expected to be 8 per cent higher than in 2010–11 and to total $193 billion.

The projection for the value of resources and energy exports in 2012–13 is for a year-on-year decrease of about 2 per cent, with the total value of resources and energy exports expected to total $189 billion.

“Is mining investment approaching its peak? Yes. But mining investment still has some way to run”.

“The first phase of the mining boom, the sustained rise in commodity prices that boosted growth in national income, probably has ended,” suggest the JP Morgan economists in the International Times this month. “But the more durable and arguably more important volume phases of the mining boom have much further to run”.

In other words, data shows China has grown very rapidly to a point and is now plateauing. This means that while China initially demanded more and more iron ore, copper, and coal, now it is expected China will settle at a more consistent demand level.

At the same time, the development of our mining and energy industry projects are now well underway, with the value of resource projects currently under development in Australia worth $264bn to the construction pipeline.  According to a range of economists, advanced minerals project construction is expected to peak in 2013-2014.  But the really interesting point of note is that of this project construction pipeline, two-thirds is represented by “very major” LNG projects, the National Bank economists note, and their development extends though to 2017.

What comes after production is the period of operation, where many of our mines and facilities are expected to operate at near capacity for ten to twenty years, depending on their mine lifecycles.  During this phase, the large capital expenditure budgets of initial engineering and construction go away, but the export impacts and economic benefits continue to be reaped as we extract our natural resources and continue to contribute to our nations Gross Domestic Product (GDP), although at a lower level to the period in which the engineering pipeline is at its strongest.

The impact on labour forces
The estimated capital expenditure on the rollout of resources projects amounted to about $32 billion in 2010-11, rising to $56 billion in 2011-12 and $78 billion in 2012-13. The estimates suggest that spending will peak in 2013-14, at about 6 per cent of GDP committed projects. But, as the projects are completed, capital spending is estimated to fall by 80 per cent to about $17 billion by 2016-17. Construction employment on these projects, as inferred from the project totals specified by the companies, is expected to peak at about 80,000 in 2013-14 but to fall sharply after 2014-15.   What will happen to this labour force after the construction boom is over?  Will we have other industries for our workforce to move to or will we face a classic case of Dutch Disease that has been known to occur in other countries when natural resource exploitation increases the currency and punishes industries like manufacturing that are dependent on competitive export rates. For this, only time and our currency will tell.

Deferrals and deletions of projects
The market is somewhat panicked by the number and level of recent project deletions or deferrals, but CommBank notes such deletions do not actually make up a large proportion of all projects. Data suggests the value of all projects deleted over the past 13 months (including Olympic Dam and Outer Harbour but not, as yet, the FMG final phase) adds to $51bn or 11% of all advanced and less advanced projects.  The impact of this is expected to add up to a 2% decrease in mining exports in the financial year to June 2013.

The deletions and completion of the construction phases will undoubtedly take the pressure off costs in coming months and years, allowing the labour market to settle down and provide a bit of natural selection to the projects that are indeed the most financially viable.  But a 2% fall in export values does not signify the end of the mining boom… not yet anyway.

Article by John Manuel, Director, Prosperity Wealth Advisers Pty Ltd. John and our other Advisers provide Financial Planning and Family Office services to our clients from offices in Brisbane, Sydney and Newcastle.

Economic Update – September 2012

Following consecutive cuts in April and May, the Reserve Bank of Australia (RBA) left the overnight cash rate unchanged at 3.50% in July and in August.   Many economists are speculating that rate cuts will now be seen in the race towards Christmas. 

The Reserve Bank Board was of the view that global GDP will grow at average pace for the remainder of 2012 but believes there are clear potential downside risks that need to be monitored. The key concerns cited were contracting growth in Europe and weaker economic indicators in China.

Locally, it has been commodities that have caused the greatest short term pain for our economy and financial markets, with iron ore spot prices falling to below $US90 and coal prices having slumped by up to 30% in some categories during the month of August and in early September.

Bond markets were volatile during August but most markets reversed intra-month trends to end close to their starting values. The Australian 10-year government bond yield was a strong case in point, increasing sharply in the first half of August hitting a high of 3.44%, before falling back to its starting value of 3.01% by the end of the month.

Equity markets generally continued to rise through August on rising hopes for another round of Quantitative Easing from the Federal Reserve and bond buying from the ECB. The Materials sector underperformed its global counterparts and was one of the worst performing sectors domestically due to the sharply falling iron ore price.

The best performing Australian large-cap stocks during the month included Bluescope Steel (+26.4%), Primary Health Care (+23.5%) and Resmed (+20.8%). The worst performers came from commodity and resource services sectors, Boart Longyear (-38.4%), Atlas Iron (-21.7%) and Lynas Corporation (-20.5%).

U.S. and European stock markets posted strong returns in August, with investors gaining confidence that the ECB will intervene in government bond markets to stabilise the region.

Chinese stocks were weaker market performers in August, falling 3.10%, as the government continued to deploy mechanisms designed to slow the economy. Asia ex-Japan also declined as a result of the slowing trade links, to end the month 0.41% higher, underperforming the global benchmark by 4.91%.

The Australian dollar fell against most major currencies, largely due to the falling price of iron ore, of one of our major commodities. In particular, the AUD declined by 3.93% against the Euro as investors garnered some confidence due to the increasing possibility of ECB stabilisation mechanisms.

The S&P/ASX 200 Property Accumulation Index was down 0.14% in August underperforming the broader Australian sharemarket.

At a stock specific level Goodman Group (6.12%) was the strongest performer on the back of the corporate restructuring by adding Goodman Logistics (HPK), the Lend Lease Group (4.81%) also performing strongly. The Aspen Group (-23.29%) was the poorest performing security, with the resignation in August of their managing director being a contributing factor to this loss. The Stockland Trust (-5.07%) also fell due to poorly received 2011/12 Financial Year results.

Gold (+4.81%) and Oil (+9.55%) were up strongly in August, while the more broad CRB Spot Commodity Index was up 2.05%.

Volatility fell in August by 1.46% as measured by the VIX Index.

 

Looking Ahead

Our Advisers are looking for the following activity in coming months:

– Financial Markets have rallied on (fulfilled) expectations that major central banks would take action to stimulate their economies, further progress will require a confirmation of recovery. It could take several months for economic data to do this.

– The European Central Banks proposal to buy the bonds of troubled countries reduces the risk of disaster in the Eurozone. This financial support has however only come in return for increased austerity.

– Commodity prices did surge on the long awaited QE3 announcement however the long term resources prices will be determined more by China QE3.
Article by John Manuel, Director, Prosperity Wealth Advisers Pty Ltd. John and our other Advisers provide Financial Planning and Family Office services to our clients from offices in Brisbane, Sydney and Newcastle.  

Economic Update: March 2012

Quarter 1 of 2012 brought mixed messages in Australia, with two months of strength, followed by a weaker March. 

Australian Equities, as measured by the ASX All Ordinaries Index, gained 0.72% in March. The top 200 companies, measured by S&P/ASX 200 market capitalisation Index, gained 0.85% to outperform the market.

Leading these gains was the S&P/ASX 300 Information Technologies industry sector which ended the month 13.5% higher and the Healthcare Sector which ended the month up 7.51% and the quarter up 11.76%.

The Materials sector was the worst performing industry during March, declining by 3.96% due to falling commodities prices. Poorer than expected manufacturing data from China, as well as an announcement by the government to slow down economic growth, triggered a decline in the price of production metals; aluminium, nickel and zinc, in anticipation of reduced demand from the nation.  This flowed through to many Australian resources stocks.

The Reserve Bank of Australia (RBA) kept the overnight cash rate steady during March, defying some analysts’ predictions of a further interest rate drop.

This is said to have had some impact on Australian property where confidence remains fragile.  The sector experienced a minor correction during March, declining by 0.59%, after posting two solid months of gains, to end the quarter 7.14% higher. Also contributing to the March decline was a decrease in the number of new home loans and housing construction commencements, which are leading property indicators, directing investors to exercise caution in the sector.

On the back of the lack of interest rate cut, and other global liquidity movements the Australian Dollar recorded a decline against the Euro, depreciating by 4.08% last month. The AUD also fell against the British Pound (GBP), finishing the March quarter 4.61% lower.   It also fared badly against the US Dollar (USD) and the Japanese Yen (JPY), depreciating by 4.16% in the quarter and 1.83% during March.

The first quarter of 2012  saw optimism returning worldwide to equity markets from the nearing conclusion of the European sovereign debt crisis. While the disaster is not yet entirely averted, as seen in recent days, an important stabilising block was implemented during March, with the EU and IMF providing Greece with a second bailout package. Investors in Europe responded positively to this announcement and drove the MSCI Europe index 3.68% higher, to end a strong quarter during which it appreciated 9.51%.

Asian equity markets did not perform with as much consistency, seeing varied results with the TOPIX (Japan) gaining 2.15%, while the Hang Seng Index (Hong Kong) declined by 5.47%.

Looking Ahead

Looking ahead we are watching for the following activity this quarter:

  • Volatility at lower levels, but continuing as Europe continues to traverse fiscal austerity in many nations.
  • Continued improvements in international confidence as the US economy strengthens towards the pre-election period.
  • Continued potential for an interest rate cut in Australia in coming months.

 

Source: Data and statistics drawn from Zenith Monthly Market Report, March 2012

Disclaimer: This article has been written by Prosperity Wealth Advisers Pty Ltd, Corporate Authorised Representative (No 345322) of Primeplan Securities Pty Ltd AFS Licence No 229537 (ABN 59 070 507 274). Suite 16, Level 3, 299 Toorak Road, South Yarra VIC 3141. Tel 03 9826 2800

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