Fidelity Australian Equities Fund commentary

April 2012

Australian stocks rose for a fourth consecutive month in April after signs of an economic slowdown and a low reading on inflation prompted talk the Reserve Bank would cut rates to spur the economy. The S&P/ASX 200 Accumulation Index rose 1.4%.
 During the month, a report showed the Australia’s inflation slowed to 0.6% in the 12 months ended March, well below the central bank’s 2% to 3% target. While the central bank left rates unchanged in April, its comments pointed to a rate cut. On May 1, the Reserve Bank cut the cash rate by a larger-than-expected 0.5% to 3.75%.

The slowing in inflation followed a batch of weaker-than-expected economic data. Building approvals for February fell 7.8% from a year earlier, while housing approvals shrank 3.4% over the same period, adding to concerns about the housing market. Business conditions stayed weak, especially in retail (-15), construction (-6) and manufacturing (-4) where zero is the neutral level. Consumer sentiment fell in April to 94.5 from 96.1 in March, well below the neutral level of 100. Of special concern was the 14.4% drop in the report’s classification “perception of family finances versus a year ago”.

The portfolio

The portfolio outperformed over the month by 0.20%.* The biggest contributors included overweights to Telstra and Oil Search and an underweight to QBE Insurance.

Telstra gained 8.7% after Moody’s declared the company’s A2 debt rating stable when the telecom reaffirmed its dividend of 28 cents for fiscal 2012 and 2013 and said it will delay returning extra cash to shareholders until at least 2014. During the month, the Federal Court approved the $1.9 billion bid by Telstra subsidiary Foxtel to buy Austar, which cements Foxtel’s dominance of the pay-TV market. Oil Search jumped 5.5% after the oil producer said it has gained interest in joint explorations that could lead to another LNG venture in Papua New Guinea. QBE lost 2.3% after Moody’s lowered the outlook on the insurer’s A3 debt rating, citing the company’s aggressive debt profile.

The biggest detractors included overweights to Iluka Resources and Bradken and an underweight to BHP Billiton. Iluka tumbled 4.4% after saying March-quarter mineral-sands production had fallen 13% from a year earlier and that zircon sales figures were “low”. Bradken lost 14% after the mining-services company lowered full-year earnings growth for fiscal 2012 to 10% from 25% to 30% due to problems with two narrow-gauge wagons for use in Western Australia. BHP Billiton rose 2% after its first-quarter production report showed encouraging gains for base metals, aluminium and stainless steel, even as coal, iron ore and oil output slid.

Outlook

Paul Taylor, the Portfolio Manager, says the Australian economy remains well-placed to endure near-term uncertainty. “Unlike most countries, policymakers in the country still have many policy options in their arsenal,” he says. “Australian companies are well-positioned to deliver growth and attractive yields against the challenging economic backdrop.”

Despite its rise this year, the Australian market remains attractively valued. It is trading at 13.4 times earnings, well-below its five-year average of 16.4 times earnings, and a dividend yield of just below 5% as at the end of March. “Strong corporate balance sheets and free cashflow levels indicate that dividend yields are sustainable,” Paul says. “More companies saw their consensus forward earnings upgraded relative to downgrades in March. Share buybacks and capital returns should also increase further.”

Sources: Royal Bank of Scotland, JPMorgan, Macquarie Equities Research, UBS Investment Research and Bloomberg. Any reference to companies are for illustration purposes only and do not constitute a recommendation.

* Net returns have been calculated using mid-prices and are net of Fidelity’s management costs, transactional and operational costs. The calculation assumes reinvestment of distributions. No allowance has been made for tax. The return of capital is not guaranteed. Past performance is not a reliable indicator of future performance.