Dark Clouds On The Horizon – Risk Or Opportunity?

Fiona Clark, 3 July 2013

Any change in the status quo presents risks and opportunities. Winners and losers. Silver linings amongst dark clouds. A key portfolio management skill is identifying where these risks and opportunities lie. Is that silver lining genuine, or a fleeting illusion?

Identifying risks is the most critical, because the first rule in investing is to not lose money. On the other hand it’s easy to get lost in negativity and lose sight of potential opportunities, particularly in today’s uncertain market conditions.

Consider the current focus on the Australian mining sector’s demise. I could take issue with this premise (Mark Twain’s “Reports of my death are greatly exaggerated” is perfectly applicable to the Australian resources industry’s plight). Yet sentiment is awful due to a variety of “logical” grounds:

  • Commodity prices have peaked and look set for further falls
  • Chinese growth has peaked and an increased focus on bank loan quality and environmental considerations by authorities (at the expense of growth) has spooked investors
  • The US Federal Reserve has indicated the reduction, or “tapering”, of its quantitative easing program, widely interpreted as a signal for the end of global growth
  • Several high profile cut-backs to mining investment projects, including the shelving of BHP Billiton’s Olympic Dam expansion, Woodside’s exit from the Browse project (James Price Point) development and Fortescue’s reduced expansion plans in the Pilbara

But even if one took the most bearish of views, does the end of the mining world, as we have come to known it in recent years, present more than just risks? Are there any opportunities?

I recently spotted an article in the Australian Financial Review headed “Resources downturn has upside” [Read it here – subscription required]. This type of headline catches my eye, and I wasn’t disappointed. It turns out the biggest automotive retailer in Australia, Perth based Automotive Holdings Group (AHG), is just chuffed about the downturn. Chief Executive Bronte Howson explains: “The apprentices do their three, four, five years and especially some of the younger ones shoot up north and double their salary.” Over the last few months, Mr Howson has found it easier to retain his diesel mechanics and other skilled tradespeople. “The demand up north is coming off. When it comes off, people migrate back to Perth or over East” he says. This is a huge bonus for a company that has just invested five years and a lot of money to train staff.

Automotive is one of several industries that will benefit from an easing of shortages in skilled labour in the mining state. In the construction industry, ABN Group’s managing director, Dale Alcock, said that the easing in worker shortages had come at a good time for his industry. “It’s actually a positive for the construction market, because construction is ramping up”, he said. These sentiments were echoed by several of the companies that we visited in Perth recently, particularly those in the building and logistics industries.

Notwithstanding the lack of flexibility in the Australian labour force, the emerging trend highlights that there will be benefits as labour availability (and costs) improve in other sectors.

Another potential benefit relates to the resources sector itself. As a result of its decision to pull out of the Browse project, Woodside was able to return the spare cash to shareholders as a special dividend. It is quite feasible that the reduced (and more disciplined) capital expenditure programs being undertaken by today’s mining companies, with their new management and renewed focus on shareholder demands, may result in miners being sought for their dividends as much as their exposure to global growth and minerals demand. Which seems both strange and exciting at the same time.

The next part is the hardest. Once you see the potential opportunity, how do you take advantage of it? It might be a bit early to be buying resources for yield, but it’s something to keep watch for. And looking for companies who rely on skilled labour, previously lured to the mines by the salaries and high-flying (pardon the pun) lifestyles, shouldn’t be too difficult in theory. How long it takes and whether it translates into earnings is another matter!

The point is to resist the urge to be either too optimistic or pessimistic when it comes to investing. There will be companies which do well (and those who do poorly) in all kinds of conditions. The key is to identify both the risks AND the opportunities. Email: fjclark@primevalue.com.au