fnarena tip on tee

taken from FNarena.com
(tee is at the bottom of editorial with other tips)

The odd relationship between resources and telcos

By Rudi Filapek-Vandyck

Wednesday a month ago I wrote an analysis about how miners of natural resources and telecommunication companies share a similar key characteristic these days: both have become subject to a new paradigm.

Unfortunately, for the likes of Telstra (TLS), Singapore Telecom's (SGT) Optus and AAPT/Telecom New Zealand (TEL), the new paradigm for the telecommunication industry is the complete opposite of the one that is reshaping the global resources industry.

What lies ahead for the likes of Telstra is new applications eating into older services, large amounts of investments to stay ahead of the pack (or keep up) and governments that are less prepared to feed and protect the old milking cow - and more competition, which tends to exacerbate the effects of all previous factors combined.

At Commonwealth Bank economist Joseph Capurso believes he has found another relationship between both sectors. Capurso recently conducted a study into how higher prices for commodities benefit the different sectors of the Australian economy. It will hardly be a surprise that the energy sector is to benefit the most.

A big surprise, I thought, was that the telecommunication industry comes out as the second biggest beneficiary.

Higher prices for natural resources push up the value of the Australian dollar, Capurso explains. This effect comes with the fact that Australia's exports are mainly commodities. It's a characteristic the Australian currency shares with the Canadian dollar and the South African Rand.

A higher valued domestic currency automatically lowers the prices for imports to "below the level they would have otherwise been", says Capurso. This benefits the average Aussie consumer as real incomes become higher than they otherwise would be - in today's context this means consumer spending is likely to go up.

This is not something that happens overnight. It takes time for the higher priced domestic currency to result in lower import, consumer and capital prices. In addition, it also takes time for local businesses and consumers to spend more in response to lower prices. Because of the long delay for the effect to trickle through, Capurso believes Australian consumers and businesses are to benefit from higher prices for natural resources up to several years after the initial price rise.

But why is telecommunication benefiting more than, for instance, consumer discretionary and the health sector? Capurso believes that in a developed economy such as Australia, where the majority of the population is relatively well off, a big chunk of the increased spending will go to new gadgets and applications, and much less so to basic needs, hence the relatively higher benefits for the telecommunication industry.

All this, of course, is pure trickle through economics - and only half of the story.

In a separate note published on Friday, Capurso noted that when the Reserve Bank of Australia recently increased interest rates the RBA cited strong increases in commodity prices as a major factor behind that decision.

And while Brazil's Companhia Vale do Rio Doce (CVRD) and Rio Tinto (RIO) have tried their best in forcing the Chinese steel mills in a check mate position by negotiating new iron ore fine contracts with customers in Europe, Japan and South Korea, the achieved 19% price increase may lead to another interest rate hike later this year.

The latest Statement on Monetary Policy from the RBA reveals the Reserve Bank had taken a 10% increase in iron ore prices for the coming year into account.

Rio Tinto's newest contracts are almost double that figure.

Add a federal budget which is widely seen as providing further stimulus to Australians increasing their spending and it is easy to see why Capurso argues the case for another rate rise in Australia has further increased.

This, one may assume, is far likely to have a shorter term impact than the aforementioned positive longer term stimulus - and it is a clear negative one. So while Australians can be expected to spend more on telecom services and applications while they become richer, it is but fair to assume they will be looking at cutting their luxury expenses at times when the opposite occurs.

It still remains an open question whether this will have a real impact on the telecommunication industry as competition is still driving down prices and increasing product bonuses.

The changing sector dynamics will make it harder for the likes of Optus to stay ahead of the pack and for Telecom New Zealand to successfully turn around AAPT.

In the meantime, it would appear Australians have already started to have a good look at their luxury costs, and they are drawing conclusions.

My friend Rob told me this week one of his acquaintances, who is a personal fitness trainer, had told him many of his customers had decided to cut back on their expenses over the past few weeks, leading to the highest number of cancellations he had experienced in many years - in just a matter of a few weeks.

I bet there are quite a number of smaller and larger businesses out there that cannot wait for the new budget stimuli to kick in.





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Highlight Stocks
AWC - FN Arena's Neutral Indicator dived below 51% again on Friday and as has been the case over the past four years local shares retreated soon after. Meanwhile, commodity analysts are reiterating their support for resources companies whose share prices are feeling the weight of investor angst and falling spot prices. Alumina Ltd climbed to the number one position in our universe during the week and now wears the tag "highest recommended stock in Australia".

BKN - It's not just share prices of resources companies that have landed in sell-off mode since last week, others with a strong relationship to the sector, such as Bradken, are subject to the same investor fear that it may all be over. The result has been broker analysts reiterating their positive stance on the stock during the week and we even noticed one recommendation upgrade.

SLM - The loss of a big contract from Coles put shares of Salmat in a near freefall. It was probably for the first time ever that every single expert in our universe changed their recommendation on a given stock on the same day. We counted two upgrades and five downgrades. The average price target has come off by 12% to $3.59.

LEI - Have things finally started to pick up again for Leigton Holdings? Deutsche Bank analysts certainly believe so. They upgraded the stock to a Buy, while Citigroup raised its opinion to a Hold. Leighton has been at the bottom of the market since its last profit warning last year. That position is now shared with iiNet (IIN), Virgin Blue (VBA), Austereo (AEO) and Bendigo Bank (BEN). This may serve as an indicator for investors: remain cautious with regards to telcos, airlines, media and regional banks.

TEE - Times are equally hard for junior telco Tele-IP. A promising story is receiving no attention amidst a general distaste for anything in relationship with the local telecom industry. TEE shares hit an all-time high of $0.06 earlier this year but they have now fallen back to $0.026. And trading volumes seem to be declining by the day. A good story in the wrong industry at the wrong time? The future will tell.