Recession risks down under

September 29, 2022

Sydney skyline at twilight, with the Sydney Opera House and Harbour Bridge.

Last week, Fedex released their latest reported earnings, depicting grim views of the economy. As a result of the weak quarterly numbers, its CEO to predicts the coming of a recession. Following what could can be defined as the great Covid-related delivery boom, Fedex’s harsh predicted slowdown is understandable.  

Recession thesis accepted, not all sectors and geographies are created equal and understanding the intensity of the recession is an important factor. Let’s look at country level numbers; the following results for the one-year probability of a recession were recently as disclosed in Bloomberg: China 20%, Australia 25%, Japan 30%, Hong Kong 30% US 50%, UK 60%, France 50% and Canada 40%. As data continues to appear, these numbers may prove conservative on the odds of a recession happening, they could however be insightful to find less affected geographies.  

With low inflation and low yen, it’s understandable why Japan can be seen as a favorable defensive jurisdiction.  We should add low valuations for its equities as well. But why is a country like Australia even lower on the recession risk? In fact, if put together Japan and Australia represent 42% of our EAFE developed markets universe and offer a defensive position as we cycle into recession.  Let’s look a bit more why Australia is faring better than other regions. 

The Reserve Bank of Australia is in the midst of its sharpest tightening cycle in a generation, having raised rates by 2.25 percentage points since May. But it’s now approaching a neutral rate, potentially allowing it to return to smaller, quarter percentage-point moves. That compares with the US Federal Reserve, which may deliver a third straight three-quarter-point increase later this month. 

Australia has also been a rare beneficiary of fallout from Russia’s invasion of Ukraine as disruptions to commodity and energy supplies have sent coal and other prices soaring. The nation posted a record-high monthly trade surplus this year fueled by sales of coal, iron ore and liquefied natural gas. 

Australia has had a tailwind from trade that other countries just don’t have. The export of LNG and coal have been highly beneficial. Unusually, the surge in export prices isn’t being reflected in Australia’s commodity-linked currency, which has averaged 69 US cents over the past three months. A lower currency swells profits from commodity exports priced in dollars and makes the country more appealing to overseas visitors and students.  

Australia’s employment-to-population ratio is near a record high as is its participation rate — both much stronger than many other countries — highlighting the underlying momentum in the labor market. Job vacancies also remain elevated, suggesting that strength will persist. 

Australians still have plenty of savings to tap into to support consumption, having built up a large amount of cash from fiscal stimulus delivered during Covid lockdowns when there were few options to spend.  

If we look at our holdings in Australia, we are able find companies with world class expertise. As an example, with its vast amount of resources, Australia has very large resource extraction complexes that have trained the most capable pool of experts in material transformation at large scale. 

Alumina (AWC:AU) 

Global Alpha holds Alumina, part owner of the world’s largest alumina business which is the main ingredient to produce aluminum. Most of the alumina produced by company is exported to China. Its Middle East competition better serves the European continent. Although the aluminum/alumina markets weaken during a recession, German aluminum facilities could suffer the most under a gas rationed winter of the Russian war. Alumina is also the lowest cost producer globally and produces the greenest alumina (gas vs coal powered). The company offers a 10% dividend yield and aluminum remains a key component of the climate change infrastructure, automotive as well as the rebounding airline industry. 

Furthering our aluminum discussion, we turn to a pop culture question: aluminum cans versus plastic and glass bottles. We all know for taste it goes glass, can, then plastic. Glass is great, but is expensive to transport and recycle. Aluminum cans are therefore the winner in terms of logistics, recyclability, and carbon footprint. 

Orora (ORA:AU) 

We own Orora, the largest producer of aluminum cans for soft drinks in Australia and New Zealand. The company’s facilities are strategically positioned beside its clients and has pass through agreements with clients on material cost fluctuation. Historically, soft drink consumptions only slightly declines during a recession. Further, Orora clients have indicated 5% yearly growth on capacity requirements for the next several years. There is also leverage in the model as capex is added to existing facilities providing great return in investment. Its dividend yield is above 5% in addition to its growth profile. Although both Alumina and Orora are in the materials sector, Orora has very low commodity exposure providing it with more of a staples profile.

Global Alpha Capital Management Ltd.
September 29th, 2022