This Idea Makes Too Much Sense

Confirmation bias can be dangerous, so I'm not a regular reader of the fancy research reports pushed by the big investment banks. That said, when I was forwarded a copy of Morgan Stanley's Investment Ideas for 2011, I wasn't at all surprised to read that seven of its top 10 ideas were a play in some shape or form on continued growth in emerging markets.

But of particular note in their report for me was their bullishness toward "resource-rich countries."

It's good to have stuff
Foreseeing "growth in excess of 6% in 2011 for [emerging market] economies," Morgan Stanley notes that "Equities in commodity-rich countries -- in particular, Australia, Canada and Norway -- are well-positioned to benefit." This sentiment was echoed in Don Coxe's 2011 outlook when he wrote, "We remain of the view that one should invest in what those vigorous Asian economies need to buy." Similarly, I wrote to Motley Fool Global Gains members at the end of 2009 that over the next five to 10 years "Countries with stuff will do better than countries without it -- with 'stuff' being metals, minerals, food, oil, and gas."

When one starts thinking about countries that have stuff, Australia is at the top of the short-list.

Land down under ... of stuff
Australia is the world's largest exporter of coal, second-largest producer of iron ore (90% of which is exported to Asia), and an important source of petroleum, aluminum, and natural gas. All told, minerals and fuels accounted for more than 25% of Australia's $218 billion worth of exports and commodities account for seven of Australia's top 10 exports.

Yet despite my desire to invest in stuff, Asia's rising consumption of stuff, and Australia's wealth of stuff, I have somehow yet to recommend or buy for myself a single Australian stock. I've looked at Canada, of course, buying shares recently of Canadian Oil Sands Trust and putting Canadian Natural Resources (NYSE: CNQ  ) and Canadian National Railway (NYSE: CNI  ) -- good companies that I would love to own at the right price -- on my watch list. But Australia has at least one advantage relative to Canada -- it's a whole lot closer to Asia.

What to do with this information
Given these facts, I've resolved to increase my exposure to Australia this year. It's an economy that should continue to benefit from growth in Asia, but doesn't offer the same level of political and governance risk that comes with investing in China or India.

There's a problem, however, in that the major U.S. exchanges aren't exactly swimming with overlooked Australian companies. The main commodities play, mining giant BHP Billiton (NYSE: BHP  ) , is well-covered by the investment community, and the big banks, such as Westpac (NYSE: WBK  ) , don't look at all attractive given Australia's precarious housing market.

A few names to consider
One opportunity is to invest via Canadian holding company and Global Gains recommendation Brookfield Asset Management (NYSE: BAM  ) , which along with subsidiary Brookfield Infrastructure Partners (NYSE: BIP  ) , purchased a stake in Australia's Dalrymple Bay Coal Terminal from distressed seller Babcock & Brown in 2009. Dalrymple Bay is the world's third-largest coal shipping facility, and Brookfield is already at work expanding the facility because, as Brookfield CEO Bruce Flatt noted at the end of 2009, "The commodity boom is something that is going to happen for the next 25 years." He further added about his willingness to deploy capital down under, "Our view is that if you're a foreign investor and looking at Australia, it's an attractive place given the size, the amount of resources, the fiscal situation, and the rule of law."

Dalrymple Bay, in other words, is an asset that will benefit from the massive long-term tailwind of the need for coal in Asia and Brookfield thinks it was smart to buy when short-term sentiment had become bearish. Coal prices are up since then, but Australia's coal industry finds itself in trouble today again due to the recent flooding in Queensland state. The government there recently estimated that Australia's coal industry lost 15 million tons, or 20% of its overall production, in the quarter -- a reality that will depress earnings for coal miners and for Dalrymple Bay.

This has caused area miners such as MacArthur Coal to lower their guidance, and Australia overall is estimating at least a $2 billion drop in coal export sales. That's a big number, and we could see stocks in Australia drop as that decline flows through to mining services companies and ultimately the Australian economy.

Temporary setback, permanent opportunity
Weakness in Australia's mining industry in the first calendar quarter will ultimately be offset by the 25-year boom that Brookfield's Bruce Flatt mentioned above. That's one reason why our Global Gains research team is heading to Australia in early February to sit down with managers a variety of promising companies -- some affected by the recent flood -- that will benefit from Australia's growing commodity trade. I'm excited to do so because it's an idea that makes too much sense. Not only is Australia an attractive market for the reasons mentioned, but -- and maybe this is true of you as well -- I am dramatically underexposed to it.

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Tim Hanson is advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. Brookfield Infrastructure Partners is a Motley Fool Inside Value choice. Canadian National Railway is a Motley Fool Stock Advisor recommendation. Brookfield Asset Management and Brookfield Infrastructure Partners are Motley Fool Global Gains picks. Brookfield Infrastructure Partners is a Motley Fool Hidden Gems recommendation. The Fool owns shares of Brookfield Infrastructure Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (38)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 10, 2011, at 4:25 PM, boogaloog wrote:

    So how does the Australian housing bubble (http://www.fool.com/investing/international/2011/02/09/the-n... factor in to your view?

  • Report this Comment On February 11, 2011, at 3:54 PM, lirat2 wrote:

    Statement made Australia is "a whole lot closer to Asia than Canada". It is 5636 miles from Vancouver to Shanghai. It is 7369 miles from Brisbane to Vancouver!

  • Report this Comment On February 11, 2011, at 4:39 PM, lirat2 wrote:

    Correction - sorry - it is 4555 miles from Brisbane to Shanghai. Still western Canada is not that far different from some of Asia.

  • Report this Comment On February 12, 2011, at 2:47 PM, mike2153 wrote:

    Take a look at Sun Dance Energy Australia, SDCJF.PK. It's a penny stock, but it's been on a nice solid upward trajectory for about six months. I bought some and am very happy with it.

  • Report this Comment On February 15, 2011, at 11:45 PM, ed1value wrote:

    Hi,

    I actually live in Australia. A few of risks I would identify in investing into Australia.

    1) The Austrlaian Dollar I would say is at least 20% overvalued.

    2) Our market is dependant on China. Any down turn there will have a big impact on the Aussie $ and resource stocks here.

    3) Housing Market. Property is at least 30% overvalued. We never had a down turn in property during the GFC.

    4) The two key commodities that are driving the boom here is Coal & iron ore both are well above their marginal costs. Everyone is trying to open a Coal or Iron Ore mine. I think we have 1 to 2 more years and the supply demand balance will start shifting back to the marginal cost of production. Watch the fall in prices!

    Infrastructure may be the space to look at as Australia has underinvested in this space and regulated contracts mean some predictabilty in earnings

    Ed

  • Report this Comment On April 11, 2012, at 5:04 PM, AdamGalas wrote:

    The reason I am planning to add BAM to my trifecta of "buy and hold forever" stocks (the other 2 being Markel and Bank of New York Mellon) is because they don't care about the short term. Will commodity prices like Iron ore and coal soon peak and maybe collapse as global mines come online? Sure, and CEO Jim Buff will take that as an opportunity to snap up yet more coal and iron producers=)

    Keep in mind that BAM's success breeds success. They are raising new money to the tune of $27 billion last year, this year probably $30+ billion, next year? Maybe $40 billion.

    Buff is becoming known as the "Buffet of Canada" and as his prowess becomes more evident and his fame grows, the funds will come pouring into BAM, until, by the end of 2015 I wouldn't be surprised to see it managing $250 billion.

    What does that mean? That BAM will be THE BIGGEST ELEPHANT IN THE ROOM! No one else will be able to pull off the kind of deals they will be too.

    As the assets increase, (so do the fees) then the dividend will gradually rise faster and faster, causing the stock to rise from it's current .7 P/B to a more fair 1.5X, which will mean market crushing returns.

    With Buff at the helm, and global growth putting upward pressure on commodity prices, long term investors can't lose!

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