07/06/2013 - 16:05

Rapid downshift to a slowing market

07/06/2013 - 16:05

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The rapid change to a deflating economy will be difficult for some, but offer opportunities for others.

Forget rising costs, discounts are on their way – for everything from Perth’s famously overpriced coffee to the fees charged by contractors suddenly short of work.

Adjusting to this emerging shift in the way business works will be painful for some people, but it will need to happen quickly.

Just as a balloon deflates much faster than it can be blown up, so too will prices in Western Australia’s once overheated economy go into a rapid reverse, as the following examples illustrate.

• BHP Billiton and Rio Tinto, two of the biggest direct employers and two of the biggest users of outside consultants, are swinging an axe at their cost base. Employment recruiting has been frozen and retrenchment is the order of the day as expansion plans are modified. Contractors are being told the new terms of work on a take-it-or-leave it basis. Those cuts will flow down the food chain.

• Hancock Prospecting is looking closely at its need to import up to 1,700 foreign workers on temporary visas for its emerging Roy Hill project. Approval has been granted for the foreign staff but locals are suddenly available.

• Mineral exploration drilling contractors are ‘stacking’ their rigs as work dries up. One business, which had 10 active rigs a few months ago, now finds that all are idle as exploration companies, especially small firms, squirrel away their declining cash reserves, close offices, sack staff, and activate their survival plan.

• The WA government is planning to cut its workforce by 1,500 as revenues fall; a modest cut compared with the 14,000 government workers losing their jobs in Queensland. And that’s before considering the job cuts on the way at Ford, HSBC Bank and even the Australian Turf Club, where a 10 per cent staff cut is being made because we’re betting less on horse races.

• Companies still in their mine development phase are enjoying a surprise benefit of the changed climate. Projects which once had big cost-overrun contingencies built into their budgets are coming in on time and on budget, as shown most recently at a gold project of Alkane Resources.

At its Tomingley project in NSW, Alkane is making brisk progress, with chief executive Ian Chalmers pleasantly surprised that the relatively small development is on track.

The test for Alkane will come when it proceeds with its much bigger Dubbo zirconia and rare earths project located in the same region as Tomingley, and which has a budget estimate of $996.4 million.

Where the Dubbo mine becomes interesting, however, is in the 20 per cent contingency charge demanded by engineers and finance consultants; because that is what’s been happening over the past few years – big blow-outs.

Given the Tomingley experience of a project being built on time and on budget, and given the emerging shortage of work for construction contractors specialising in mineral processing, work it will be interesting to see if that 20 per cent cost blow-out contingency is required.

If it is not, then investors might have reason to re-think their opinion of companies with new projects on their books, because if the Dubbo mine can also be built on time and on budget it will not cost $996.4 million; it will be $199 million cheaper, at $797 million.

That is not a reason to rush out and buy Alkane shares, but it is an interesting pointer to what happens when a boom goes into reverse and spare capacity suddenly becomes available and contractors (and coffee shops) fight for business.

Heading south

One place where discounts from the mining slowdown might not be available is the South West of WA, where that region’s two most important industries, wine and tourism, are poised to enjoy an overdue recovery. And that could mean rising, not falling, prices.

The dollar is one reason for the improving outlook with wine makers able to start dusting off their export plans after being squeezed out of the US, British, and European markets that once soaked up Australian wine.

The same currency effect should also boost tourism, in two ways. Foreign visitors will find Australia cheaper, and locals will be forced to stay at home, with the South West the preferred destination when Italy drops off the itinerary.

Property should be among the first sectors to move up as the dollar-effect flows into business activity, while another force, rising Perth property prices, could compound the demand for residential property in the south of the state as older people cash out of their Perth homes and seek the good life in the country, preferably near the coast.

Time bomb

On a less-optimistic note, there are signs emerging of a future banking crisis in the US caused by ultra-low interest rates and investors hunting for a better return by leveraging their portfolios.

According to figures released by the New York Stock Exchange, the level of borrowing by clients against their brokerage accounts hit an all-time high of $US384.4 billion in April, a 29 per cent increase on a year ago.

On one hand, the extra borrowing to play the market might be seen as a sign of rising optimism. On the other, the higher debt levels for leveraged investors could be interpreted as time bomb.

In the know

Andrew Forrest, if he follows the oil and gas industry, might have been amused to read about the collapse of $30 billion in LNG sales contracts Chevron announced in 2009 with Korea Gas.

Last week, apparently for the first time, Chevron said the Koreans dropped the heavily promoted deal in 2011.

The reason Mr Forrest would be interested is that he once thought he had an iron ore sales agreement with Chinese buyers, only to have them walk away (and the corporate cops walk in to accuse him of not properly informing the market).

There are differences with Chevron’s failed Korean gas sale, but the principle of keeping a market informed is much the same.

 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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