• Australia’s record economic expansion is now well into the 20th year. The Australian economy grew by 0.7 per cent in the December quarter, after lifting by a downwardly revised 0.1 per cent in the September quarer (originally reported as growth of 0.2 per cent). Annual economic growth held steady at 2.7 per cent.
• For the calendar year 2010 the economy grew 2.6 per cent in 2010, below 15-year average of 3.25 per cent.
• The biggest contribution to growth came from the change in inventories (+0.8pp), followed by household consumption and government investment (both +0.2pp).
• Eight of the 19 industry sectors contracted in the December quarter. The strongest contributions to growth came from Professional, scientific and technical services, Administrative and support services, and Arts and recreation services.
• The data is entirely consistent with surveyed evidence and what we are hearing from businesses across the country. The Reserve Bank has previously indicated that it is comfortable with current interest rate settings and there is nothing in today’s result that is likely to see a shift from that view.
• A more accurate description of the performance of States and Territory economies is state final demand plus net exports. The Northern Territory (up 5.4 per cent), had the fastest growth in the December quarter, followed by South Australia (up 3.0 per cent),and Western Australia (up 1.6 per cent). Growth was weakest in Queensland (down 1.5 per cent).

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• The profit-reporting season has largely concluded, although there are a small number of ASX 200 companies to report. CommSec has assessed the results of the 120 companies that reported half year (HY) results (results for the six months to December) and 32 companies that reported for the full year (FY) to December. (Results are up to and including February 25). Aggregate half-year profits are up 25.2 per cent on a year ago while aggregate FY earnings are up 183 per cent.
• Overall 101 companies or 84 per cent of HY companies produced a profit for the half year while only two of the FY companies didn’t report a profit. And 59 per cent of the HY companies reported an improvement in profit while 83 per cent of FY companies reported a similar lift in earnings.
• As at June the 152 companies had cash balances of $102.5 billion, up 25 per cent on the previous reporting periods.
• The vast majority of ASX 200 companies paid dividends. Of the HY reporting companies, 83 per cent issued a dividend while 80 per cent of the FY reporting companies issued a dividend.
• Just like last reporting season, aggregate earnings results for Corporate Australia were solid, but analysts wanted more. Bloomberg reports that 29 per cent of companies beat market expectations for earnings per share (positive surprises) while 49 per cent disappointed.

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• The general sense is that the profit-reporting season has so far proved very mixed. And the numbers back it up. Figures produced from Bloomberg show that there have been 19 positive EPS (earnings per share) surprises from the 61 ASX 200 companies that have reported so far with 25 negative surprises.
• CommSec has assessed the results of the 61 companies from the ASX 200 that have so far reported halfyear (HY) results and 10 companies that reported for the full year (FY) to December.
• Of the companies reporting half-year results, aggregate profits are up 41.4 per cent on a year ago with sales up 13.6 per cent, outpacing a 10.6 per cent lift in expenses. Of the small number of companies
  reporting profits for the 12 months to December, earnings are up 86.1 per cent on a year ago.

What do the figures show and what does it all mean?

• So far, the earnings season is almost a carbon copy of the last one. It has left analysts wanting more but the figures still show that Corporate Australia is in great shape.
• Focussing on the companies that have reported earnings for the six months to December, aggregate earnings are up a very healthy 41.4 per cent on a year ago. Sales have lifted almost 14 per cent, outpacing a near 11 per cent increase in cost of sales or expenses. Cash levels are up almost 51 per cent to $50 billion while earnings per share, on average, have risen by 17 per cent. And only 18 per cent of companies have reported lower earnings than a year ago.
• The other encouraging news for investors is that most companies have either increased or maintained dividends with only 16 per cent of companies reducing dividends compared with a year ago.
• So overall, there are good reasons to conclude that Corporate Australia is in solid shape. But figures from Bloomberg indicate that only 31 per cent of the ASX 200 companies that have reported results so far have beaten market expectations on EPS (that is, yielded positive “surprises”) with 41 percent of results under-shooting expectations (negative surprises) and 28 per cent of companies reporting earnings in line with expectations.
• Both basic materials and financials have been evenly divided with positive and negative surprises. Most disappointments have occurred in consumer goods, industrials and telecommunications with most positive surprises in the health care sector.
• The other concern for investors has been the generally cautious or downbeat profit outlook statements from listed companies. Clearly consumer-facing companies have expressed the greatest uncertainty about the next six months but even resources companies are worried about the potential for a hard landing in China as well as the ability to secure labour and resources to maintain production and progress with new projects.

Outlook:

• At the last profit-reporting season in late August 2010, we expressed caution about the year ahead. At that time we felt that the coming year would be more of the same – the economy getting back to “normal” growth with “normal” interest rates and “normal” profit growth. Clearly this is hardly the type of conditions that would prompt investors to take big bets on Australia. In August last year we forecast that the ASX 200/All Ordinaries would reach 5,400 by the end of 2011. We haven’t changed that call. Stocks are by no means cheap with the 16.07 historic price-earnings ratio above the long-term average of 15.5.

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Headline developments of the past week

• China continued to tighten the monetary screws with another interest rates hike. This should not really have been a surprise to anyone and further tightening is likely as Chinese authorities move to vacuum up liquidity being pumped into the economy by their efforts to slow the appreciation of the Renminbi and as part of an ongoing effort to control inflation. However, we remain of the view that China’s growth will slow back to a more sustainable pace but it will not be crunched. Most of the inflation problem in China is food related and likely to reverse later this year. Moreover China’s economy is not particularly interest rate sensitive with the bulk of fixed investment financed by corporate earnings and household debt is very low.
• RBA Governor Glenn Steven’s Parliamentary testimony reinforced the message that, beyond the short term disruption caused by the floods, the RBA has an upbeat medium term economic outlook but that for the time being its comfortable with current settings for interest rates. Our view remains that interest rates will remain on hold until mid year before rates start to head slowly higher again.

Major global economic releases and implications

• US economic data was generally solid. Weekly mortgage applications fell but against this consumer credit, small business confidence and weekly retail sales data rose by more than expected and weekly jobless claims fell to their lowest level since July 2008. With the US economy looking stronger and stronger it wouldn’t surprise to see increasing market talk of the first rate hike from later this year.
• US earnings results continued to surprise on the upside, with so far 70% of results coming in better than expected. December quarter 2010 profits are on track to come in 32% above year ago levels. The driver of stronger profits has shifted from cost savings to revenue growth, with revenue growth running around 6.8%.
• European data was a bit on the soft side with a sharp fall in German factor orders and industrial production, but the former followed a very strong rise the previous month. Japanese economic data was generally positive with gains in the December leading index rose, consumer confidence, housing finance and machine orders.

Australian economic releases and implications

• In Australia, the December half earnings reporting season has kicked off on a relatively solid note with good results from companies such as Boral, Commonwealth Bank, Stockland and Rio. So far 47% of companies have come in above expectations compared to a norm over the last seven years of 46% and 73% of companies have reported a rise in profits on a year ago. However, it’s early days yet with only 35 major companies having reported. Two themes are readily apparent. First, the outstanding strength of the resources sector compared to non-resources stocks. Second, several companies announced plans to return capital to shareholders via increased dividends and share buybacks. With corporate cash holdings at record levels and gearing low there is plenty of scope for further increases in dividends and buybacks going forward.

Source: AMP Capital Investors

Source: AMP Capital Investors

• Australian economic data was mixed. Retail sales rose but only marginally in December and business conditions softened in January mainly due to the floods. Against this February consumer confidence recorded a small rise and despite the floods both employment and job advertisements rose again in January indicating that the labour market remains reasonably solid, although forward looking indicators continue to point to some softening in employment growth going forward, albeit from exceptionally strong levels over the last year. There is now a high risk of negative December quarter GDP growth and thanks to a 1% or so flood related detraction from growth in the March quarter its probable March quarter growth will be negative. So two quarters in a row of negative growth in Australia is distinctly possible. However, given the key driver will be the floods it would be dangerous to read much into this as growth is likely to come roaring back from the June quarter as production returns to normal levels, flood and cyclone rebuilding kicks in and mining investment really starts ramp up.

Major market moves

• Share markets continued to move higher over the last week on increasing takeover activity, more confidence in the global growth outlook and on reduced concerns about Egypt. In Australia, the All Ords rose through the 5000 level for the first time since April reflecting good profit results and several companies announcing increased dividends and share buybacks. We expect the S&P/ASX 200 Index to hit 5,500 by year-end, which would translate to 5600 for the All Ords. Bonds continued their sell off as investors continued to bail out and confidence in the global growth outlook continued to improve.
• Industrial commodity prices generally softened on Chinese/Asian monetary tightening. Oil prices were also weighed down by increased oil stockpile levels in the US and an easing of political tensions in Egypt. Soft commodity prices continued to rise though on ongoing global supply disruptions. Softer commodity prices also weighed a bit on the Australian dollar.

What to watch in the week ahead?

• In the US, the focus will be on retail sales for January (due Tuesday) which are expected to record a modest rise but are subject to greater than normal uncertainty due to the impact of snow storms. Housing starts and permits data due will be watched closely for signs the housing sector has bottomed. While headline inflation in the US is likely to have been boosted by higher food and energy prices in January, core inflation is likely to remain benign supporting the Fed’s assessment that monetary policy should remain easy.
• In China the focus will be on inflation data for January (due Tuesday) which are expected to show a rebound to around 5.4% (from 4.6% in December) as a result of another weather related boost to food prices. Property price data for January is likely to show another slowdown in residential property price growth to around 5.5%, from 6.4% in December.
• In Australia, the minutes from the Reserve Bank’s February policy meeting and a speech by Assistant RBA Governor Lowe are likely to confirm the rates on hold for now but with a tightening bias message. Meanwhile, housing finance for December (due Monday) is likely to leave intact the impression that housing finance has stabilised after an earlier fall. January car sales data (Wednesday) may attract greater than normal attention as it may be depressed as a result of the floods.
• In Australia, the December half earnings reporting season will continue with about 60 major companies due to report including AXA, Brambles, BHP Billiton, CSL, Westfield, Qantas and Fortescue. The results are likely to continue to reflect the two speed Australian economy with resources and related stocks doing very well on the back of the surge in commodity prices but non-bank industrials likely to be much more constrained and at risk of further earnings downgrades reflecting the slowing housing and retail sectors and the strong $A.

Outlook for markets

• After months of strong gains globally, and with measures of investor sentiment running at high levels and February normally being a soft month, the risk of a short term correction or consolidation in share markets is high. However, any pullback in shares should be seen as a buying opportunity as the fundamental backdrop for shares is very positive. Valuations are reasonable, the global economic recovery is looking stronger, the global liquidity backdrop is very favourable with very low interest rates in key countries, the corporate sector is cashed up, and investors are only just starting to switch from bond funds into share funds.
• The broad trend in the $A is likely to remain up as the US dollar and the euro remain under downwards pressure, interest rates in Australia remain relatively high, and high commodity prices keep the terms of trade near early 1950s highs. By year-end, the $A is likely to have reached $US1.10.
• The risk of a sharp back-up in global bond yields this year is very high. Bond yields in key advanced countries are still below longer-term sustainable levels and bond funds are now starting to see outflows.

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With the earnings season now in progress, the past week was full of important corporate announcements that have impacted share performance. This week we discuss the News Corporation earnings report, significant profit downgrades from Myer and AGL Energy, a favourable result from JB Hi-Fi, a new CEO for Asciano and a strong rally for QBE Insurance following news that it will acquire the renewal rights to US insurer Balboa.

News Corporation’s Q2 earnings report was close to expectations and management confirmed that the company is on track to deliver on its full year earnings guidance. In terms of operational highlights, the television segment performed very strongly, underpinned by advertising growth in excess of 20%. Cable network negotiations are also driving strong revenue growth. The weakest segments were publishing and films but this was widely expected.

Myer provided the market with a trading update which revealed a 3.5% fall in sales in the six months ending 29 January 2011. Like-for-like sales declined 5.2% in the same period. This was much weaker than expected and will negatively impact net profit for FY11. Comments from management suggest a competitive retail environment (including consumers purchasing from offshore due to the strong $A), coupled with weaker consumer demand, particularly following the January flooding, were the main reasons for the sales decline. In November 2010, Myer’s guidance suggested growth in net profit after tax (NPAT) in
FY11 of between 5% and 10%. This has now been revised down significantly with Myer forecasting a fall in NPAT of up to 5%.

In stark contrast to Myer, JB Hi-Fi announced a record half year net profit of $87.9 for the six months to end December 2010. Sales rose 8.3% over the period and the company will pay a fully franked interim dividend of 48.0 cents per share. Thirteen new stores were opened in Australia and New Zealand over the period and there are plans to open another 5 in the second half. JB Hi-Fi seems to be addressing the challenge of on-line retailing which is affecting many traditional retail businesses like Myer. The company’s online sales rose 35% over the half year and were up 49% in December. Although sales guidance was
downgraded slightly, the overall result was favourable and defies the weaker trend being experienced by many companies in the retail sector.

AGL Energy announced that recent severe weather events, including the Queensland floods, extreme heat in New South Wales, Victoria and South Australia, and Cyclone Yasi, are expected to reduce forecast underlying NPAT in FY11 by between $30 and $35 million. AGL’s previous forecast for NPAT in FY11 was between $450 million and $480 million. This range has now been revised down to between $415 million and $440 million.

Asciano announced the appointment of John Mullen to succeed Peter Rowsthorn as the company’s new managing director and chief executive officer. Mr Mullen has extensive experience in transport and logistics as he was previously the CEO of DHL Express. He will formally commence as Asciano’s CEO on 14 February 2011.

QBE Insurance performed very strongly on Friday (+7%) following the announcement that it had acquired the renewal rights to US insurer Balboa for a consideration of $700 million. Balboa is currently owned by Bank of America and this attractively structured deal is part of an initial 10-year distribution agreement. Both the purchase price and deal structure are extremely attractive for QBE. Balboa is a very profitable business and it makes good commercial sense for QBE to purchase this US asset at a time when the Australian dollar is trading close to parity with the US dollar. QBE also announced a forecast NPAT for calendar year 2010 that was in line with analysts’ expectations.

Global markets

Major equity markets rallied convincingly as purchasing managers’ surveys from the US, Europe and Asia pointed to accelerating manufacturing and services output. The S&P 500 advanced two per cent to just over 13,000, and the FTSE 100 almost two per cent, closing three points below 6,000. The Nikkei 225 moved up 1.8%, despite corporate releases suggesting Japanese exporters remain hampered by the strength of the yen.

While the equity bull-market that began at the end of August 2010 shows little sign of abating, investors continue to shun ‘core’ bonds forcing yields up, and US ten-year yields hit a nine-month high last week. In the UK, where rising domestic prices are of particular concern, government bond yields rose for a fifth consecutive week, and sterling spiked as high as $1.62, in anticipation of bank base-rate rises in 2011.

The price of copper crossed $10,000 a tonne (or 434 cents a pound), while oil spiked to $103 a barrel midweek on uncertainty over developments in Egypt and the Middle East more generally, before closing a shade below the $100 mark.

Global equities

In a busy week for energy majors, ExxonMobil, the world’s largest company by market capitalisation, registered a near record 53% increase in Q4 net revenue, buoyed by rising oil prices. In the UK, BP announced a full-year loss of $4.9bn – it’s first in nearly twenty years, as the energy giant digested a $41bn charge relating to last year’s Gulf of Mexico disaster – and also the return of dividend payments, which have been suspended for three consecutive quarters. Anglo-Dutch rival Shell shed 3.3% despite reporting a near doubling of 2010 profits to $18.6bn. Elsewhere, GlaxoSmithKline rallied 3.5%, notwithstanding a slump in full-year profits from £8.7bn to £4.5bn, as the UK-based pharma giant announced a £2bn share buy-back programme. US corporate earnings for the final quarter of 2010 have generally surpassed forecasts – and companies as varied as Time Warner, UPS, Dow Chemical, Kellogg and fashion retailer Gap all saw their shares boosted as their revenues exceeded expectations
Over in Asia, Nippon Steel and Sumitomo Metal, two of Japan’s largest steelmakers, unveiled a $24.5bn merger aimed at cutting costs and matching the competitiveness of fast-growing emerging market rivals – while Baidu, China’s largest internetsearch, beat forecasts with a doubling of Q4 net revenue.

Sweden’s government is to sell its 6.3% in Nordea, the Nordic region’s largest bank, in a deal that would raise around $3bn – while LVMH, the world’s largest luxury goods company, reported 2010 sales up 19% to €20.3bn, boosted by rapid growth in Asian markets, and China in particular.

Global bonds

Ben Bernanke on Thursday restated the Federal Reserve’s commitment to a second round of asset purchases, or quantitative easing, which generally supports bond prices. Nonetheless, prices of US government bonds, or Treasuries, slid sharply as the Fed Chairman also voiced concern about the scale of the US budget deficit – which is forecast to hit a mammoth $1,480bn this year, or 10% of GDP. As a result, ten-year yields advanced a chunky 32 basis points to 3.65%.

UK ten-year yields marched up 17 basis points to 3.82% as investors continue to fret about the medium-term outlook for inflation, which could rise to four per cent during 2011. German ten-year yields also increased, although by a less marked 11 basis points to 3.26%, as the European Central Bank considers its response to Eurozone inflation now running at an annualised 2.4% – well above its target of ‘below but close’ to two per cent.

In a relatively quiet week for peripheral bonds, Spain issued €3.5bn of three- and five-year securities in a poorly subscribed auction, raising less than its €4bn target. Nonetheless, benchmark Spanish ten-year yields dropped from 5.51% to 5.16% as Madrid continues to insist the country is not in the same category as other highly indebted Eurozone nations such as Ireland and Portugal.

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Fidelity International’s analysts, who are at the heart of Fidelity’s investment process, actively meet with and review over 90% of the world’s largest listed companies on behalf of our over five million customers across Europe and Asia Pacific.

Our proprietary ‘bottom-up’ research is central to Fidelity’s investment process. Developing this research relies heavily on the quality and caliber of our analysts. They must have strong and independent thought, show a commitment to unearthing new and exciting investment opportunities, and work as a team with our global portfolio managers to buy and sell stocks at the right time, at the right value.

Every day a Fidelity analyst is meeting with a company, talking to its senior management or being briefed by its many stakeholders. They therefore develop an in-depth knowledge and thorough understanding of a company, its competitors, management, suppliers and clients.

These analysts are in a unique position to gain insights and thoughts from some of the world’s leading companies about their ideas for the future, their insights into current trends, and their plans in terms of capital expenditure, expansion, mergers and acquisitions.

To gain a better understanding of these themes and take a closer look at the more interesting issues facing some of Asia Pacific’s listed companies during 2011, we asked our fixed income and equities analysts to respond to a survey in December of last year.

The survey asked over 60 Asia Pacific Fidelity analysts to outline general themes, issues and opportunities they were hearing or witnessing from the companies they cover during Jan – Dec 2010.

This report is a snapshot of this knowledge across the Asia Pacific region which we hope you will find interesting and helpful as you make your own investment decisions.

3.0 About Fidelity

A global leader in investment management

Fidelity International is a global leader in investment management. Established in 1969, Fidelity has a presence in 23 countries and territories around the world and employs 4,676 people. Investment management is Fidelity’s primary business, managing US$231.6 billion in assets for millions of customers – major institutions through to individuals – spread over more than 750 equity, fixed income, property and asset allocation funds. Fidelity’s research spans the world – over 350 investment professionals within Fidelity International plus over 650 from associated companies contribute to and share the investment insights used by our portfolio managers.

Fidelity’s research and analysts

Fidelity adopts a research-driven, bottom-up approach to portfolio construction. As active managers, we believe that markets are only semi-efficient, meaning that markets, sectors and stocks can be overvalued or undervalued at any point in time and that research can uncover profitable opportunities.

Fund portfolios are built from the bottom up, security by security, taking account of general market trends but not being driven by them. Portfolio managers are responsible for their funds and encouraged to develop their individual flair, while benefiting from global research contributed to and shared investment professionals within Fidelity International and associated companies.

Analysts contribute to global research, undertaking extensive inquiries at all levels of a company to understand how it is positioned to deliver results for investors. Whether equities, fixed income or property-related funds, it is only through this first-hand contact with companies – rather than relying purely on a non-affiliated firm’s research – that they can fully evaluate an investment’s true potential and consistently add value for investors.

Fidelity analysts and portfolio managers across the globe access senior company management, their offices, their plants and factory floors. They talk to company’s suppliers, distributors and customers to build a three-dimensional view of every company in which they invest.

4.0 Key findings

Asian consumer bolsters another solid year of growth ahead

Revenue and operating profits

Over 77% of analysts said the companies they met with during 2010 are likely to see improved sales flows of 10% or more in 2011.

50% of analysts said they expect operating profits to grow in excess of 10% in 2011. This expectation is typical for Asia Pacific companies and in line with previous years, confirming that 2011 will be yet another year of solid growth levels for companies across the region.

Measurements used

• Profitability continues to be the most common measurement and key driver of success by management in Asia Pacific companies (64%) followed by share price performance (16%) and sales (10%).

Time horizons

• With respect to time horizons, most companies (66%) in the region are focused on delivering 2-3 year strategies, adopting a medium to long term view overall which is again, a common benchmark in Asia Pacific organisations.

The Japanese profit imperative

That profitability is a key determinant of a company’s value should come as no surprise, particularly in a weakening global economic outlook. The Japanese market, however, takes this metric to the extreme: 90% of respondents indicated it was the primary measure of success. The structurally lower margins in Japan (which relates to such issues as too much competition, lack of a competitive takeover culture, unwillingness to allow clearing through bankruptcy, etc) may indeed be the reason for management to have a more intense focus on it. The issues are however, structural so any focus on profit may not necessarily result in any rapid improvement in the situation.

The Asian consumer

The top theme fuelling this profit and sales growth that analysts indicated is linked to Asian consumption growth. In contrast with the west, retail and consumption in Asia have shown remarkable resilience, even through the crisis. Asian retail sales volumes increased by 4.8% in 2009 and 5.7% in 2010, according to the Economist Intelligence Unit, with annual growth accelerating to above 6% to generate a remarkable US$8.7trn in sales by 2014. China – the one market in Asia where private consumption is importantly growing faster even then GDP overall – in particular is being seen as a regional growth engine, and this was a key theme that underscored our analysts’ observations.

In particular, China’s consumption story loomed large as a theme for our analysts. Yet, China is by no means the only component of the Asian consumption story. Outside of China, emerging Asia not only has strong domestic demand – but also a demographic dividend to go with it. India has a rapidly expanding middle class, and an overall labour force expanding by a world-beating 2m a year. Growth in Indonesia’s domestic consumption market, which now makes up 60% of its economy, recently climbed to a 18-month high of 5.2%.

Moreover, this consumption story is no longer limited to a single market sector or product category theme. Our analysts saw growth in numerous areas, such as autos, infrastructure, healthcare, luxury products.

All cashed up (and looking to spend?)

Balance sheet strength

63% of our analysts feel the balance sheets of the companies they cover are strong, very strong or extremely strong. Whilst none of these descriptions necessarily implies “too strong”, clearly companies in Asia are now carrying too much cash on their balance sheets. This is a natural reaction to coming through a deep recession and credit crunch. In Asia, the lessons were learnt in 1997, and companies have run strong balance sheets ever since. This stood them in good stead in the 2008 credit crunch. History would indicate that as confidence returns, companies will no longer see the need to hoard so much cash, as it lowers return on equity. But are we seeing evidence of this yet, and how will they deploy the cash?

Around a third of our analysts (29%) detected a change in attitude and approach to managing this cash surplus. This was the case for Japan as well, where several of our analysts sense that companies have moved on from taking a defensive stance of hoarding cash. Given the bloated nature of balance sheets, some may view this result as a disappointingly low number. However, it seems that some companies may require more time to feel confident enough in the global recovery to deploy their cash piles. Those who do however, plan to deploy the surplus, intend to spend it during 2011 in three key areas: dividend payouts, capital expenditure and acquisitions. In Japan, the primary focus is likely to be dividend payouts (42%) compared to Asia with a primary focus on capital expenditure and acquisitions (both ranking at 30% each).

Higher dividend yields and share buy backs are both positive to the Asian market growth story. If you have underlying revenue growth of 10%, there is likely to be some operational gearing, and earnings growth should be significantly higher. In addition, you can add the dividend yield to calculate total shareholder return. If this holds true, equity shareholders in Asian companies can look forward to good capital growth coupled with increasing income; a double-benefit to returns.

Capital expenditure and expansion

Most analysts believe the companies they cover are looking to expand their operations in 2011 more rapidly by opening new facilities in locations throughout Asia but outside of Japan (36%), or opening new facilities in existing locations (21%).

Interestingly, more Japanese companies have indicated their intention to expand in Asia ex-Japan compared to Asian companies (54% vs 21%).

The majority of companies that are looking to expand in 2011 do not intend to increase their capital expenditure as an overall percentage of their revenues (73%) and will use their expected dollar increase in overall revenues to build up their business; reinvesting in the Asian growth story and driving organic growth. So companies are looking to expand but the rate of expansion is not expected to increase. Instead, it will grow in line with sales, and thus perhaps in line with free cash flow growth. As a result, this may not equate to any serious reduction in cash piles as capex will be offset by incoming operational cashflows.

The US recovery matters

Recognising that domestic profit growth in the region is also reliant on non-Asia Pacific-related economic conditions, many analysts indicated that the US economy in 2011 will be a key factor that they and the companies they cover will be watching. The impacts of a further decline or even signs of further recovery were noted as a key factors that could impact the growth momentum of Asia Pacific companies.

However, the developed world and the exports demanded by the US, are still a very important engine of growth for many Asian companies. If global demand diminishes, those companies in Asia that are focused on exports will suffer and as a result, analysts continue to believe that the outlook for the US and European economies remains an important factor.

According to the World Bank’s latest “Global Economic Prospects”, domestic demand in emerging economies accounted for over half of global growth in 2010. The developed world grew at 2.8% whilst the emerging world grew at 7%. However, the developed world and the exports demanded by the US, is sill a very important engine of growth for many Asian companies. If global demand diminishes, those companies in Asia focused on exports will suffer and as a result, analysts continue to believe that the outlook for the US and European economies remains an important factor.

In addition, the concentration on expanding production or sales capacity in China and other Asian markets, provokes the question “can the Asian growth accommodate all this expansion?” The US recovery is needed to help absorb some of this new capacity and sustain the growth momentum.

Some of our analysts also focus on the rise of intra-Asian trade and how this will impact Asian companies. It’s important to note however, that intra-Asian trade often involves the shipping of components (from Japan to China for example) for final assembly and ultimately destination to the US and Europe. The iphone is a good example – designed in California, it is assembled in China by a Taiwanese company using components made in Japan (Japanese components account for about a third of the iphone’s material costs). So, domestic demand in Asia and developed market demand in US and Europe are both key drivers of future success.

Global leadership vs global mindset

Very few of the companies analysts met in the region during 2010 are already global leaders and very few, in the eyes of our analysts, have the potential to become global leaders in the next five years.

The vast majority of companies do, however, have a global strategy as well as management teams who actively consider both global opportunities in addition to domestic ones.

Certainly, a number of firms from Asia have become household names globally, largely through scaling up domestic market competencies into international positions through market share acquisition: hence India’s world-beating business process outsourcing sector, or Korea’s digital device giants, or Australia’s leaders in the ‘rocks and crops’ space.

The traditional sense of going global, i.e. providing globally competitive products and services to win market share away from home, may be changing. For Asian companies busy capturing growth opportunities in their home ground, venturing into global markets and investing into developing globally attractive products may not be a high priority. This becomes a slightly different story for Japan, where globalisation is a requirement to grow for some companies.

Japan and China still on track

Whilst local and global consensus tends to assume that Japan’s maturing economy will cripple Japanese enterprises ability to head global competition, our Tokyo analysts point out that Japan will continue to generate global leaders. Half of our Tokyo analysts say that their sectors already have some or many global leaders, and 42% say some companies in their respective sectors have the potential to become global leaders in the next five years.

Most of these sectors already have proven global leaders today (such as electronics, auto & auto parts, machinery, trading companies) but few new faces have the potential to make it to the global league tables such as the internet or entertainment sectors.

Outside Japan, we tend to think of Samsung, LG and Hyundai and think the list stops there. But actually there are more Asian leaders than we think, typically in non-branded areas such as the Indian generic pharmaceutical companies or for example, the Chinese dominance in rare earths.

Corporate governance

Half the analysts surveyed said it will take 10 years or longer for the companies they meet within Asia today to adopt global standards with only 2 1% of companies operating at this level today.

A different perspective in Japan

It bears noting that Japanese responses are more enthusiastic about the opportunities that these technology trends offer. Today Japan already is a global leader in manufacturing display screens, ICs and chipsets which are critical inputs into the supply chain, and our Tokyo analysts highlight additional interesting growth opportunities, such as tablet computing, mobile gaming and payment platforms, and display technologies. The Japanese government’s huge commitments (through subsidies and incentives) to push its companies into global leadership positions in green technologies likely make climate change a more tangible and exciting opportunity there than in the region as a whole.

Key challenges and issues

When asked to identify the leading challenge facing companies in 2011, the three most popular themes our analysts raised were as follows:

• 25% Regulation: government policies, tax, government spending and political uncertainties
• 20% Inflation: Inflation causing rising costs, rising interest rates, fiscal tightening
• 10% Competition: price competition, pricing pressure, foreign competitors, domestic consumption
• 29% of our analysts are concerned about governments tightening their grip in areas such as preventing oligopolistic markets, enforcing product liability, controlling labour standards etc; reflecting governments’ keenness to keep an eye on consumer protection as private consumption becomes a key growth engine for the region.

Whilst regulation and competition are perennial factors that concern companies and analysts, inflation is the biggest new concern. Expressing itself through higher wage costs and higher raw material costs, it is likely to be a big headwind for many companies this year

The consumer, whilst more confident than in 2009, may not be robust enough to absorb a pass-through of higher costs.

6.0 The final word

Matthew Sutherland, Head of Research, Asia Pacific, Fidelity International

“If there was nothing left to worry about, markets would be at a peak. But there is plenty left to worry about – persistently high unemployment in the US, fiscal belt-tightening in the UK, the seismic cracks appearing in the fabric of the Eurozone and its currency, monetary tightening to arrest inflation in China. I expect the bull market to go on ‘climbing the wall of worry’ this year.

Companies are indicating significant levels of revenue growth this year. This is good news, and should provide the bedrock for another strong year of market performance. The potential fly in the ointment here is likely to be inflation. It is expressing itself via higher wages and higher raw material costs, and could result in margin expectations being reduced as the year goes on. This would not be atypical – it’s the reason “sell in May and go away” works as a market adage.

Aside from revenue growth, additional benefits will come from an increased willingness of companies to do something constructive with the overly-large cash piles they built up as a reaction to the problems of 2008/9. Interestingly, whilst they will spend on capex, capex will not grow as a percentage of sales. More importantly, they are likely to give more back to shareholders via increased dividends and buybacks. We should thus have a year with good earnings growth coupled with higher yields and buy-backs, which makes for much higher total shareholder returns.

It’s interesting that analysts are still focused on the US economy. They are right to do so. Whilst domestic demand in emerging market accounted for half the world’s growth last year, according to the World Bank, the other half of the world’s growth came from other areas, and the US economy is still the world’s largest. So at the margin, its success or failure to recover can make a big difference to companies’ ability to grow, especially in the export areas of the economy.

The analysts did not really mention this, but the longer term worries in my view include social unrest and political instability resulting from higher food costs, water shortages, and the growing disparity between rich and poor.”

Hiroki Sampei, Director of Research, Japan, Fidelity International

“The results tell us that companies across Asia Pacific continue to expect a strong Asian consumption demand, as the middle class grows and urbanisation progresses. Another interesting point is that many of our Asia ex Japan analysts are more concerned about a supply shortage in workforce, energy, infrastructure etc to back up this growth, rather than an over supply of production capacity.

With so much expectation on the Asian Consumer engine, we need to be levelheaded about how far earnings growth can be sustained by this single engine. This is why the US recovery does matter for the Asia Pacific companies to continue their path of healthy growth. On the contrary, when the US recovery happens, this may potentially fuel inflation which many of our analysts have flagged as a potential bottleneck for growth.

The daily company visits and research activities conducted by our analysts, aggregate into a vast database of information that help us develop our own understanding of what is happening from a macro perspective. Another advantage for us, is that our approach allows us to take in what is happening even before the macro statistics are released. From here we identify the risks and opportunities that may impact the companies we research and apply this insight back into our stock picking.”

Sabita Prakash, Head of Fixed Income, Asia Pacific

“Asia’s credit universe largely spans corporates in the more basic infrastructure services, including property, commodities, TMT, energy and utilities, reflective of the emerging nature of the underlying economies. Quite naturally, the prospects for companies in these sectors are biased towards growth given the emerging markets they support, largely China, India and Indonesia. Nonetheless, the relatively stable nature of infrastructure demand leads our fixed analysts to expect that top and bottomlines may be stable rather than grow substantially, which is ideal from a credit investor’s perspective.

While our fixed income analysts do expect strong bottom-lines, they are somewhat wary of chunky capex and M&A plans that are generally supported by cash flows, but often substantially through external (debt) financing. That said, analysts are sanguine about credit quality given Asian companies’ strong liquidity profiles built up over the past few years. Furthermore, company managements appear to be cautiously optimistic following lessons learned from the crisis. In terms of expansion, analysts felt there was a greater focus on gaining regional scale and market share rather than expanding globally. The two notes of caution the analysts repeatedly mentioned were regulatory risks that could put the brakes on planned expansion and corporate governance standards, which have been improving, but are still considered to be low compared to other developed markets.”

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Asian companies have emerged from the global financial crisis with very strong balance sheets and good revenue growth expectations, with many of them potentially planning to deploy excess cash in 2011 through acquisitions, capital expenditure or dividend payouts, a survey by Fidelity International has found.

A survey of Fidelity’s analysts in the Asia Pacific region provided the insights from some of the world’s leading companies which they follow closely and in which they invest.

“The vast majority of companies meeting with us in the region continue to have very strong balance sheets (63%) and deploying their excess cash through capex, dividends and buy-backs will improve shareholder returns, and make another strong year of market performance more likely,” said Matthew Sutherland, Head of Fidelity’s Asia Pacific research team.

When asked about profit expectations, over 77% of Fidelity’s analysts said the companies they met with during 2010 expect to see sales growth of over 10% in 2011, and 50% of analysts said they expect operating margins to grow in excess of 10% in 2011. “

While this expectation is typical for Asia Pacific companies and in line with previous years, it does highlight the fact that 2011 may be another year of solid growth levels for companies across the region,” Matthew said.

Across the region, respondents also said the surplus cash they are seeing in Asia Pacific companies is likely to be spent on dividend payouts, capital expenditure or acquisitions. (All three were ranked at 23.5%.)

“Aside from revenue growth, additional benefits may come from an increased willingness of companies to do something constructive with the overly-large cash piles they built up as a reaction to the problems of 2008/9.

“Interestingly, whilst they are likely to spend on capex, capex may not grow as a percentage of sales. More importantly, they are likely to give more back to shareholders via increased dividends and buybacks. We should thus expect a year with good earnings growth coupled with higher yields and buy-backs, which makes for likely higher total shareholder returns.”

Regulation and inflation are recurring themes of concern faced by companies in 2011.

“The potential fly in the ointment in 2011 is likely to be inflation. It is expressing itself via higher wages and higher raw material costs, and could result in margin expectations being reduced as the year goes on,” Matthew added. “Having said that though, if there was nothing left to worry about, markets would be at a peak. The fact there is still concerns means that markets may continue to ‘climb the wall of worry’ in 2011”.

For a complete analysis of the survey, click here

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• The NAB business confidence index eased from +8.1 to +6.2 in November. The business conditions index rose from +1.6 in October to +3.7 in November.
• Forward looking sub-indices remained decidedly weak despite modest improvements. Profits ticked higher from 17-month lows, trading conditions remained near nine-month lows and new orders are still
  contracting.
• Australian dwelling starts slumped by 13.2 per cent in the September quarter, after lifting for the previous four quarters. In the September quarter, starts rose in only three of the eight states and territories.
• In seasonally adjusted terms work started on 170,153 dwellings over the past year – the biggest annual result in almost six years.

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• Company profits fell by 1.5 per cent in the December quarter, led by the construction sector. Excluding mining, profits fell by a much larger 3.3 per cent in the quarter. Profits rose in just five of the 15 industry sectors.
• Sales also fell. Sales fell in ten of the 15 industry sectors in the September with aggregate sales down by 0.9 per cent. Sales in the mining states of Northern Territory and Western Australia outperformed.
• But inventories fall. Inventories (stocks) held by businesses fell by 0.8 per cent in the September quarter in inflation-adjusted terms.
• New home sales rose by 2.4 per cent in October. Over the past six months home sales have fallen by over 20 per cent.
• According to the Australian Institute of Petroleum the national average retail pump price rose 0.7 cents a litre last week to 125.0 cents a litre – a 15-week high. The Singapore unleaded price is holding at five month high in Aussie dollar terms and will continue to filter through to domestic pump prices.

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• The Reserve Bank Governor has delivered testimony to the House of Respresentatives Economics Committee. Transcripts of the testimony have been released.

Selected comments from the testimony

• Provided below are some selected comments by Glenn Stevens (Governor), Guy Debelle (Assistant Governor, Financial Markets) and Philip Lowe (Assistant Governor, Economics).

Why lift rates in November, not October:
“Reasonable people can differ about these things—and we had quite a long discussion at both these recent meetings about when a step might be taken—but on balance, the way we came down was that, in October, I personally did not think the case was quite made but I was persuaded that we were across the line in November.”
RBA decision to hike rates in November
“But, having been involved in this process one way or another for quite a long time, I cannot think of very many cases in history where we looked back and thought, ‘Yep, we tightened too soon.’ I can think of several times where we looked back and thought we should have tightened a bit earlier.”

“I think it is better really to move in a reasonably timely fashion to a point where you might be able to rest for a while. That is a better position to be in.”

“Of course, we can never quite say that there definitely will not be any more but I think a lot of people probably would rather be in the position of knowing where they stand, at least for a period of time, than having the continual anxiety.”

Outlook for interest rates

“What it means is that for the period we are going into in the near term I think this is about the right level. At the moment, most commentators do not anticipate and market pricing does not anticipate any further near-term change by us for quite some time. I think that is probably a reasonable position for them to have based on the information we have now.”

Guy Debelle: “The market pricing only has the cash rate rising to five per cent by the middle of next year and rising maybe a little beyond that but not a lot, so not quite as much as the economists you are talking about suggest. (The consensus view of a number of economists is that the cash rate by 2011 will probably be around 5.5 per cent.)”

Glenn Stevens: “I am not sure myself, to be frank, where we are going to be in a year’s time—you cannot be.”

“We may need some more than we have at the moment at some point, but at this stage the expectations are for only fairly gradual and not very close together increases. At this point, I certainly do not want to steer people away from that today.”

“…there will probably be some more next year (rate hikes) and maybe a little bit more after that. It is not unreasonable to think that if you buy the central scenario that we have sketched out, which is that one way or another something will happen to take us off course. That is the central view. It is not unreasonable for people to think that, but that is just saying that it is unlikely there will be anything from us imminently, and I think that is probably a reasonable expectation of people just now.”

“I do not think it is sensible to speculate about increases right now.”

Terms of trade / Two-speed economy

“There is a multi-speed story, even within regions, I think.”

“This is a once or twice in 100 years event.”

“…it is almost a three-speed economy—there is the mining sector, the traded part of the economy that is not mining and is affected by the exchange rate, and the rest.”

Bank profits

“The rate of return on equity that the banks are earning is good. It is probably not, at this point, as high as it was some years ago. As we have said before in the committee, if my choice is between banks with good profits and banks with no profits then I choose the former every time from an overall macroeconomic point of view. People look at the overall size of profits in billions of dollars, but we need to be careful not to forget the size of the capital that is invested in these institutions, because you have to compare the two. The rate of return on equity of 15 or 16 per cent—something like that—that they are earning is good, but many Australian corporates would be looking to earn those kinds of rates of return, not just banks.”

RBA takes changes in bank rates into account

“But in the end the question is really whether all those people with a mortgage are paying seriously higher rates than they should be from an economic management point of view. What I am saying is that I do not think they are, because we have pretty much offset the change in the margins by doing different things in the cash rate from what we would have done had the margins not shifted.”

Wage growth

“We are seeing some pick-up in overall wage growth, at this point not faster than we had expected would be the case, given what has happened in the economy. Where is the line between too high and too low? It is hard to say, but I would think that this is a period now in which we need to proceed with some care.”

“I think, we would probably say those figures we had last week were not view changing. There is a larger increase in the quarter because the fair pay decision comes through in a lump, and in the previous period there was no increase temporarily.”

Unemployment can fall further

“There are at least some grounds to say that there is a bit more scope for labour demand to rise than you might think just by looking at the official unemployment rate on its face. I think that is a reasonable call. Having said that, our general assessment is that the amount of spare capacity in the economy overall is probably reasonably modest.”

Rates now above “normal”

“I would have said that the 4.5 cash rate, which is clearly well below what was normal before, is for all intents and purposes normal in the world we are in now where the margins have widened because it delivered a mortgage rate or a business loan rate that was pretty much the average of the past 15 years. As of the last decision, we have moved above that a bit now. I think we would have to say that, particularly given the increase in loan rates is a bit higher than what we did, monetary policy settings are a bit above normal now.”

Consumer spending

“Consumer spending is more careful and cautious now than it was and retailers will say that. Overall consumption is still growing, probably a little bit below average, but still rising.”

“My guess is that there has been a kind of sea change in people’s attitudes that we would expect to persist for a while.

“Retailers do find this tough. We hear this all the time from them. It is tough. People have money but you have to work harder to get them to part with it now than you did a couple of years ago. That is putting competitive pressure on pricing, which is one of the things that is helping us keep inflation low. A higher exchange rate is helping them do that because the imported products are getting cheaper. We have a bit more of that ahead, I think.”

Handover from public to private sector

“At an aggregate level our assessment is—and this was one of the uncertainties that we faced all year—will this handover occur on schedule or won’t it. We are still not 100 per cent sure, but we think that it is probably going to occur.”

Supply-side deficiencies

Philip Lowe: “There are obviously areas, in transport, in education, in health, where things can be done to improve the ability of the economy to produce goods and services efficiently.”

Glenn Stevens: “…but we are probably going to need more investment in electricity, are we not, over the years ahead, and water? Some of that is being done. There is a fair bit of urban infrastructure that would be desirable, as anybody who lives in any of our major east coast cities—or west coast, for that matter—would think. All of that has to be done, but we have to try to do that at the same time as we build more houses and build more mines.”

National Broadband Network: Public sector undertaking a project that the private sector rejected?

“Whether this is one of them would be another question. But I think you can imagine some projects that the private sector just does not feel it can take the risk on but on which the public sector—which, after all, has a stronger balance sheet than anyone else—might on some occasions be able to accept that risk. But there ought to be, of course, a proper cost-benefit analysis of that case in those instances.”

“We do not have a problem here of public debt sustainability. The fiscal issues that are relevant are the ones that were talked about earlier, such as the effects on demand and so on. I have never felt in recent years that the size of the public debt that we have outstanding is a material problem for the country.”

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