Will the Australian Economy Boom or Bust in 2017?

So, is the Aussie economy booming, or is it heading for recession?

A glance at Friday’s market gives both the bulls and bears reasons to stick with their respective views.

First, this from Bloomberg (for the bulls):

Australia & New Zealand Banking Group Ltd. first-quarter cash earnings rose on a stronger performance from the lender’s domestic businesses, while the outlook for bad debts has improved.

Hurrah! An economic rebound abounds.

But wait. Postpone that tickertape parade for at least a moment (for the bears):

Virgin Australia Holdings Ltd. deferred delivery of 40 Boeing Co. aircraft worth $4.4 billion as the airline swung to a first-half loss.

Whoa! Those are two big numbers — 40 new aeroplanes (Boeing 737s) and $4.4 billion.

As we write, the stock is now trading for less than 20 cents. Its market capitalisation stands at a meagre $1.6 billion. The company’s first-half revenue was $2.61 billion. For the same period last year it was $2.63 billion.

The company lost $36.1 million in the latest quarter, compared to a $45.7 million profit for the previous corresponding period.

Looking at Virgin Australia Holdings Ltd’s [ASX:VAH] balance sheet doesn’t provide much cause for optimism either. The company has debt to the tune of $3 billion. You can offset just over $1 billion in cash, but we can only assume there’s as much as $4.4 billion of debt to add to the borrowings, depending on how the deal is structured.

But, regardless, Virgin Australia is making a big bet on a growing Australia. Or should that be a sustainably growing Australia?

Getting back to the Australia and New Zealand Banking Group Ltd’s [ASX:ANZ] results, we’d argue (you got it, we’re bearish even when the results are bullish!) that, while a rise in lending may support the case for a growing Australian economy, it doesn’t necessarily mean it’s ‘good’ growth.

After all, a boom precedes every bubble. The fact that an economy is growing doesn’t necessarily mean that it’s a reason to cheer. We’d argue that’s exactly the case here.

What’s more, even when the headline looks positive, the investor reaction isn’t. Something which ties into a key theme that colleague and Port Phillip Publishing’s Head of Research, Greg Canavan, has covered recently.

We’re talking about the ‘Crunch Point’ in the Australian natural gas industry.

The latest results from Santos Ltd [ASX:STO] show just how hard it is to plan for and invest in big capital expenditure projects years in advance, and still make a return when the revenue starts flowing.

As Bloomberg reports:

Santos Ltd., Australia’s third-biggest oil and gas producer, posted a 29 percent rise in full-year profit after booking record production and sales volumes.

Underlying profit, which excludes one-time items, was $63 million in the 12 months to Dec. 31, Adelaide-based Santos said Friday. The mean estimate of 12 analysts surveyed by Bloomberg was $23 million. The company’s net loss, which includes a writedown on its Gladstone LNG project, narrowed to $1 billion from $1.9 billion.

You can trace the Gladstone LNG project back to at least 2008. That’s when the natural gas story first popped up on my radar. It took seven years from the early stages of planning until it finally produced LNG from its facility.

As you’re fully aware, a lot can change in the economy in seven years. That was true for Santos — and the other LNG players in Queensland. And for the Santos share price, well, no doubt the huge capital investment has had a big influence on the share price.

Santos Share Price
Source: Bloomberg

For your information, the Santos share price is down 77% since that 2008 peak. Zoiks!

But while the likes of Santos and others slide, Greg has focused his attention on specific niche plays in the sector — where he believes rapid growth lies ahead.

Plays that Greg says are ripe for big returns as the natural gas and LNG market dynamics move into a new phase. We’ll see how it plays out. But Greg’s analysis and advice makes a lot of sense based on what we’ve seen of it. We recommend checking it out here.

Returning to Virgin Australia, we wonder whether the airline could either learn from Santos’ capital investment woes, or whether it will just have to grin and bear it…and, more importantly, whether investors can learn anything from it.

Check out the Virgin Australia share price performance below:

Virgin Australia Share Price 2017
Source: Bloomberg

For your information, the Virgin Australia share price is down 92% since that 2007 peak. Zoiks!

As a contrarian, we, and you, may be tempted to pile in at this sub-20 cent price. But, frankly, we can’t be sure the worst is over. Clearly Virgin has a commitment to buy the 40 Boeing 737s — hence the reason for postponing, rather than cancelling, delivery.

If this commitment results in a significant increase in the company’s debt, and if the oil price continues to trade above US$50 per barrel, the next two years could see this sub-20-cent stock slowly turning into a sub-10-cent stock.

We’ll continue to watch it with keen interest. But watch it is all we’ll do.


Editor’s note: The above article is an edited extract from Port Phillip Insider.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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