September, 2023
In March 2006, we attended the Credit Suisse Asian Investment conference in Hong Kong. We were living there at the time, which coincided with the annual Hong Kong 7’s Rugby tournament. It was traditionally the biggest week of the year in Hong Kong and in 2006, as China was industrialising rapidly, there was no better city to be. The peak in irrational exuberance was still a good 12-18 months away, but the mood was very bullish. The IPO market was hot, there was money to be made. We had a very positive disposition on the commodity markets at the time given we (felt at least) had a front row seat to the accelerating demand of Chinese steel production. Every quarter, Shanghai was changing, and you had to be on the ground to feel it. We felt we had an edge being so close to the coal face.
At this particular conference we listened to a talk that had a profound impact on the way we think about investing. The speaker stood up and asked the audience to think of a number between 1 and 100. This task was easy enough. He then asked us to assume what the average number chosen by all the people in the room (roughly 200 or so investors) would be. Relatively straight forward. Finally he asked us to write down a number, that we thought would be 2/3rds of the number the average audience member wrote down. He repeated this 3 times so it sunk in. Write down a number that is 2/3rds of what the rest of the room would write down.
This task was infinitely more complex given the assumption that every investor is then second guessing what everyone else is writing down. Now this is the essence of how a market functions. Often it’s not first order thinking (pick a number), or even second order thinking (what consensus thinks). Actually investing involves the complexities of a room (or market) full of incredibly well educated people, using third order (or fourth order) thinking, and trying to get ahead of the pack by extending that thinking even further. Using the example above. The actual answer most investors gave was around 14. That is, if the average number between 1 and 100 is 50 (consensus), then most investors assumed that 2/3rds of 50 is 33, but that is what everyone else wrote down, so the next derivative is 22 (2/3rds of 33). However extending that thinking again, arrives at the number 14 (2/3rds of 22). We found this fascinating as a (relatively) young portfolio manager thinking about expectations and market psychology. This talk was given by widely regarded financial author Michael Mauboussin, who later wrote the book Expectations Investing, amongst many other widely acclaimed books.
Successful investing often requires a different train of thought to consensus thinking, and often outliers tend to be the most successful investors, by extending their thinking the furthest. This shouldn’t be confused with complexity of a business model, as many of the most successful investors keep the company fundamentals relatively simple. In 2023, this third and fourth order thinking can be observed in the AI space, the GLP-1 space (weight loss drugs), the energy markets, the lithium market and at a macro level, the USD, inflation expectations and the inverted yield curve (recession watch). Much of our process tends to try to understand what consensus thinks, and where (if at all) we have a different view than the crowd. It’s not difficult to find sectors where the crowd has pushed expectations too high (or too low), and what that ultimately means for allocating capital at a point in time. The obvious missing link here is having a high conviction view on what an assessed valuation should be versus what is being priced in.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Quarterly-Thoughts-October-2023.pdfAugust, 2023
During the month the fund returned -1.5% relative to the -0.7% fall in the ASX300. The strong performers in August were led by Aussie Broadband (ABB), demonstrating exceptional cash flow growth and continued momentum in residential broadband connections. Expectations, like many strong August performers, were cautious heading into the result. The pipeline of business or enterprise customers augurs well for continued FY24 growth. News Corp also performed strongly through August by demonstrating the resilience of earnings stemming not just from the realestate.com.au investment, but the Dow Jones business unit, which we view as a very strong franchise. The implied multiple for Dow Jones (if we strip out the NWS stake in REA) is circa 4-5x, while we believe the business should be valued closer to 11-12x EV/EBITDA, which continues our belief that the conglomerate structure of NWS materially undervalues the organisation.
Underperformers for the month were led by Resmed (RMD), which has becomes one of the most polarising valuation arguments we can recall. While the RMD quarterly was a slight disappointment from a gross margin perspective, the stock has fallen 28% since the result in response to the powerful narrative around weight loss drugs.
The thesis being that these drugs (Ozempic, Wegovy, Mounjaro) if taken consistently over a 12-18 month period, can materially reduce obesity, and therefore the addressable market for Obstructive Sleep Apnea (OSA) will be significantly reduced in the coming 5-7 years, with obesity being linked to OSA. We will discuss this in more detail in the next quarterly, suffice to say, weight loss drugs are still very early in the lifecycle with many side effects still misunderstood. Mr Market has declared that RMD is guilty until proven innocent in terms of the medium term growth rates attached to OSA. At this stage, we tend to view this price weakness more as an opportunity than a threat. Austal (ASB), we continue to view as an asymmetric investment case below AUD2.00. Without question we have found it frustrating with a book value above AUD2.50 and a very strong revenue growth trajectory over the next 5 years given the recent contract wins that see the ASB order book at record highs. While FY24 guidance was slightly softer, it is a transition year as they ramp up towards the 2 new programs starting in mid 2024. We also note that guidance for FY24 was using an AUD currency of 0.72 vs the spot rate at 0.64. All else being equal, this would be a 15% eps upgrade at spot, but we are quite sure that no one is looking. The market remains materially below our own FY26 forecasts, which unfortunately, requires more patience.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-August-2023.pdfJuly, 2023
During the month the fund returned 1.5% relative to the 2.9% gain in the ASX300. The strong performers in April were led by Beach Petroleum, which had been derated over the past 12 months on the back of some challenging quarterly production numbers. The June quarter result showed a stronger pricing outcome than expectations, while some operational delays (Waitsia and Thylacine) have not derailed the simple story around a 50% increase in production over the next 2 years, while trading on less than 2.0x EV/EBITDA in FY25, which equates to a FCF yield of >20%. AGL was also a strong performer. On our numbers AGL continues to trade on ~5.2x EV to EBITDA 1 year forward vs an average of NZ Gentailers on ~13x EBITDA. We see AGL as an energy transition arbitrage as they generate strong cash flow from thermal assets to fund battery and renewable investments effectively replacing the lost earnings which hopefully provides opportunity for a multi year re-rate to that of their Trans-Tasman peers.
Underperformers for the month were led by Austal Limited (ASB). ASB updated the market in July regarding their US Towing, Salvage and Rescue Ships (T-ATS) contract, with a further downwards adjustment of AUD60m against that program and amid uncertainty to the timing of any reasonable equity adjustments (REA). The drop in ASB’s market cap (~AUSD120m) has been ~ double the extra provision of a 2 year program. I.e., the market is skeptical of the corporate activity resulting in a takeover and/or is extrapolating the underperformance in the T-ATS contract (their first steel contract) against the subsequent steel contract wins OPC and TAGOS. We don’t share these concerns, believing that even if the corporate interest evaporates, the OPC and TAGOS contracts include design by ASB and have different structures than the T-ATS contract, and believe the operational efficiencies of running 2 large scale multi year contracts in Alabama, combined with the ongoing ramp up in annuity style sustainment earnings, places the FCF generation of ASB over the next 5 years as materially underappreciated.
CSL was also weaker during July after competitor Argenx released top line data of its phase III trials of Vyvgart, for use in patients with CIPD (neurological disorder involving weakness and reduced senses in the arms and legs). The trial showed a similar response rate and relapse rate to IVIG studies, thus while a competent alternate therapy, it doesn’t appear to be a material game changer for CIPD patients in switching away from current IVIG therapies. Note Vyvgart has been used in Myasthenia Gravis (MG) patients for several years, with 7-8% penetration rates of market share.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-July-2023.pdfMay, 2023
During the month the fund returned 0.7% relative to the 2.5% fall in the ASX300. The strong performers in April were led by Austal (ASB), which had actually been a frustrating investment thesis since announcing a US3.5bn contract with the US Coast Guard last July. For a variety of reasons ASB retraced all its gains from last September to May, trading on just 0.6x PB. In May ASB announced the award of a design contract for the T-AGOS surveillance ship, which is highly likely to convert to a US3.2bn 7 ship program. This would effectively see ASB have a full order book for the next 10 years at their Alabama facility, while creating more certainty around the sustainment (maintenance) program. Post this contract, ASB will have an order book of around AUD11bn which suggests (to us) the market cap of AUD800m is mispriced. Recent press speculation suggests we are not alone. We added AGL to the portfolio in the first quarter, acknowledging the tailwinds in the electricity market remain highly cash flow positive for AGL, while recognising AGL has to be a key participant in the energy transition in Australia over the next 10 years. Allkem (AKE) is also a recent addition as we watched the lithium price retrace much of its 2022 gains, while remaining believers in the structural EV story.
We were attracted to the relative maturity of the AKE assets and the production growth to come over the next 3 years, while being pleasantly surprised by the merger with Livent group. This merger creates a vertically integrated EV player of scale with both geographic resource and product diversification.
The underperformers for the month were led by Aussie Broadband (ABB), which stands to benefit (as do all telcos) from a revised pricing structure with the NBN. The ACCC draft submission effectively delayed the prospect of a pricing tailwind, but this is still likely to eventuate over the next 6-12 months. Those telcos more exposed to higher end plans (ABB) should see the cost of connection to the NBN fall in aggregate (eventually). QBE was also softer in May after a strong 6 months, after guiding to a higher catastrophe claim outlook in CY23 than we (or the market) had hoped. While we believe QBE is doing a far better job of controlling the controllables, unfortunately they have yet to devise a plan to control the weather, which is perhaps why it is trading on an FY24 PE of 8.8x. Imdex (IMD) has been a long term position that we have reduced over the course of 2023, being slightly cautious around exploration spend of their customers over the next 12 months.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-May-2023.pdfApril, 2023
During the month the fund returned 0.9% relative to the 1.8% rise in the ASX300. We have continued to see 90% of the portfolio behaving as we would hope, while the past 4-6 months has seen several idiosyncratic challenges with our stock selection. The strong performers in April were led by Genesis Mining (GMD), which restructured its acquisition of St Barbara’s Gwalia gold mine in the Leonora district. While optically this has both strong shareholder support from GMD shareholders and the SBM board has endorsed the deal (scheduled for a June EGM), we note that in recent days Silver Lake (SLR) has made an offer to SBM for the same assets at (optically at least) a superior bid. We will watch carefully as this unfolds, but again, given the SBM board’s approval of the GMD bid, we are hopeful that the necessary approvals are met by the end of the quarter. CSL had a stronger month with the tailwind being a site visit to the CSL European operations, which demonstrated strong fixed cost leverage with the new fractionation processing facility and the operational readiness for the new CSL-112 product, which promises to be an exciting cash flow driver over the medium term.
Synlait (SM1) had another tough month after reporting a further downward revision to infant formula demand from key customer A2M causing a further (NZD20m) hit to profit guidance, placing them at approximately breakeven for FY2023. Management remain confident in SAMR approval for A2M in Q4 FY23 and delivery of strong double digit growth in Advanced Nutrition sales volumes when the new multinational customer commences. SM1 is now trading on 0.4x book value per share and 6x FY25 PE, with optionality around its asset base. One for deep value contrarians. Mineral Resources (MIN) also underperformed with the quarterly showing challenges in all 3 divisions leading to downgrades. Mining Services production volumes were lower following completion of 2 external mining contracts. Iron Ore costs were revised to the top end of guidance and lithium production at Mt Marion suffered higher costs and lower spodumene and hydroxide sales. MIN’s quarterly is somewhat a reflection of the tougher labour market in WA, a softer period seasonally for lithium and some timing issues. Develop (DVP) was also softer on the back of weaker commodity prices despite some impressive drill results at Woodlawn.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-April-2023.pdfFebruary, 2023
During the month the fund returned -1.1% relative to the -2.5% fall in the ASX300. Our broad assessment of this outcome being, we got the micro drivers right (individual company positions), while we felt the impact of macro headwinds (rising USD hurt our gold positions). Origin Energy (ORG) led the outperformers, after informing the market of a revised bid from the Brookfield consortium at AUD8.90 per share. Heading into this outcome we had felt the equity market had all but given up on a formal bid (trading at AUD7.00 per share), which seemed at odds with all previous public commentary from Brookfield regarding their commitment to the energy transition of the Australian electricity grid. Brambles (BXB) appears to us to be in a sweet spot, for it offers a very basic service (pallets) facilitating the logistics of FMCG distribution. Given how capital constrained the world is, owning 360m pallets globally with a replacement cost of USD30-35 per pallet is an asset base that is incredibly hard to replicate. BXB has demonstrated pricing power with pallet shortages from its competitors, leading to higher demand for its reliable service. This pricing power has seen earnings revised upwards, with the strong tailwinds having further to play out over the next 12-18 months. The Lottery Corp (TLC) also delivered a strong result leading to eps upgrades. While TLC is well understood, the scope for pricing levers to continue over the next 12-18 months suggest a very predictable cash flow profile ahead of it.
Jervois (JRV) has been problematic for the fund over the past 4 months, which has been heavily influenced by the 35% fall in the cobalt price over this period. Given more than 70% of cobalt is produced from the DRC (Democratic Republic of Congo) and less than 9% is produced by OECD nations, the visibility of what drives the short term pricing dynamics is opaque. Our thesis for JRV was predominantly driven by its strategically relevant position as having the largest cobalt mine in the US. A USD16/lb cobalt price is unhelpful, hence our focus is the cobalt market dynamics from this point. Westgold (WGX) retraced much of its January strength through February, as the USD gold price softened on USD strength. We understand the logic of this relationship, but keep one eye firmly on the upcoming US debt ceiling debate, the increase in deficit spending in the US, and the Eastern Bloc’s firm desire to remove the influence of the USD on global trade.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-February-2023-1.pdfJanuary, 2023
During the month the fund returned 3.8% in a relatively strong month for the ASX, with most sectors seeing gains led by consumer discretionary names, while only utilities lagged (ORG). Outperformers for the month were led by Westgold (WGX), a recent position purchased in the 4th quarter. As gold rallied on the back of a declining USD, most gold names rose, with WGX demonstrating a strong operational turnaround is under way. The operating costs should continue to trend lower in CY23, while the hedge book rolling off will see strong margin expansion for WGX in FY24. Mineral Resources (MIN) continues to offer exponential earnings growth through new projects, with a compelling gas project in the Perth Basin adding to its medium term appeal. Imdex (IMD) was a stock we spoke to in our recent note “Return of the Developer”, where we see IMD well placed to benefit from an elongated cycle and new technologies. The recent equity raising to fund the purchase of Norwegian mining services company Devico was received well, as IMD also delivered a robust 1H FY23 result at the same time. Valuing IMD closer to international peers suggests the rerating has further to go.
Austal was a material underperformer in January as they revised down FY23 earnings after increasing the provision for an onerous contract with the US Navy. This specifically relates to the US Towing Salvage and Rescue Ships (T-ATS) whereby the initial fixed price contract was met with variations and modifications by the US Navy, and as such, ASB will possibly incur a loss on this program. The word possibly is used, as ASB has submitted requests for equitable adjustments (REAs) in respect of the changes to the initial contracts. As it is too early to assess whether the US Navy reimburses ASB for the higher costs of the program, the provision was taken in FY23. This announcement was accompanied by press that several republican senators in the electorate of Eastern Shipbuilders (an ASB competitor) voiced “concerns” that ASB may be the source of military secrets being leaked to the Chinese. With poor sentiment and some redemption selling, ASB is now trading on just 0.6x PB value, with net cash and an exciting pipeline of opportunities in front of them. We think it is heavily oversold, and completely unloved.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-January-2023.pdfNovember, 2022
During the month the fund returned 5.2% in a relatively strong month for the ASX, with the other barbell of the market, Metals and Mining delivering 18% (BHP 22%, FMG 32%) after the Banks’ 15% return in
October.
Outperformers for the month were led by Origin Energy (ORG) which was the subject of a takeover bid at AUD9/share; the 3rd but first disclosed to the market, from a combination of Brookfield Asset Management and MidOcean Energy. We had added ORG to the portfolio mid 2021 at ~80% of its book value with conviction that the assets were being underappreciated and undervalued. Although regulatory risk has the potential to alter terms of the deal, we place a high probability on the transaction completing, hence remain holders.
Mineral Resources (MIN) continues to offer exponential earnings growth through new projects, with a compelling gas project in the Perth
Basin adding to its medium term appeal. Our gold holdings performed well throughout the month with recent addition Northern Star (NST) rising 22% during the month. Our current view is that gold equities offer meaningful upside in 2023 in a world where many companies are either fully valued or face earnings headwinds as economic conditions bite.
Jervois (JRV) was and continues to remain weak after a large USD150m equity raise to fully fund restart of Sao Miguel Paulista (SMP) nickel + cobalt refinery (Brazil), Idaho Cobalt mine restart (USA) and a study of the expansion of their Kokkola cobalt refinery (Finland). Notwithstanding its weakness we believe JRV represents one of the more reasonably priced exposures to battery materials with a highly credentialled management team and now strengthened balance sheet. Lendlease, in what has now become somewhat of a frustrating pattern delivered a further downgrade during the month. LLC now trades on <0.8x book value and ~9x FY24 earnings, on expectations that have dramatically reduced over the past 18 months. It is definitely unloved.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-November-2022.pdfOctober, 2022
For the month of October the fund returned 3.8%, relative to the ASX300 Accumulation Index return of 6.0%. The strength in the ASX300 was led by the bank sector after a Bank of Queensland result that highlighted the current tailwinds behind the net interest margins of bank earnings. Banks are capturing the benefit of higher interest rates, without yet feeling the impacts of those higher rates on impaired loans.
In fact impaired loans at ANZ and WBC are running at 4-5bp of total loans, 25bp below the 35 year average of 30bp. Our view of banks remains consistent in that they are leveraged exposure to the Australian economic cycle. We are less than convinced that banks offer any real downside protection should economic conditions worsen over the next 12 months. We will broadly keep a watch, but note the rising pressure on commercial property pricing, which is worth bearing in mind. The strong performers for the month were again led by Mineral Resources (MIN), a long term holding that benefited both from the current enthusiasm for anything related to the EV thematic and the actual project pipeline within the MIN portfolio. In our view it actually has a relatively predictable pathway to see EBITDA grow at least 200% over the next 3 years, while there is more chatter around an eventual separation of the lithium assets from the MIN portfolio. Nufarm (NUF) offers interesting value given the crop protection business is still experiencing favorable growing conditions, while the Nuseed business has a visible pathway to create strong value for shareholders over the next 3-5 years. We note a recent transaction at UPL (a NUF competitor) valuing their seeds business at 26x EV/EBITDA. Optically this provides a material uplift to the NUF portfolio.
Our gold allocation hasn’t worked in 2022, at all. OceanaGold (OGC) has been our preferred gold name for the past 2 years, based on our conviction in the assets in the ground across four diversified operations.
We remain holders on a fundamental basis, while the primary listing has moved to Canada. OGC fell 12% through the month with broad sentiment across the sector after posting better than expected quarterly production numbers. We still see strong value on offer. Aurelia (AMI) delivered a feasibility study into developing Federation, their prized asset. This feasibility study was disappointing from an economic perspective relative to expectations that were far higher than delivered. We exited the position shortly after. Gold remains around 6% of the portfolio which we maintain is prudent from an allocation perspective
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-October-2022.pdfAugust, 2022
For the month of August the fund returned 3.3%, relative to the ASX300 Accumulation Index return of 1.2%. The strong performers for the month were led by Mineral Resources (MIN), a long term holding that benefited both from the current enthusiasm for anything related to the EV thematic and the actual project pipeline within the MIN portfolio.
The announcement of the structure of the Onslow JV Iron Ore project whereby MIN will build the infrastructure for the JV, but then be able to provide the mining services over the 30 year project and charge infrastructure access fees that generate a high teens IRR, illustrates to us, yet again, why MIN is our preferred resource exposure. In our view it actually has a relatively predictable pathway to see EBITDA grow at least 200% over the next 3 years. Ridley (RIC) is another holding where we have strong confidence in the management team to execute on their growth ambitions, irrespective of the macro environment. Much of the organic growth in the RIC business is internal optimisation, new product lines in the pet-food category and incremental market share gains in the bulk stock-feed category, which underpins a predictable growth pathway with strong cash conversion, all at a reasonable price.
OceanaGold (OGC) has been our preferred gold name for the past 2 years, based on our conviction in the assets in the ground across four diversified operations. At the end of July OGC made the surprising decision to exit their CDI (Chess Depositary Interest) program with the ASX, to convert all the share trading back to the primary Canadian listing. Less than 10% of OGC shares have been historically traded on the ASX. This has seen the OGC share price suffer from forced selling, while our mandate enables the fund to hold the Canadian listed entity.
We think the short term pressure on the OGC share price (due to leaving the ASX) will see an opportunity for OGC to rebound post this event over the next 6-8 weeks. Hence we remain comfortable holders on a fundamental basis. Seek (SEK) was added to the fund in June on the thesis that persistent labour market tightness will see elevated job ads for the foreseeable future. CEO Ian Narev gave somewhat conflicting signals around the SEK guidance for FY23, which led to a muted response to what was actually a very strong result.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-August-2022.pdfJuly, 2022
For the month of July the fund returned 5.2%, relative to the ASX300 Accumulation Index return of 6.0%. The strong performers for the month were led by Austal (ASB), which ties into the notion of asymmetic risk. Prior to announcing an 11 ship (Offshore Patrol Cutters) contract with the US Coast Guard for USD3.3bn, ASB was trading at a 20% discount to book value, with AUD200m in cash on their balance sheet, while generating significant EBIT from their maintenance contracts on ships already built. The US Navy had gifted ASB USD50m to reconfigure their US base in Alabama to enable steel ship manufacturing. It seemed implausible to us that ASB wouldn’t ever win another US contract, which is what the market had seemingly priced in, in our opinion. ASB rose 45% through July after announcing that contract, with the US Navy remaining public in their desire to continue to bolster their Naval defences over the next 3-5 years, work that ASB remains well placed to tender for. Mineral Resources (MIN) and CSL were other strong performers, with MIN delivering a surprising hydroxide tolling contribution from the lithium business, which in our mind, only solidifies the business model strength of MIN over the next 3-5 years.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-July-2022.pdfMay, 2022
Don’t fight the Fed. Since the GFC the FOMC has erred on the side of being market friendly, with a dovish tilt at the first sign of economic weakness. This created the mindset of “buying the dip” any time equities were sold off more than 10-15%. Unfortunately for equity investors, the US monetary policy since the GFC has been an effective on/off switch. Most of the time, the switch has been on. It’s currently turned off. We still have market expectations of another 5-6 interest rate hikes in 2022, combined with the unwinding of the QE program post the COVID inspired central bank largess, which makes for the fastest change in financial conditions in the past 40 years.
So what would see a central bank pivot? Simplistically the dual mandate of fighting inflation and maintaining full employment are the Fed’s stated objectives, hence a change in momentum in either metric would suggest expectations for ongoing rate hikes would be wound back. Whilst many of the forward looking economic data points suggest pending consumer weakness ahead (confidence, forward orders), the backward looking unemployment rate remains very strong. Thus to this end, the Fed appears set to raise rates again in June and July (while the RBA is on the same path). We would truly need to see inflation peaking and the unemployment rate to start going up for this current trajectory to change course. In this sense, economic weakness again becomes good news for asset pricing. We don’t profess to offer a view on the timing of either, agreeing wholeheartedly with Yogi Berra.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-May-2022-2.pdfMay, 2022
For the month of May the fund returned -2.2%, relative to the ASX300 Accumulation Index return of -2.8%. We hold the notion that the best prospects of protecting capital and growing earnings in a highly inflationary environment is a bar bell approach. For margins to hold, and therefore profits to hold/grow, we need to see one of two things. Either strong commodity led tailwinds (hydrocarbons, electricity etc), or extremely strong pricing power, whereby we hold the view that only a select handful of Australian stocks have true pricing power.
GQG Partners (GQG) was the strongest performing stock in May. A position we entered in March as we watched a high quality global fund manager, with strong inflows sell off over 45% from its November 21 IPO. Buying a highly cash generative business with growth momentum on less than 10x PE and a 10% dividend yield was compelling in our view. Mineral Resources (MIN) continues to be our preferred commodity exposure.
Nufarm (NUF) was sold off in May after a strong earnings release that was followed with a 15.9% equity sell-down from Sumitomo Corp, having bought the stake in 2010. This has left NUF facing an equity overhang, which has little to do with the medium term fundamentals of the business. The Nuseed platform remains compelling in our view, and remains significantly undervalued in the current corporate structure of NUF. With 31% eps upgrades to FY23 earnings since the start of the year, we are somewhat surprised by the 20% sell off since the result. But markets continue to challenge us.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-May-2022-1.pdfApril, 2022
Ron Burgundy would suggest that things have escalated quickly. Perhaps too quickly. The myriad of obstacles facing asset pricing in May 2022 appear challenging from a macro standpoint.
The hawkish monetary policy positioning by central banks globally appears to be coinciding with a slowing global economy led by the drawn out Russian occupation of Ukraine and the Chinese Covid Zero policy. Supply impacts from energy and food (Russia and Ukraine) combined with supply impacts of consumer goods (Chinese lockdowns) appear to leave much inflation fighting to still be done. Traditional economic data points (confidence, retail sales, US housing) look to be rolling over, and anecdotally, accelerating downwards. Unemployment remains robust in many countries, which will most likely leave central bankers believing the current trajectory for interest rates is the right path. We will watch employment numbers closely for a change in tone or thinking around the consensus expectations for 8-9 interest rate hikes in the US this year.
We have long been of the view that not even the most skilled forecaster can predict the interest rate path, or economic trajectory for that matter, with anything more than a best guess over a 12 month horizon. There are simply too many variables that stand in the way. We would frame our thinking around the chances of interest rates being loosened in 12 months time at the same probability as ongoing rate hikes, such is the sensitivity in asset prices to interest rate directions. Holding a diverse range of stocks for the uncertainty over the next 12 months appears to us to be the most prudent path in preserving capita
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-May-2022.pdfFebruary, 2022
For the month of February the fund returned 3.0%, relative to the ASX300 Accumulation Index return of 2.1%. We added Nufarm (NUF) to the portfolio in Q3 2021, as it was trading below book value, with a strong agricultural cycle and an underappreciated R&D portfolio researching sustainable fuels and farming practices. This has translated into both near term earnings upgrades due to the current cycle, but more importantly, validation of the R&D portfolio with BP signing a 10 year agreement to take Nuseed’s Carinata product for aviation fuel. Nuseed Carinata is a non-food cover crop that can be used to produce low-carbon biofuel feedstock that is sustainable and scalable. At the February investor day, NUF projected ambitious targets for both the crop protection business, and the Nuseed business. If they can execute on this strategy, NUF has a very strong 2-3 years ahead of it. Woodside (WPL) has been a laggard over 2021 due to growth capex concerns, but has tailwinds in the ongoing tightness in global LNG pricing.
The upcoming independent assessment of the BHP Petroleum business we believe will highlight just how high quality the WPL portfolio will be post merger. It also paid a 5% dividend in February, which helped. OceanaGold (OGC) appears to us to be finally turning a corner. Relative to peers, it has compelling valuation support, predictable production growth and exciting resource extensions across its major assets. Gold remains a core portfolio allocation, as do certain commodity exposures.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-February-2022.pdfJanuary, 2022
For the month of January the fund returned -4.2%, relative to the ASX300 Accumulation Index return of -6.5%. Clearly January was a challenging month, but in the context of how strong equity returns have been over the past 2 years, a pullback of some sort was not unexpected. From a broader market perspective, earnings, dividends and valuation support will drive returns for the foreseeable future while we remain very focused on the individual companies in the portfolio. We are hopeful that the February reporting season will be favourable for our style of benchmark unaware investing. Being passive is a poor option in 2022.
Origin Energy (ORG) was the strongest performer in January as further strength in the East Coast electricty price as well as a strong quarterly for APLNG volumes suggests to us that the earnings trough is very much in the rear view mirror. Strong cash generation and an undergeared balance sheet sees enhanced prospects of higher divdiends or capital returns. Mineral Resources (MIN) saw further strength on a combination of a recovery in the iron ore price, and continued lithium price strength, where MIN has a very high quality asset in Wodgina in the process of ramping up. G.U.D Holdings (GUD) was added to the portfolio on an equity placement in December to purchase AutoPacificGroup (APG) which is a towing and trailering accessories retailer. GUD currently trades on 12.8x FY23 PER, a 5.8% dividend yield and relatively visible earnings momentum.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Chester-High-Conviction-Fund-Performance-Report-January-2022.pdfDecember, 2021
The CHCF posted a 3.5% gain in the December quarter, relative to the 2.2% increase in the ASX300 Accumulation Index. We believe there are several key holdings that are well positioned for strong periods over CY22. We remain genuinely excited by the valuation support within the portfolio, as well as a pre IPO position that will come to the market in May/June where we expect a significant valuation uplift. Mineral Resources (MIN) saw a strong recovery on both iron ore sentiment and the increasing understanding of the high quality lithium assets within the group. Our attraction to MIN over the past 4 years has been both the leadership of Chris Ellison and the enviable suite of assets across mining services, lithium and iron ore, providing a truly well balanced portfolio. Aurelia Metals (AMI) remains undervalued in our view as a strong cash generative company (<4x EV/EBITDA) with a company transforming discovery in Federation that the market (in our view) materially underappreciates.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/CHCF-Quarterly-Thoughts-January-2022.pdfNovember, 2021
For the month of November the fund returned 0.4%, relative to the ASX300 Accumulation Index return of -0.5%. In what has been a volatile period for Mineral Resources (MIN), it recovered in November post falling over 40% due to its iron ore exposure, which left the company trading below our assessed valuation of the mining services and lithium businesses, effectively implying the value of the iron ore business was worth less than zero. It remains our preferred resource name because of the diversity of the revenue streams, with strong cash flow growth to come from the lithium and mining service businesses, with iron ore being effectively a free option at circa AUD40. Aurelia Metals (AMI) we have held for a period of time whilst being very favourably disposed to the current cash generation (<3.0x EV/EBITDA) while drilling out a very exciting discovery called Federation, geographically very close to existing infrastructure. It is predominantly a gold producer, but the ore body is polymetallic, which provides a source of diversification with copper, lead, silver and zinc by-product credits. The production profile will double with the introduction of Federation in 2024, while it trades at roughly 50% of our assessed NAV.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/211130-Chester-High-Conviction-Fund-Performance-Report-v2-1.pdfSeptember, 2021
The CHCF posted a 6.3% gain in the September quarter, relative to the 1.8% increase in the ASX300 Accumulation Index. The strategy has had a pleasing 12 month period, with contributions across a wide range of stocks in different sectors. We believe there are several key holdings that are well positioned for strong periods over FY22. Aussie Broadband (ABB) has been the strongest performer for the fund over the past 12 months. The simple premise of the ABB investment thesis was (and remains) a founder led business with exceptional customer service leading to strong market share gains. A recent capital raise to potentially double their business looks to be transformative. We have just initiated a position in another pre IPO investment that has us as excited as we were about ABB 12 months ago. We will touch on this more in the lead up to the IPO in the next 12 months.
Ioneer (INR) has been a small position as it has a very strategic lithium deposit (Rhyolite Ridge) in Nevada, as US investors are bidding up locally based assets for the EV wave that is coming. We exited the position over the past month as in our view, a very full valuation is now being reflected in the share price after selling down the project into a JV structure to fund the development of Rhyolite Ridge. BHP was softer through the quarter as the iron ore price saw a significant correction after Chinese steel production appears to be slowing on concerns over property development funding. We had significantly reduced our MIN and BHP exposure by early August. United Malt Group (UMG) was weaker after another mildly unsurprising downgrade related to re-opening issues for event and hospitality industries. While this has been treated by the market as structural, we believe these issues are far more cyclical in nature.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/210930-Chester-High-Conviction-Fund-Performance-Report.pdfAugust, 2021
For the month of August the fund returned 3.5%, relative to the ASX300 Accumulation Index return of 2.6%. We did view reporting season to be relatively stock specific from a performance perspective, where we were pleased, in aggregate, as to how the portfolio was positioned. Aussie Broadband (ABB) has been a very strong performer for the fund over the past 12 months, but it continues to prove its business model, which is simply delivering a high quality broadband product with exceptional customer service.
It is the customer service piece that has seen ABB continue to win market share at the expense of larger incumbents. At the end of FY21 ABB had approx 400k subscribers, but has already added at least 70k subscribers in 1H 22 (including white label customers), showing the business model is being more widely adopted. Downer (DOW) has been one for the patient, but ultimately the 2020 decision to simplify the business into a pure urban services model has paid dividends, with the free cash generation proving the model works and has led to a share price re-rating. We still believe the DOW share price is undervaluing the cash flows that are now relatively predictable in nature, albeit somewhat impacted in the short term by lockdowns.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/210831-Chester-High-Conviction-Fund-Performance-Report.pdfJuly, 2021
For the month of July the fund returned 1.7%, relative to the ASX300 Accumulation Index return of 1.1%. The continued strength in the iron ore price through the first half of 2021 has seen a very strong period of cash generation for the listed iron ore producers and with that an expectation of very strong dividend growth in FY21. We are watching some of the developments in China very closely as to the plight of Chinese real estate developers and restrictions on movement associated with containing the rise of COVID cases. These issues suggest a slowing of demand for iron ore, hence the recent 30% fall in the iron ore price.
Mineral Resources (MIN) was yet again one of the strongest performers for the fund in July, but given the comments above, we deemed it prudent to lighten our holding late in the month. BHP was added to the portfolio last December and has been our preferred large cap resource exposure for its relative diversification and superior production profile. Comet Ridge (COI) has been a problematic investment for the fund owing to its stranded gas resource in the Bowen Basin.
A recent restructuring of the joint venture partnership in the Mahalo field to leave COI and Santos as the JV partners streamlines the decision making process and enables the Mahalo project to realise the full value of the gas resource over the coming 2-3 years.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/210731-Chester-High-Conviction-Fund-Performance-Report.pdfJune, 2021
What has surprised us over the past 6 weeks has been the strength in the bond market, with the US 10 year yield falling from 1.6% to 1.4% (at the time of writing). Nominal bond yields have two components, (GDP) growth expectations and inflation expectations. The price action of the US 10 year bond suggests to us that the market has lowered its expectations for one of these components. This implicitly suggests future (GDP) growth expectations have fallen. We can’t see how inflation expectations are falling yet. Commodity prices (oil in particular) remain elevated, housing prices (in the US) are rising, which suggests that almost 25% of the CPI basket (a measure called owners’ equivalent rent or OER) is also rising and wages are accelerating. Wages in our mind become the structural piece of higher costs and it remains our view that in the US (and Australia) the overriding metric being used to guide policy response is the unemployment rate. When unemployment falls to an “acceptable” range, only then will monetary policy become less accommodative. Hence wage growth is being mandated by policy makers.
The intellectual challenge here becomes the inflation delta (or the rate of change). In 2021 thus far, inflation has risen from 1.36% in December to 5.4% in June, hence inflation has accelerated. The wide ranging consensus expectations are for inflation to now moderate (fall) from 5.4% to below 4% over the next 3 months, all due to the base effect of the severe lockdowns in the 2nd quarter 2020. The real black swan event would be if CPI kept on RISING from here as this would disrupt the current goldilocks scenario, where growth as a style has had a very strong 3-4 weeks, as bond yields have fallen, signaling the economic recovery period has now peaked. We are not as willing to make that assessment. The earnings growth in the market can largely be attributed to the cyclical sectors, with financials and materials seeing the best eps momentum.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/210630-Chester-High-Conviction-Fund-Performance-Report.pdfMay, 2021
Fear and greed often drive markets, and they (markets) were certainly fearful last August/September, the only fear in Australian property right now is the fear of missing out. CBA rose 13% in May, highlighting (to us anyway) near on euphoric trading conditions for Australian banks and property markets. The ASX300 recorded one of the best months for any global index in May (2.3% vs the S&P500 0.7%). Australia has been a strong beneficiary of the reflation trade, which has been a significant tailwind for the two largest sectors of the ASX300 Index (financials and resources combined constitute approximately 50% of the ASX300). Both sectors have continued to see positive earnings revisions on the back of lower impairment charges (banks) and higher commodity prices (resources), with higher dividends coming over the next 12 months, supporting the ASX300.
For the month of May the fund returned 1.0%, relative to the ASX300 Accumulation Index return of 2.3%. We had taken a view in the middle of 2020 that the exploration spend would accelerate over the coming 2-3 years given the robust commodity prices. One of our preferred exposures to this thesis has been ALS Limited (ALQ) which delivered a very strong result and outlook in May. The fixed cost leverage of stronger assay volumes saw large upgrades. Including dividends, ALQ has returned almost 100% for us over the past 12 months and while we continue to hold, we have taken the opportunity to lighten the position into strength. OceanaGold (OGC) has been our preferred gold exposure on valuation grounds for around 18 months. This thesis has required patience (and still does) but in our view, the asset base is not reflected in the current share price, but it rose strongly in May on a stronger gold backdrop. Westpac (WBC) has been our preferred bank exposure due to our valuation framework. It also performed strongly in May with an in line result but an aggressive cost out program which was taken enthusiastically by the market.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/210531-Chester-High-Conviction-Fund-Performance-Report.pdfApril, 2021
For the month of April the fund returned 5.4%, relative to the ASX300 Accumulation Index return of 3.7%. April saw a strong month for commodity related names while technology stocks had a respite from ongoing rotational pressure. The financial sector remains well bid on economic and property price strength. The bank sector looks to have reported a strong set of results with the release of provisions providing a significant tailwind to profitability.
The margin pressure with low interest rates is not going away any time soon. Mineral Resources (MIN) has been a strong performer for our strategy for the past few years, while a deeper understanding of their growth projects following a site visit has seen renewed interest in the long term growth optionality. Aussie Broadband (ABB) also had a strong month while we have taken the opportunity to lighten our holding. The gold sector also saw some buying on the back of the real yield turning more negative over the past 6 weeks (the difference between the US 10 yr bond and inflation expectations). The near term direction for gold looks to be influenced by the next inflation print on May the 12th.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/210430-Chester-High-Conviction-Fund-Performance-Report.pdfNovember, 2020
For the month of November, the fund returned 10.5%, relative to the ASX300 Accumulation Index return of 10.2%. For November, the strongest contributions for the fund were across the more value oriented names. We wrote up News Corp (NWS) in our last quarterly as a stock that remains significantly undervalued as a result of owning 62% of realestate.com.au and Dow Jones (owner of the Wall Street Journal and Barrons). Our sum of the parts still suggests significant upside to the NWS share price based on these assets alone, while a speculated offer to buy Foxtel for AUD2.0bn would only add to the valuation argument.
Mineral Resources (MIN) was another stock we considered to be significantly undervalued, but has had the tailwinds of the iron ore price combined with better awareness of the significant organic growth in the MIN portfolio over the next 3 years. It remains our preferred exposure to both iron ore and lithium. Lynas Corp (LYC) is a stock we have owned for a significant period, with the simple thesis of its asset base being incredibly valuable as the only meaningful global producer of rare earths outside China. LYC remains highly leveraged to the NdPr price (the key elements of rare earths) which looks in short supply over the next 2-3 years. The gold sector saw some profit taking through November. Aurelia Metals (AMI) was weaker after a capital raising for what we saw as a sensible purchase of a privately held gold mine in NSW with significant upside. We believe AMI is compelling value on both a cash flow basis and an asset backed basis in the low 40c range.
We note that post month end OceanaGold (OGC) has been informed that the Office of the President of the Philippines wishes to finalise the renewal of the FTAA (Financial or Technical Assistance Agreement) for the reopening of the Didipio Gold mine. This FTAA expired in July 2019 and has contributed significantly to the share price underperformance of OGC over that time frame. The liquidity position at the end of November was 7.9%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/201130-Chester-High-Conviction-Fund-Performance-Report.pdfticker: OPS7755AU
release_schedule: Monthly
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factsheet_url:
https://www.chesteram.com.au/funds/chester-high-conviction/
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asset_class: Domestic Equity
asset_category: Australia Large Growth
peer_benchmark: Domestic Equity - Large Growth Index
broad_market_index: ASX Index 200 Index
structure: Managed Fund
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fund_features:
Chester High Conviction aims to outperform the S&P/ASX300 Accumulation Index by 500bp (before fees) over a rolling 3-year time frame. The Fund will invest in a diversified portfolio of stocks predominantly comprising of listed companies in the S&P/ASX 300 Index (up to 100% of the Fund), a non- index position in stocks listed outside Australia (between 0-20%), while cash allocation can be between 0%-20%.