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  • A different kind of trend

    “Life moves pretty fast. If you don’t stop and look around once in a while you could miss it” — Ferris Bueller’s Day Off Despite being released only a year after this writer was born Ferris Bueller was one of our favourite movies growing up. A movie about living in the moment, friendship and self discovery – what was there not to like? For us it highlighted the importance of fun (we try to enjoy ourselves irrespective of performance) and the occasional break from routine so we don’t miss out on what life is really all about. Most of us in markets would confess to at some point having focused on the day to day rather than zooming out a bit. Whether it be the minutia of the macro watch on inflation, growth and hence interest rates, it can have us sometimes miss the forest for the trees. At Chester Asset Management we do keep an eye on the economic environment as it is increasingly influential in where we invest, particularly in a macro heavy market such as the ASX, however we acknowledge that trying to pick winners and losers off short term macro data can be inherently fraught with danger due to the impacts of government intervention in stimulating specific sectors of the economy. One way we try to circumvent this is to focus on underlying megatrends. Some of our investors or people who have heard from us may be familiar with a version of the below slide, we have been rolling with it for 7 years with minimal changes, because that’s the thing about megatrends. Source: Chester Asset Management Below we try to summarise the key points around demographics for the two most populous nations on the planet; China and India, as well as Australia and try to provide insights in how these demographic trends may influence key market sectors into the future. China Demographics – The cyclical impacts of famine and ‘feasting’ As a consequence of questionable economic policies in China from 1958-1959 when millions of farmers were pulled off the land to engage in ill-advised rural industries, China suffered near famine conditions between 1959 and 1962. It is estimated (given the Government never officially acknowledged the famine) that it caused up to 40 million deaths. The presumed psychological impact of the famine (I know what I want to do when I’m hungry) was a heightened fertility rate, which saw the population boom between 1963 to 1973, from ~680 to 880 million people. The growth was so rapid the Government was shocked into action, introducing the “later, longer, fewer” campaign which encouraged later marriage, longer gaps between kids and fewer children. The fertility rate (children per woman) in the 1970s subsequently dropped from 5.8 to 2.4. Despite the drop the Government went one step further in the 1980s by introducing the infamous one child policy. The combination of the famine, baby boom, government reaction and fertility decline created what became known as a demographic dividend, evident from the dependency ratio; the number of young people (under 15) and old people (over 65) for every 100 working age people falling from 80 in 1975 to 36 in 2010! The demographic dividend helped contribute to China’s rapid growth over this time. However, as all market participants (except maybe the crypto and tech bros) know about tailwinds they will eventually become headwinds, it just depends on your time reference. Hence, as the baby boom workers from the 1960s and 1970s become retirees and the impact of the one child policy shrinks the workforce it leads to an increasing dependency ratio. I.e. in 2022 it is estimated that there were under 50 people outside the working age population (i.e. aged 0 to 14 or >65) to 100 people in it. Focusing on just the over 65 dependents, at present, each retiree is supported by the contributions of five workers. The ratio is half what it was a decade ago and, per the graph below is trending towards 4-to-1 in 2030 and 2-to-1 in 2050. Some specific actions to combat this dependency issue are: Relaxing the one child policy. This policy update was announced in 2016 to two children and amended to three children in 2021. Increasing the retirement age and trying to shift to more of a service based economy so the labour force can work for longer. The current retirement age in China is ~60 years old for men, 55 for female civil servants and 50 for female workers. In 2023 reports emerged that China was planning to raise its retirement age gradually and in phases to cope with this demographic challenge they face. The president of the Chinese Academy of Labour and Social Sciences in 2023 was quoted as stating that there was a “progressive, flexible and differentiated path to raising the retirement age” i.e. there is no specific timeline to implementation. Instituting a universal pension plan. The pension plan now effectively consists of three pillars the first of which was introduced in 1997 with a basic pension system in the 1990s. The second layer, enterprise annuities was introduced in 2004 and in 2022 the third layer, individual retirement accounts (IRAs) were launched. There was a notable push for adoption between 2009 and 2013 when China effectively tripled the number of people covered by the old-age pension system. Increasing the level of automation (and or focusing on productivity). We suspect the government will provide further incentives for automation and R&D into AI but there is another underlying issue at play in China that this can impact so it is a delicate situation. China’s youth unemployment rate is currently hovering around 15. On another note, China has net negative migration, more people permanently leaving the country than entering which further exacerbates the issue around working age population. In 2023 alone the WorldBank estimated China’s net migration at (310k). Note this contrasts with Australia, where some of the issues of the Baby Boomer generation have been somewhat circumvented by an expansionary migration policy, refer comments below. India Demographics – A more sustainable dividend Similar to China, India's demographic dynamics have been influenced by government actions, economic conditions, and social norms, leading to significant shifts in its population structure over the decades. India was rocked during the mid 20th century by famines, the first of which, the Bengal famine of 1943, occurred during World War II as a combination of food procurement for the war and crop failure. The Bengal Famine was thought to have caused the deaths of some 3 million people. Famine conditions also re-occurred in 1966 and 1972 as a result of drought but not to the same extent. The situation began to improve with the ‘Green Revolution’ in the 1960s, which introduced high-yielding variety seeds, improved irrigation infrastructure, and modern agricultural techniques such as mechanized farm tools, pesticides and fertilisers. This transformation in agriculture not only helped avert famine but also led to a significant increase in food production. The improved food security contributed to a population boom. However, India also benefited from improvement in living standards which helped see a meaningful decline in mortality rates as health conditions improved and life expectancy increased. Between 1960 and 1980, India's population grew from approximately 450 million to 700 million. Recognizing the challenges of managing such a large and rapidly growing population, the Indian Government initiated various family planning programs. During ‘the Emergency Period’ from 1975 to 1977, under prime minister Indira Gandhi, a controversial and coercive sterilization campaign was launched. There were even reports of police cordoning off villages and dragging men to surgery. It was believed that during 1975 ~6m Indian men were sterilized in just a year, a number reported to be 15x the number of people sterilized by the nazis in World War II (1) . This led to a decline in the fertility rate but also sparked public outrage and political backlash. Whether it kickstarted the decline in the fertility rate further we’ll never know but the drop, per the graph below is quite stark since the Emergency Period began. In the subsequent decades, the Government shifted to more voluntary and incentive-based family planning measures. The introduction of widespread education about family planning, improved access to contraception, and economic incentives for smaller families gradually led to a decline in fertility rates. For context this has seen the fertility rate drop from ~6 children per woman in the 1960s to 3-4 in the 1990s and closer to 2.2 today. Source: Statista 2024 India's population, unlike China’s has created a demographic dividend, defined as the economic growth potential resulting from changes in a country's age structure. This began to emerge prominently in the late 20th century. With a larger proportion of the population entering the working-age group, the dependency ratio declined. This shift provided India with a substantial labour force, contributing to economic growth and increased productivity. From 1991 to 2018 India experienced a period of rapid economic growth, often attributed to liberalisation policies, increased foreign investment, and the rise of the IT sector. The growing working-age population played a crucial role in this economic expansion, as it fueled consumer demand, increased savings, and enhanced the labor supply. This period of prosperity has contributed to ongoing population growth with India reportedly overtaking China as the most populous nation in 2023 but unlike China, India’s population is anticipated to keep growing until ~2065. Today India has ~65% of its population under 35 years old! As the country’s population continues to age though, the demographic dividend is gradually diminishing. By 2050, the proportion of people aged 60 and over is expected to increase significantly, leading to a rising dependency ratio. UN estimates that the number of people aged 60 and over will increase from 149m in 2022 to 347m in 2050. Source: UN Population statistics Promoting higher fertility rates: Unlike China, India's fertility rate of around 2.1, remains close to replacement level. However, efforts are being made to ensure it does not fall below sustainable levels through initiatives that support families, such as parental leave policies and financial incentives. Improving healthcare and social security: The government is working to strengthen healthcare infrastructure and expand social security programs to support the ageing population. This includes initiatives like the National Health Mission and the Pradhan Mantri Jan Arogya Yojana (PM-JAY), which aim to provide affordable healthcare to all citizens. Encouraging skill development: To harness the potential of the young working-age population, India is investing heavily in skill development programs. Initiatives like Skill India and the National Skill Development Mission aim to equip the workforce with the necessary skills to meet the demands of a modern economy. Boosting economic growth through innovation: The Indian government is promoting innovation and entrepreneurship to create new job opportunities and drive economic growth. Programs like Startup India and Make in India are designed to foster a business-friendly environment and attract investments. By investing in healthcare, education, and skill development, and by fostering a conducive environment for economic innovation, India can navigate its demographic transition and continue its journey toward sustainable development and prosperity. We further note however that India’s national elections have just concluded with a surprise result that unlike 2015 and 2019 the Bhartiya Janata Party (BJP) didn’t win in a landslide. Hence despite Modi securing a third term he has had to form a coalition government for the first time. This means that Modi won’t have the same level of support during this term and will need to navigate coalition politics. Australia Demographics – Why continue to build local when it’s easier to import? Australia’s demographic landscape is a fascinating reflection of its economic policies, migration trends, and social changes. Over the past several decades, these factors have shaped the country's population dynamics, leading to significant shifts in age structure and workforce composition. It bears many similarities to a number of other western countries such as the US. In the aftermath of World War II, Australia embarked on an ambitious immigration program to boost its population and workforce. The government actively encouraged immigration from Europe, resulting in a significant influx of new residents. This period saw Australia's population grow rapidly from ~7.5 million to over 13 million people by the early 1970s. The increase in population was driven not only by immigration but also by a post-war baby boom. The fertility rate peaked in the late 1950s and early 1960s, with an average of 3.5 children per woman. My grandparents helped lift the average! This population growth provided a substantial boost to the economy, as a larger workforce supported industrial expansion and infrastructure development. By the 1970s, Australia began to experience a decline in fertility rates, similar to trends observed in other developed countries. Several factors contributed to this decline, including increased access to contraception, greater participation of women in the workforce, and shifts in social attitudes towards family size. By the 1980s, the fertility rate had fallen to around 1.9 children per woman. In response to these demographic changes, the Australian government implemented policies aimed at supporting families and encouraging higher fertility rates, some of which are addressed below. Migration has also continued to play a crucial role in shaping Australia's demographic profile. The government has maintained a robust immigration program, targeting skilled migrants to address labour shortages and support economic growth. This approach has helped offset the natural decline in fertility rates and ensured a steady increase in population. In recent years, Australia has also focused on attracting international students and temporary workers, further diversifying the population and contributing to the economy. The combination of permanent and temporary migration has allowed Australia to maintain a relatively young and dynamic workforce compared to other developed nations. Australia's own demographic dividend became evident as the proportion of working-age individuals increased relative to dependents. From the 1970s to the early 2000s, the dependency ratio declined, providing a boost to the economy. During this period, Australia experienced sustained economic growth, supported by a strong labour force, high levels of productivity, and a favourable global economic environment. The mining boom in the early 2000s further fueled economic expansion, attracting investment and creating jobs. Similar to India, as Australia's population continues to age, the demographic dividend is reducing. The proportion of people aged 65 and over is projected to increase significantly, leading to a rising dependency ratio. By 2050, it is expected that there will be around 3 working-age individuals for every senior citizen, compared to around 5 in the late 2000s. Australia’s dependency ratio, Source: ABS Data The current fertility rate in Australia is 1.6, well below the replacement rate of ~2.1 births per woman. Source: Propel Funerals, May 2024 Presentation To address the challenges of an ageing Baby Boomer generation, the Australian government is implementing several measures: Encouraging higher birth rates: The government continues to support families through policies such as paid parental leave [2] , childcare subsidies [3] , and family tax benefits [4] . These measures aim to make it easier for families to have children and balance work and family responsibilities. Peter Costello’s 2004 baby bonus catch-cry of “one for mum, one for dad, one for the country” didn’t exactly lead to a wave of procreation. Jim Chalmers said in May 2024 “It would be better if birth rates were higher”, he doesn’t quite capture the headlines like Costello but the sentiment is there! Promoting skilled migration: Australia's immigration program remains a key strategy for addressing labor shortages and supporting economic growth. By attracting skilled migrants, the government aims to maintain a dynamic and productive workforce. Notably however after a recent high intake of ~740k migrant arrivals in FY2023 (net 528k) Australia has budgeted for a reduction in the number of migrant intakes for 2024-2025 down to net 260k Investing in health and social services: To support the ageing population, the Australian government is investing in healthcare and social services. Initiatives such as the National Disability Insurance Scheme (NDIS) and aged care reforms aim to improve the quality of life for older Australian. There are plenty of issues we can see with the NDIS but the sentiment behind it is a positive one. In our opinion the NDIS is in need of meaningful reform Enhancing workforce participation: The government is encouraging greater workforce participation among older individuals through policies that promote flexible work arrangements and lifelong learning. This approach aims to extend the working lives of older Australians and reduce the dependency ratio Source: ABS Statistics Demographic Impacts on ASX sectors Tabled below we have summarized some of the potential impacts across all ASX sectors Source: Chester Asset Management For those that prefer to visualize we have compiled some key graphs below Australia’s demographics are set to lead to a ‘death boom’ Recent ABS Data suggests the growth in spending per capita is growing at a faster rate the older we are. Is this indicating a structural tailwind as we age? Source: Property Update, ABS Data Asian demand for seaborne metallurgical coal appears to be increasing, driven by India Source: Wood Mackenzie / Whitehaven Coal Presentation August 2023 While Chinese steel production appears to be peaking. Source: Chester Asset Management, Bloomberg Does 16% of the world’s population still need to produce 53% of the world’s steel? Particularly if their population is declining and there is an oversupply of houses! (~1/3 of Chinese steel demand is driven from housing). Meanwhile medical spending increases rapidly with age Source: Peter G Peterson Foundation Retirement villages in Australia have a double tailwind from the ageing population and underpenetrated market. Source: The Weekly Source Closing Although each portfolio holding has idiosyncratic merit underpinning it (a combination of quality, value and insight), demographics can be partly responsible for some of our positioning below. Healthcare (overweight) – CSL, RMD, TLX Agribusiness (increased protein intake and need for yield) – RIC, NUF Energy and Energy infrastructure – AZJ, AGL Real Estate (retirement living) – EGH Materials (Iron Ore underweight) – limited exposure ex MIN You're still here? It's over. Go home. Go. [1] (VIEW LINK) [2]   (VIEW LINK) [3] (VIEW LINK) [4]   (VIEW LINK)

  • The role of equities in your superannuation portfolio

    Capital protection plus capital growth are the twin goals many of us have for our super. Here's how an actively managed share fund can achieve both. Equities have a lot to offer as an investment to grow retirement savings. Long term capital growth plus ongoing dividend income is a combination that makes shares a favourite among self-managed super funds (SMSFs) and retail investors. Fortunately, there are several ways to gain exposure to shares. Options include holding shares directly, investing via an exchange traded fund (ETF) or by purchasing units in an unlisted actively managed fund. These choices are not mutually exclusive. Investors can opt for a combination of all three. However, an actively managed fund can offer important advantages. Active management calls for discipline - and plenty of research Research shows that retail investors often mistime their entry into and out of share markets. Volatility can be a major factor here. Investors tend to buy when markets are booming (and share values are high), and bail out when markets dip and values fall. ETFs can help investors avoid this issue. The downside is that most ETFs are index funds that simply mirror the market. This keeps fund fees low though it comes at the cost of returns that match the market at best, rather than outpace it. An actively managed share fund brings an additional factor to the table - discipline. Investment guru Warren Buffett is credited with saying investors should be fearful when others are greedy, and be greedy when others are fearful. In other words, the winning strategy is to buy when markets are down, and sell when prices are high. It is the discipline to stick with this approach that allows experienced, active fund managers to deliver above-market returns. The Chester High Conviction Fund is a great example of this outperformance. As the table below shows, over the long term Australian shares have delivered average annual returns of about 8% though returns can be far more volatile over the short term. The Chester High Conviction Fund has far-outpaced the market, achieving returns after fees of averaging around 14% annually. When it comes to saving for retirement, this 6% outperformance can make a tremendous difference to an investor's wealth by the time they are ready to hang up their work boots. Investing in transformative companies How is the Chester High Conviction Fund able to deliver higher returns than, say, ETFs? The answer is simple. Unlike most ETFs, which track a given benchmark, we do not hold stocks that make up the benchmark. Let me explain. The Aussie share market, and market indices, are dominated by a few big names. Our biggest listed companies may be favourites among direct retail investors, but their sheer scale makes it hard for these corporates to generate returns above 7% annually. As a fund manager for over 20 years, experience has taught me that to consistently achieve returns in the low teens, a portfolio needs to concentrate on smaller and medium-sized listed companies - what we call the small- and mid-caps. These are the companies with the agility to transform as our economy transforms. It calls for a long term focus, but this matches the investment horizon for superannuation savings. The upshot is that the Chester High Conviction Fund looks for the high performers among the small- and mid-caps within the S&P/ASX 300 Accumulation Index. Finding those unloved, underappreciated or undiscovered stocks calls for plenty of research: It's not called a 'high conviction' fund for nothing. But the fund isn't just about high returns. Clever strategies to grow and protect capital The Chester High Conviction Fund has a mandate to grow and protect investors' capital. These are exactly the twin goals that so many of us look for in our superannuation portfolio. And we achieve them through a clever strategy. Around 6-8% of the fund's portfolio is invested in cash and gold. Holding cash allows the fund to buy attractively-priced stocks when they become available. That's the growth component. The appeal of gold is that it has very low correlation to other asset classes. Price movements are relatively independent. In this way, gold can reduce overall volatility and provide the element of capital protection. A fund that lives up to its promise The Chester High Conviction Fund team has worked together for over a decade. Our combined expertise really shows up in the fund returns. For investors who are looking to grow generational wealth while preserving capital, the fund lives up to its promise. It can make a valuable difference to the value of your nest egg when you're ready to exit the workforce.

  • A day in the life of an equity fund manager

    What does the world of investment management really involve? Here is how growing wealth and preserving capital drive our daily routine. One of the great aspects of investment management is that no two days are the same.  As an Australian equity fund manager, Chester Asset Management aims to find the high performers that can help our investors protect and grow wealth. As part of this goal, my day starts at sunrise. Australia's equity market is closely tied to US markets. So, I begin each morning checking what has happened overnight in the US, and making sense of the 'why' behind market movements such as changes to interest rates. After a quick breakfast with the family, I like to run or ride to work. I'm at my desk by 8.30 am, and the next two hours are usually taken up analysing the daily news flow. This can include announcements from the Aussie stock exchange, media releases about new products from individual companies, and quarterly production updates. This early activity gives me - and my team of analysts - a framework on which to base investment decisions. The Chester High Conviction Fund, which was awarded Money magazine's Best Australian Shares Fund in both 2023 and 2024, has achieved average after-fee returns of 14.4% annually over the past 10 years.  Those sorts of returns don't happen by chance. Careful research plays a critical role. Afternoons spent with company leaders By the time midday rolls around, I generally only have time for a snack at my desk. That's because the afternoons are especially busy. This is the time our investment team spends speaking with fund investors, working on our quarterly fund updates, and meeting with company leaders. As a fund manager, being able to meet and talk with company executives directly gives us an advantage that retail investors don't share. On a typical day, my team and I engage with anywhere from three to eight companies. That's more than 1000 listed companies each year. These close encounters are absolutely instrumental to developing a sense of how a company is tracking. As a fund manager with a team of career investment specialists, we look for companies that are under-loved or under-appreciated by the market, yet have plenty of upside. Meeting with company executives can be particularly revealing on this score. It's about being able to read body language, and pick up subtleties that can shine a revealing light on a company's fortunes and future prospects. The remainder of my afternoon is often spent on further research, addressing issues that are not time-sensitive. Our team of five analysts typically review the various opportunities facing the 35 or so stocks in the fund's portfolio. But we have a watchlist of over 50 listed companies that we research on a daily basis. The aim of all this analysis is to minimise downside surprises while maximising the upside of investment opportunities. This is part of how Chester Asset Management approaches investing. Our goal of protecting and growing our investors' wealth makes it essential that we recognise the downsides of an investment, while being confident the upsides are skewed in our favour. Achieving the best results for investors As the fund manager, the buck stops with me. It's a significant responsibility, though, after 20 years in the role, I know when it's appropriate to back the stock selection suggested by my analysts - a team I have tremendous faith in. I guess one of the unique aspects of my job is that I personally know a lot of our unitholders. I also have my own money invested in the fund. It's a powerful reminder of the importance of the decisions I make. So, while the focus of my day is driven by our mandate to protect and grow wealth, we stick to disciplined processes. We know these will deliver the best long-term results for our investors. My day doesn't end when I leave the office. Last thing each evening, I check the news feed from home. Stock markets are impacted by a vast array of factors, and a single piece of information could make a difference to the returns that Chester Asset Management delivers to investors. And I am always mindful that our unitholders have put their trust in me and my team, to help them achieve their personal goals.

  • Notice to investors: Changes to your investment administration

    This article contains important information regarding your investment. As previously communicated by email, as a Responsible Entity of your investments, Copia Investment Partners (Copia) employs a panel of service providers that help facilitate the reporting for your investments with us. On 18th December 2023 ("the transition date"), Copia will be changing one of its service providers that manages the client administration and registration from Iress Managed Funds Administration (MFA) to Boardroom. This follows an extensive review by Copia to determine which provider is best able to deliver client services that is among industry best practice. As a result of this review, we have chosen BoardRoom who have a 30-year track record in managing client administration and registry services. Benefits for you: The new service will provide the following benefits: The ability to make new and additional investments online A portfolio view your investments in one central location ("InvestorServe") The ability to view and manage personal information including contact details, banking information and tax file number online Access to online statements and distribution advice Access to information on holdings including distribution details, tax and trust financial information being stored in a secure portal for future access at any time. What will change? Change to your account number Change to bank details for applications Change to email address for submitting forms Change to investor portal Investor account number Your new Boardroom investor account number will be referred to as a “unit number”.  The unit number will be in the following format: U10 + Existing Account Number. For example, if your existing account number is 10023457, your new unit number will be U1010023457. Bank details for applications From 2pm on Friday 15th December 2023, Copia’s bank details for receiving application monies will be as follows: Account Name: Boardroom Pty Ltd ITF COPIA Funds - Application A/CBSB: 332-027Account Number: 556-074-208 Email address for submitting forms From 2pm on Friday, 15th December 2023, the following email address should be used to return completed forms for processing (e.g. Application Forms, Withdrawal Forms, Change of Details Forms): Accessing your investment via the investor portal The new investor portal will be called “InvestorServe”. Instructions on how to access InvestorServe will be communicated to you by email. If you have any questions, please don’t hesitate to contact our Client Services Team: 9am to 5pm Melbourne business days ​ P  1800 442 129 (free call within Australia) P  +61 3 9602 3199 E

  • Winner: Money magazine's Best of the Best | Best Australian Shares Fund 2024

    Chester Asset Management are thrilled to announce that the Chester High Conviction Fund has been recognised as Money magazine’s Best Australian Shares Fund 2024, marking its second consecutive win after also securing the award in 2023. We were delighted to attend the lunch in Sydney alongside representatives from Copia Investment Partners. How the winner is chosen: "Rainmaker, publisher of Money, has been reviewing superannuation, managed funds and their investment managers for more than 20 years. To conduct the banking products assessments Rainmaker and Money teamed up with InfoChoice, one of Australia's leading financial product comparison websites. When choosing which managed funds or exchange traded products (ETP) to invest with, investors are looking not just for funds that scored the highest investment returns but also managed their investment risks. This includes an assessment of which managed funds most protect your capital." More information: About the Chester High Conviction Fund Contact us Best of the Best Awards

  • Making Sense of the Macro & Commodity Bull Market Thesis with Anthony Kavanagh

    Chester Asset Management Co-founder and Portfolio Manager Anthony Kavanagh had the great opportunity to sit down with Jonas Dorling from Money of Mine. The conversation covered all things Chester, how the portfolio is built, the role commodities play as well as all things macro, from China to India to Australia. Click here to subscribe to the monthly report for updates on the current market outlook, Chester's performance and more.

  • Lonsec Symposium | Passive vs Active: Which is right for the environment?

    We were pleased to be part of a panel discussion at the Lonsec 2023 Symposium, focusing on the merits of active and passive investing. The session was hosted by Brook Sweeney from Lonsec, with Rob Tucker from Chester Asset Management on the active side, and Cameron Gleeson from Betashares on the passive and smart beta side. We hope the session was informative for the audience and thank Sara Rawis and the Lonsec team for hosting a great event. Rob highlighted the challenges index strategies have in terms of the allocation to the most expensive stocks and lack of adequate industry diversification when it comes to the ASX, while also discussing the advantage of active management in terms of fundamental analysis that will support the potential for outperformance in the future. This is a key focus for the investment team managing the Chester High Conviction Fund, distributed by Copia Investment Partners.

  • Can you trust the Weatherman?

    Meteorologist. The only job where you can be wrong every day and still keep your job. — Willard Scott Meteorologists or weather people are inherently not trusted. They are extremely public figures that people rely on to make decisions every day about how the coming day/ week will prevail. It can be a tough gig. However similar to the analogy of weather people, as fund managers sometimes it can be challenging getting caught in the day to day weather patterns of the market. It is always best to zoom out and take a longer term view. Hence we took note last month when the Bureau of Meteorology (not sure if we’re still allowed to call it the BOM) officially declared La Niña over with Australia (and the world) now on watch for El Niño conditions. This could be a material longer term change. First of all, what is a La Niña and El Niño? The layman’s view is that El Niño and La Niña are opposite phases of a naturally occurring global climate cycle that effects weather patterns and hence climate globally. El Niño happens when the Pacific Ocean heats to a temperature higher than normal which can cause variability in rain patterns generally meaning drier conditions (although not guaranteed in all locations). La Niña on the other hand refers to the Pacific Ocean getting cooler than normal, almost causing the opposite effects, i.e., more rain and flooding in some areas. In Australia specifically El Niño has seen warmer conditions across the country including drier conditions in the east and in southern Australia, increasing the risk of bushfires and droughts and reduced rainfall up north. La Niña in Australia has generally been associated with cooler temperatures across most of the country and wetter conditions across northern and eastern Australia, think the recent Queensland floods. If you are asking yourself where’d my 40 degree summer’s go? The answer is we have seen 3 La Niña years in a row, only the fourth time this has occurred since 1900. 2022 was also regarded as the wettest year for Sydney on record. In North America El Niños are usually associated with wet and stormy conditions in southern states of the US but warmer and drier conditions in the northern part of the country. La Niña however generally sees drier and warmer conditions in the south and wetter and more cooler conditions in the north. Hurricanes across the Atlantic are also a key feature of La Niña periods. Although there is some debate whether we were truly in La Niña/ El Niño for some of these years the general pattern for the past 40 years is presented in the graph below with blue indicating La Niña and red indicating El Niño periods. Source: (VIEW LINK) Specifically for the past 15 years the following patterns have been observed: La Niña 2020 to 2022 El Niño 2018 to 2019 La Niña 2016 to 2018 El Niño 2014 to 2016 La Niña 2010 to 2012 El Niño 2009 to 2010 La Niña 2007 to 2009 Apart from deciding whether to continue carrying around an umbrella why is this an important observation and can it impact earnings and hence stock returns? We have summarised some company impacts below. Insurance We start with what we see as the most obvious beneficiary of an end to La Niña in insurers. Insurance Broker and Risk consultant Aon in partnership with Climalab recently presented a report titled Say Goodbye to the Big Wet and Excessive Losses. Within the report was the following graph showing insured disaster losses across Australia for the past 50 years. It simplistically shows La Niña = higher weather losses vs El Niño periods. Source: Aon Report, Say Goodbye to the Big Wet and Excessive Losses The recent La Niña period has led to consecutive years of flooding across the east of Australia. Aon specifically argues that “all previous triple dip La Niña’s have been a precursor to a flip in the Pacific Decadal Variability (PDV). I.e., a switch to an El Niño dominated period that has “persisted for at least a decade”. We consider the past 10 years of data across the insurers and note that although there have been recent periods that are classified as neutral or El Niño years, the dominant conditions have been that of La Niña. QBE QBE differs to Suncorp (SUN) and IAG Australia (IAG) in that it is a truly global insurance company with approximately only 25% of premiums written in the Australia Pacific region and the rest of the business split fairly evenly between North America and the rest of the world (International). Since 2017 QBE has been positioning for growth and turning around underperforming businesses. This has been somewhat accelerated by the commencement of CEO Andrew Horton in September 2021. One of the measures to improve returns and reduce volatility has been to raise the level of catastrophe (“Cat”) provisioning from USD685m in 2021, to USD962m in CY2022 and now USD1,175m. The provision vs claims of the past 10 years is presented in the graph below. Source: QBE CY2022 Results Presentation We have tabled this below to demonstrate the variability in claims across El Niño and La Niña years and what that might mean for overall claims going forward. Source: Chester Asset Management with data from QBE Annual Results reports As is evident in the table above La Niña has brought with it material damage from weather events. The 3 years most significantly impacted being 2017, 2021 and 2022. 2017 included damages from the impacts of Hurricanes Harvey, Irma Maria, as well as California Wildfires 2021 included Winter Storm Uri and Hurricane Ida 2022 included Hurricane Ian and the French storms The table above suggests to us potential for a catastrophe claims beat should ‘normal’ (if there is such a thing) El Niño conditions prevail. SUNCORP AND IAG Suncorp (SUN), if their bank sale achieves ACCC approval, is set to become a pure play insurer. SUN has ~16% market share (28% motor and 22% home) across Australia with brands such as AAMI and GIO. IAG has traditionally been regarded as the premium insurance name in Australia with historically strong performance from brands such as NRMA, CGU, RACV (JV), SGIO, etc. and ~20% market share. Both IAG and SUN have been materially impacted by Cat claims in recent years from the severe flood events. SUN’s claims from FY2014 to FY2022 are evident in the graph below. Source: Suncorp Presentation, FY2022 For comparison to QBE, we have prepared a similar table however the results don’t highlight much difference in claims between El Niño and La Niña years for the Australian insurers since 2012. In FY2015 in particular (El Niño year) there were elevated claims associated with storm events in Brisbane (November 2014) and NSW (April 2015). We also believe that El Niño conditions bring with them increased risk of bushfires. Source: Chester Asset Management with data from IAG and SUN Annual Results reports As highlighted above the dominant weather pattern over the past 15 years has been La Niña and hence despite there not being obvious evidence in the table of variances between El Niño and La Niña years, the work by Aon and Climalab supports reduced peril/ natural hazard claims for both insurers should we enter a period dominated by El Niño. Agribusiness Apart from Insurance, the Agribusiness subsector is the most impacted by weather conditions. We have tabled some of the potential impacts to select ASX Agribusiness names below. Source: Chester Asset Management, various sources In relation to Graincorp, East Coast Australia (ECA) production[1] is presented in the chart below. Source(s): Chester Asset Management, Graincorp, ABARES It is worth pointing out that the FY23 winter crop is currently forecast at 28.9Mt (vs 10 year average of 20.9Mt) and the ECA summer (sorghum) crop is estimated at 2.5Mt taking the total forecast to 31.4Mt. I.e., another strong year benefiting from La Niña rainfall. Should we enter a period of El Niño however the data suggests production materially below that of La Niña years. Construction and Development The FY2022 and now FY2023 rain and flooding events across eastern Australia has been extremely challenging for a host of industrials, namely construction and development companies. As noted above 2022 for Sydney was the wettest on record and the 2022 financial year saw almost 3 times the average rainfall of the previous 5 years. Source: Boral FY2022 Results Presentation Below for reference we have tabled the rainfall experienced in NSW in September for the past 10 years. We have used this as a guide to the degree of variability between El Niño and La Niña years. Source: Chester Asset Management, Bureau of Meteorology I.e., in the graph above La Niña years are ~30% above the 10 year average rainfall figure and El Niño years ~40% below. A sample of industrial companies we note that have recently been impacted by the weather are tabled below. Source: Chester Asset Management and various results material Mining and Utilities We have seen a host of miners impacted by wet weather in the past few months. Tabled below are a recent subset, on the east coast. These operators obviously stand to benefit from drier conditions. Source: Chester Asset Management, company results We also note that El Niño drier conditions are combated with increased energy (air-conditioner) use so an El Niño dominant period could lead to volume growth and electricity price benefits for the likes of AGL and Origin Energy. 2019, the last El Nino period in particular brought with it a spike in electricity prices with the March Quarter in Victoria averaging ~AUD200/MWh. Closing So, the question really comes down to can you trust the Weatherman? Because if you can, and we are set up for an El Niño dominated decade there could be some material benefactors within the insurance, industrial and mining sectors and conversely some areas of risk to be mindful of in Ag. Bring on long hot summers. [1] per the ABARES definition of Winter Crop + Sorghum crop relied upon by GNC

  • The tough choices awaiting Australian consumers in 2023

    Having lived through a period of over-consumption are we now facing a consumption hangover? As the dust settles on another festive season the mind very quickly moves to the year ahead. Any portfolio manager will tell you that one’s portfolio is never far from the front of their mind. Even during this seasonally quieter period for company updates and broader news flow we at Chester approach 2023 with a healthy level of anxiety. As investors it is the sense of unease about the companies that we own that motivates us to continually review and test the assumptions that underpin our investments. A portfolio manager is forever seeking additional information that either strengthens or challenges the investment case they hold for companies. Arguably no segment of the market embodies this time of year like the retail sector. From Christmas gifts and family celebrations to new year festivities and back-to-school preparations, the importance of this period for retailers can’t be understated. As we await the annual barrage of updates over the coming weeks as companies and various industry participants offer their assessment of the all-important December-January trading period, there is no escaping the fact that 2023 offers a decidedly uncertain outlook for domestic retail. Did that really happen…? The level of disruption felt by retailers over the last three years is well understood. By necessity traditional spending patterns and behaviours went out the window as the impacts of lockdowns, store closures, travel restrictions, stimulus packages and global freight disruption all contributed to a retail environment no one could have anticipated. Personally, the reminders of this unprecedented period are all too many. From the constant emails of retailers purchased with during the pandemic to the frequent online grocery orders that continue to arrive and of course the far too many streaming services that continue to be paid for (but less frequently watched) there is no doubt consumers and retailers alike adapted to the conditions. Highlighted below (Chart 1) and notable for the extreme volatility caused by the changing Government rules through the period, the net result is that Australians spent at a very healthy rate in recent years. Buoyed by historically low interest rates and the confidence gained from record house prices, together with restrictions on things like travel and entertainment, retail consumption grew well in excess of historic rates. The challenges faced by retailers sourcing enough product to keep up with the extreme demand also saw discounting materially reduced from historic levels resulting in the expansion of gross margins as consumers became less concerned about price and very focused on availability. (See Table 1) Chart 1. Source: ABS, Macquarie At a category level some of the ASX’s largest retailers were amongst the biggest beneficiaries from the strong consumption through the period. Viewing the below chart (Chart 2) it’s easy to see why the likes of JB Hi-Fi (JBH), Harvey Norman (HVN), Wesfarmers (WES), Metcash (MTS), Nick Scali (NCK) and Adairs (ADH) all saw their sales rise significantly through the period. Throw in the likes of Super Retail Group (SUL) with their key outdoor brands Rebel, Super Cheap Auto and BCF, plus the likes of Domino’s Pizza (DMP) and Collins Foods (CKF) whose customers valued the convenience of their fast-food offerings when dining options were restricted the list of ASX retailers to benefit from the changing consumer behaviour in recent years is quite extensive. Chart 2. Source: ABS, Macquarie Of course, achieving sales remains just one part of the equation for retailers and the ability to convert sales to profits and ultimately cash flow hasn’t been without its challenges. Across these measures the performance of domestic retailers has been decidedly mixed. The huge spikes in online demand during the pandemic challenged the supply chains and fulfilment capabilities of businesses like never before. Managing inventories has remained amongst the greatest challenges for retailers as extended delivery times from overseas suppliers has increased working capital requirements at a time when customer demand has remained highly volatile. Covid winners... Where are they now? The share prices of some of the earliest pandemic ‘Winners’ certainly highlights the challenges businesses have faced over the last couple of years (Chart 3). For the likes of (KGN), Redbubble (RBL), City Chic (CCX) and Adore Beauty (ABY) whose IPO was perfectly timed in October 2020, their online business models (with the exception of CCX who maintain some store presence in Australia) meant they were huge early beneficiaries of the consumer move to online shopping through the pandemic. Ultimately each has struggled to manage the costs associated with their rapid business growth as they’ve attempted to invest in stock and business infrastructure at a time when forecasting customer demand has been extremely difficult. In the case of KGN’s founder Ruslan Kogan’s predictions that having introduced millions of new shoppers to his site during the initial stages of the pandemic Australia would experience a permanent step-change in online shopping behaviour this hasn’t materialised. For KGN, this bet has been both expensive and painful as high supply chain costs have been absorbed as demand has slowed and excess inventory cleared at large discounts. Chart 3. Source: Bloomberg Returning to the outlook for 2023 there is no question that the conditions for domestic retailers are more challenging now. With inflation firmly embedded and central banks jolted to belatedly commence raising interest rates in 2022 household budgets will almost certainly be under more pressure. Cost of living pressures across key housing categories (including rents, food and utilities) and social services like healthcare and education look likely to remain elevated in the near term at least. For homeowners, much has already been made about the approaching fixed rate mortgage reset horizon and it remains hard to predict how households will prioritise their spending as interest repayments rise. Savings levels remain higher than historic levels but the extent to which consumers will be prepared to further reduce their savings to continue to spend on goods and lifestyle items remains to be seen. Highlighted below (Chart 4), of the approximately 35% (~$740 billion) of household mortgages that are currently being serviced at fixed rates about two thirds are due to expire in the next 12 months and well over 80% by the end of 2024. Whilst subject to change, currently a mortgage holder would be looking at a >3% increase on their interest repayment rates. This is clearly material. Chart 4. Source: RBA, Barrenjoey Combined with the outstanding balance of variable mortgages that have already seen significant re-pricing higher since the RBA commenced the current rate hiking cycle in May 2022 it’s clear home owners are going to be allocating more of their income to servicing mortgages in the periods ahead. The below chart (Chart 5) offers an estimate of the size of increases households will face in the next couple of years as the interest repayments on their mortgages and other personal credit lines rise. Chart 5. Source: ABS, Macrobond, UBS Naturally, equity investors have already attempted to factor in the more challenging outlook for consumer stocks. Reviewing the best and worst performed ASX sectors of the last 12 months below (Chart 6) it’s clear that expectations for stocks within the ‘Discretionary’ basket in particular have been lowered as the approaching headwinds have risen. Chart 6. Source: Bloomberg Amongst the best performed ASX retailers through the pandemic affected 2021 and 2022 financial years (shaded grey below) it’s clear that some level of reversion toward historic sales and margin trends is anticipated over the next couple of years. Perhaps the most reasonable conclusion to draw from the current consensus forecasts is that the Australian consumer is expected to prove pretty resilient over the next 18 months at least. To our mind, this possibility sits amongst the more optimistic scenarios that could unfold. Table 1. Source: Bloomberg (f = Consensus forecasts) What to expect in 2023? Speaking to numerous management teams across the ASX retail landscape pre-Christmas there was a relatively unanimous expectation that Australian consumers were keen to enjoy their Christmas’ and spending was therefore likely to remain pretty healthy over the holiday period. While suggesting there were some signs shoppers were becoming a little more reluctant to transact without deeper discounts through the November ‘cyber’ sales period for the most part executives we spoke to remained cautiously optimistic. Beyond the Christmas/new year period however, most management teams recognised the likelihood that some collective ‘belt-tightening’ was probable in 2023 as the challenges highlighted earlier materialise. The scene is therefore set for potential positive earnings surprises in February if as expected consumers continued to spend throughout 2022 and profit margins remained resilient. Recognising that this appears the consensus view we’d expect the market will be more focused on the outlook with the key areas of focus likely to include: Initial sales performance in the new year, inventory levels and associated working capital and cash flow performance and finally gross margin trends and discounting behaviour. Beyond near-term trading expectations much of our recent discussions with listed retailers has centred around the extent to which the recent disruption to the sector is likely to prove permanent and how this stands to benefit or challenge their businesses. Hardly surprising, most management teams were naturally optimistic that they would emerge from the last few years in a better competitive position. The working from home movement remains topical and not surprisingly the likes of JBH, HVN and BRG are optimistic that the persistence of this trend should be an additional tailwind for their businesses as consumers continue to invest and upgrade their home offices. The belief that the pandemic only further consolidated technology as a central component of one’s lifestyle is hardly surprising. A slightly more off-centre take on the potential tailwinds more working from home would deliver a business was offered by Premier Investments (PMV) chairman Solly Lew in 2022 when he suggested people (himself included) are spending more and more time at home in their pyjamas. Recent results from the group’s best performing brand Peter Alexander suggest he may well be right. Retailers such as SUL and KMD Brands (formerly Kathmandu) whose stable of brands includes Rip Curl, are optimistic that the pandemic has supported a shift in lifestyle priorities that will see people continue to favour more time outdoors beyond the major cities, a potentially favourable trend for these companies. The importance of digital engagement with customers and the role of online in the overall retail experience will continue to remain very topical for the sector. For the many ASX retailers that maintain large store networks across Australia their performance over the last couple of years has largely supported their conviction in the ‘omni-channel’ retail model that offers customers maximum flexibility about how they buy from them. With recent feedback suggesting major shopping centres saw foot traffic very close to the levels experienced pre-pandemic it seems likely that predictions the pandemic would rapidly accelerate the demise of bricks and mortar retailing were misguided. The below chart (Chart 7) highlights that entering 2023 online purchases as a percentage of total retail sales has more or less returned to its recent growth trajectory. Chart 7. Source: ABS, Macquarie Amongst a number of ‘omni-retailers’ it has been noted that a positive outcome from consumers increasingly using technology to research and compare products online is that stores have become more productive in recent times. That is, shoppers are increasingly arriving at stores ready to spend because their “browsing” has already occurred online. Together with more favourable lease terms achieved through the pandemic by several retailers these factors should offer some offset to potentially more challenging retail conditions ahead. The experiences of the major supermarkets over the last couple of years sets the scene for an interesting period ahead. Despite the sales benefits enjoyed by each of Woolworths (WOW) and Coles (COL) throughout the pandemic the challenges of servicing significantly higher rates of online ordering and managing national supply chains regularly disrupted by staffing challenges and volatile customer demand has seen profit margins come under pressure. Noting the different strategies and partnerships WOW and COL are employing to service online shoppers how the respective management groups balance their considerable investment across store networks, online and customer loyalty programs, and their supply chains will be closely watched. For MTS, as a wholesaler to the grocery sector (amongst others), while their model certainly offered it some protection from the cost challenges faced by the majors over the last couple of years it remains to be seen if it can retain the incremental market share gains it enjoyed as shoppers shopped more regularly at their community stores. A potentially more value conscious shopper over coming periods would certainly open the door for Aldi to recover the market share it ceded during the pandemic as it struggled with its international sourcing, especially for its popular general merchandise offers. The role of the online ‘Marketplace’ in the retail landscape is another keen area of focus for management teams. In an increasingly crowded segment of the market the acquisitions of Catch Group (by Wesfarmers in June 2019) and MyDeal by WOW last year suggest competition will likely remain strong at a time when online shopping trends have moderated materially from pandemic peaks (Chart 7). For WES, despite their scale and expertise as one of Australia’s leading retailers, the widening losses they are now incurring in the Catch business as they invest in key eCommerce functions such as fulfilment and customer acquisition/retention suggests further pain may lie ahead in a weakening consumer environment. Interestingly, feedback suggests Amazon’s growing scale in Australia appears to be largely coming from other online players including eBay and Kogan rather than traditional players with large store networks at this stage. So where do we sit? As always, the range of possibilities for both the Australian economy and listed equities in 2023 remains wide. How the RBA responds to a slowing economy and current inflationary challenges will certainly flow through to household confidence and consumer behaviour. For Chester, the unemployment rate looms as a key variable in 2023 and something that will be closely watched. Australia’s historically low current unemployment (Chart 8) offers some optimism that should Australia manage to avoid large scale job losses the Australian consumer may prove more resilient than has been witnessed in numerous offshore markets in the past 12 months as consumer behaviour has quickly adjusted to tougher economic conditions. This would appear to offer some upside to the current consensus thinking and is certainly something we remain cognisant of. Chart 8. Source: ABS, Goldman Sachs That said, there is little doubt Australians are facing some tough choices as to what they value most as household budgets are squeezed. Having lived through a period of over-consumption the very real possibility that we are now facing a consumption hangover can’t be ignored. While acknowledging some of the anticipated challenges faced by ASX retailers in 2023 is clearly factored into current share prices Chester begins 2023 with limited direct exposure to the consumer sectors. Amongst the ASX’s ‘Discretionary’ names in particular we remain cautious that margins will come under greater pressure than is being forecast. Expectations by some management teams that at least some of margin expansion achieved over the last couple of years can be retained in a tough economic environment seem dubious. Consistent with Chester’s investment process (see appendix) that has seen the fund allocate a relatively consistent part of the portfolio to stocks most exposed to the economic cycle (specifically; ‘Cyclicals’) we currently see better opportunities elsewhere. Whilst current portfolio positions such as The Lottery Corp (TLC), News Corp (NWS) and Brambles (BXB) are clearly exposed to not only domestic consumption, but offshore too, we remain optimistic of the resilience of these businesses and their cash flows in tougher economic conditions. Appendix:

  • Rob Tucker features on Inside The Rope podcast

    In the latest episode of the Inside the Rope podcast, Rob Tucker joins Koda Capital Adviser & Partner David Clark for an in-depth chat about the Chester High Conviction Fund, as well as Rob’s outlook on current markets. Click here to listen.

  • Return of the Developer

    “Ten years ago we were saying that the 15 to 20-year timeline was looking bleak. Now we’re saying, ‘Oh boy, in 5 to 10 years, things can get rough. Investment needs to increase and it needs to increase beyond what we were spending during the last boom in exploration” — Kevin Murphy SandP Global Commodity Insights Analyst, March 2022 Last month the world witnessed Lionel Messi lead Argentina to a famous World Cup victory in an air-conditioned stadium in the Qatari desert, midway through the European football season. If ever there was an endorsement that anything is possible with willpower and the right (government) support aka funding, it’s Qatar hosting the 2022 World Cup. The task seemed almost insurmountable when announced but Qatar was able to construct 7 stadiums over the course of 12 years with a reported price tag (for the entire event) of USD220bn, changing almost 100 years of football history in the process. Bill Shakly once famously quipped "football isn’t a matter of life and death... it is much more important than that". And as we sit here today, looking forward 12 years, Benchmark Minerals are estimating we need to construct over 380 lithium, nickel, cobalt and graphite mines (plus plenty more copper & rare earth mines, plus other infrastructure) to fuel the world's energy transition, requiring not billions but trillions of dollars, in an issue of similar importance to football. Refer below for a fantastic visual. Source: Benchmark Minerals Intelligence, for further info contact We don’t want to labour a point that has been well covered but it is obvious we are in a new era for mining as the energy transition theme moves from mainly a China story to a whole of world story. With this note we revisit a paper we wrote 2 years ago titled Return of the Explorer (“ROTE”) where we theorised the energy transition was one of multiple factors that could be leading to an upcycle in commodity exploration. We further expand on the premise we need more exploration with the statement we urgently need more development as the supply side of the equation is looking challenged. Notably the grey line, in the graph below isn’t a trend line but a separate data source. It shouldn't take a degree in data analytics to identify that exploration and development capex are highly symbiotic! Sources: Chester Asset Management, S&P Global Intelligence and GlobalData, refer section on Lycopodium for copy of GlobalData graph this data relates to. There are multiple ways to play this needed development boom and we explore this in five categories below. Exploration companies Single (and multi) mine development companies Development contractors Non energy transition commodities (sounds counterintuitive but we explain below) Production enhancing opportunities Exploration Companies (Update) In ROTE, after the drawdown in 2020 we theorised we were in the early innings of an exploration boom that could replicate previous upcycles. Under this premise we expected exploration companies such as Imdex (IMD) and ALS Limited (ALQ) to benefit with increased revenue (top-line beats) and operating leverage (margin beats). Although the path hasn’t necessarily been smooth for those names, that thesis has played out. However, 2 years into a cycle we thought might last for at least 4 years S&P are now calling for 2023 global exploration expenditure to decrease by 10-20% before recommencing its upward trajectory into 2024. Despite the weight of evidence that rapid development and exploration is needed[1], arguing with S&P’s latest analysis here might be somewhat futile[2]. The reasoning we are guessing is the US/global recession expected in 2023. That was the same explanation given to us by others when IMD and ALQ both experienced share price pullbacks in 1H CY22. We have hence included a graph of US GDP growth vs global exploration to investigate the relationship between the two. Note with only annual exploration figures we lack data points for a regression analysis but agree that the GFC and COVID did align with down years in exploration expenditure. However, the prolonged downcycle from 2013 to 2016 was in spite of a period of reasonable US GDP growth of ~2% so the relationship between exploration and GDP seems somewhat spurious. Source: Chester Asset Management with data from S&P Global Intelligence, Trading economics Outside of S&P, which we said we wouldn’t argue with, one of the more recent datapoints came with Major Drilling’s Q2 FY23 results[3]. While they acknowledged a “slight softening in activity from the junior miners” they further noted that “customer demand for CY23 looks to remain strong… (and) the growing supply shortfall in most mineral commodities continues to drive demand for … (Major’s) services”. Hence, we believe if S&P are accurate in their projection for CY2023 it would most likely be more evident in the second half. Digressing back to the football analogy with a quote from one of the game's most iconic leaders Ted Lasso "There's two buttons I never like to hit: that's panic and snooze". We feel that pausing exploration and development now would be like hitting the snooze button the day of a life changing meeting and it may require more than a few shots of strong coffee to recover from. Hence despite us finding S&P’s projection pessimistic we have aligned our global exploration model to this ~15% drop in CY23 to ~USD11bn before recovering to ~USD13bn in CY24 (CY22 levels). It is there the panic button may be hit and we expect the upcycle to continue and likely accelerate. For reference we demonstrate what this scenario, and recent trading might imply for IMD and ALQ below. IMDEX Below is IMD’s historical half year revenue, translated into USD, updated to 2H FY2022. Sources: Chester Asset Management, Imdex results announcements, S&P Global Intelligence In October 2022 IMD reported Q1 FY23 revenue of AUD106m representing growth on pcp of 22%, or 19% in constant currency. We assume that growth rate has continued into Q2 and IMD can deliver 1H revenue >AUD200m. Where revenue lands in 2H FY23 (1H CY23) is the million-dollar question but notably, per above there aren’t many instances of a negative 2H after growing double digit 1H or material drops (in AUD revenue) after double digit 1H growth (2H FY15 in USD the starkest). Furthermore IMD’s recent AGM announcements included comments that resource companies are maintaining or increasing their exploration budgets and that drilling contractors have “strong order books”, with most regions described as “strong” or steady”. This compares to the commentary accompanying the 1H FY16 results of a “Decrease in exploration expenditure in key markets”. Chester FY23 projections are presented below[4]. Source, Chester Asset Management, Imdex AGM announcement Assuming our number in 1H FY23 is close, it implies 2H consensus revenue of ~AUD170m which would represent a -17% half on half (h-o-h) decline. We project ~AUD190m revenue in the 2H and even feel that is somewhat inconsistent with AGM commentary. Hence see room for a revenue beat in FY23. We further assume with recent acquisitions and lower level of junior exposure vs market (15% vs 40%) ex Blast Dog IMD can maintain a market share slightly higher than our 2022 calculation[5] at 2.1%. This has recently proven[6] and could continue to prove too conservative an assumption due to acquisitions, mix or a range of other factors. Source: Chester Asset Management with data from S&P Global, IRESS and Imdex results announcements We have tried to reflect this USD revenue market share in projections out to FY25 noting the high degree of uncertainty in these projections. Source: Chester Asset Management To the base revenue scenario projections we further add Blast Dog revenue and show what they imply vs consensus below. Refer Blast Dog Example below for more details. Source(s): Chester Asset Management, IRESS Without being too cute with our projections, using the S&P scenario and assumed market share level we can see potential for a revenue beat in FY23, meet/miss in FY24 but a material beat in FY25, particularly if Blast Dog is successful. ALS As a refresher, exploration (‘Commodities’ division) currently only represents ~40% of ALS Limited (ALQ’s) revenue. At ALQ’s recent 1H FY23 result Commodities revenue grew at a very impressive 31%[7] with EBITDA margins expanding by 191bpts to 36.3%. It affirmed our belief of the operating leverage achievable in an upcycle. Not to take away from the strong result, it has notably been buoyed by junior miners representing ~40% of current volumes[8]. Sample volumes in Geochem were up 17% vs pcp, with organic revenue growth of 31.4%, I.e. price/mix benefit of ~14%, driven by growth in junior samples. Furthermore, Q2 sample growth slowed to 11%, following 22% in Q1. Although the market isn’t necessarily projecting growth to sustain, and ALQ appear to have picked up market share, the evolving softening in junior exploration is something to be mindful of. As has been recounted to us by industry participants there is still ample demand from intermediaries and majors as juniors slow so even if volumes are stable there may be a reversal of recent mix benefits. We have performed a similar exercise to IMD to project ALQ Commodities earnings. Based on this exercise we see potential for ALQ to exceed market expectations in FY23, however under the S&P’s 10-20% 2023 drop scenario, we believe it implies risk to FY24 before recovering to a reasonably in line FY25. Source: Chester Asset Management, ALQ results announcements Sources: Chester Asset Management, Various anonymous broker reports The Development = Alpha phase of a mining project Recently we have witnessed a host of ASX developers[9] undertake capital raisings prior to declaring commercial production. Justifications are aplenty including the need to “accelerate” and derisk developments. Hence it begs the question why invest in the ‘risky’ development phase of a project with the threat of overruns and dilutive equity raisings? The answer lies in the telling image below, essentially a Lassonde Curve[10]. Source: The Visual Capitalist What the image illustrates, is that there is actually a material derisking period during development for key mining projects that leads to share price outperformance. Bellevue Gold (BGL) a single, gold mine developer that is <12 months from production has provided an interesting backdrop to this with reference to 5 of the more successful recent single, gold mine developments. Source: BGL Macquarie Presentation, November 2022 We have tabled the key statistics of these companies below and expanded on the data to also include the share price performance of these companies 3 and 12 months post declaring production. Sources: Chester Asset Management, BGL presentation material, IRESS Conscious the BGL list represents a somewhat favourable sample, we have added to it, but focused exclusively on ASX names. Source: Chester Asset Management, BGL presentation material, IRESS As a demonstrative example rather than a complete universe this list only includes gold companies (we are supposed to be on holidays). However, we are conscious of biases inherent within this analysis including survivorship bias. We believe focusing on gold developments is worthwhile as a tried and tested commodity so reflective enough of the value add of developments. For context we have provided a sample of other ASX commodity developments below. Source: Chester Asset Management, BGL presentation material, IRESS Notwithstanding the biases it demonstrates to us a few interesting points: There is a genuine (alpha) opportunity to invest in companies within the development phase of a project For those select names in our sample that didn’t generate alpha the drawdown is actually quite small, even for companies that were later proven to be unsuccessful developments! The re-rate potential of development far exceeds that of production, I.e. on average there isn’t necessarily much benefit in holding these companies once into production (Lassonde Curve agrees with this) The return from this development phase can actually be greatest in riskier jurisdictions, i.e. WAF, ROX, EMR, TIE Hence we believe it worth considering factors that may make one company more successful in the development phase than another: Management development experience Contractors utilised and terms of contracting - fixed price, lump sum, etc. Development type - brownfields or greenfields? Balance sheet strength Portfolio diversification Flow sheet complexity Preparatory works including resource definition drilling and mine plan Pre-development NPV discount With increased prevalence of single mine companies and the outcome of the samples above it presents as a reminder not to ignore all companies entering the development phase of a mining cycle. Tabled at the end of this article are some of the development opportunities that exist on the ASX (mainly single mine but some multis). We have further highlighted some of the companies within our portfolio and on our watchlist we are watching more closely. In alphabetical order: ADT, AMI, BGL, CHN, COI, DEG, DVP, GMD, INR, JRV, LLL, NXG, PMT, STX/WGO. One thing we will highlight here though in relation to the lithium names is the re-emergence of direct shipping ore, also referred to as DSO. This was a feature of the last mini lithium boom of 2017/2018, when at the time MIN were the innovator shipping DSO from Wodgina accompanied by PLS shipping Pilgangoora DSO. This time around there is no shortage of companies lining up to espouse the merits of DSO. Given: the lengthy time to commercialization, the strong demand and the spare capacity available in China to process and concentrate lithium it makes complete sense that aspirants would want to access this early form of project funding. Core Lithium (CXO) were one of the first movers this boom, last month shipping 15k dmt of 1.4% DSO at a price of USD951/dmt CIF tendered via an auction that reportedly attracted 30 bidders. In addition to CXO; GL1, RDT, LLL and WIN are just some of the names we have heard from recently investigating the option of DSO. The discussion was also followed with the commentary in many cases “we see no reason lithium prices should soften in the near term”. Hence DSO remains an area we are cautiously watching as well as near term Chinese demand. Development Contractors As we pointed out in ROTE one way to play this kind of thematic is a pick and shovels approach. I.e., invest in companies leveraged to development. Tabled below are some of the key ASX names that fits this criteria. Sources: Chester Asset Management, various company announcements WORLEY PARSONS We have investigated Worley Parsons’ (WOR’s) past results for what a future boom might infer for earnings; however, it is challenging given WOR's heavy exposure to hydrocarbons which have largely seen declining development. The task is made even more complicated by multiple material acquisitions, segment reclassifications, corporate cost reclassifications, accounting changes and cost rationalization programs. Despite this we believe there is a level of operational leverage available as we enter into a boom period for sustainable developments. At the very least however WOR currently show that margins on sustainability work is undertaken at more favourable margins (35-40% higher[11]) than traditional work so theoretically benefits from mix shift as the book becomes more sustainability weighted. Source: WOR FY2022 Results Presentation There are arguments for and against the sustainability of sustainability margin premiums however we also believe there is opportunity for margin expansion (leverage) in traditional project work as demand ramps up to mitigate ‘lost’ Russian hydrocarbons. However, without making a call and assuming the margin differential is maintained and consensus revenue is reasonable[12] there is reason to expect an upward bias to market’s expectations for future margins as we show in the table below. Source: Chester Asset Management based on WOR data in FY2022 results presentation LYCOPODIUM We also completed analysis on Lycopodium’s (LYL) past results as a relative pure play in resource project developments. The graph below[13] represents a reasonable guide to global development capex and hence the environment in which LYL have operated in. If exploration does drop by 10-20% in 2023 we would expect a similar decline in development in 2023/2024 but outside of that, similar to exploration we would expect a reasonably swift recovery in development expenditure given the increasing urgency to satisfy transition demand. Based on the following graph Lycopodium has traditionally achieved 0.15-0.30% of the capex of the 20 leading miners 2010-2022, average ~0.25%. Sources: Chester Asset Management, Lycopodium historic results, GlobalData Sources: Chester Asset Management, Lycopodium historic results, GlobalData Although a small sample size the data suggests stronger margins during the upcycle of capex periods. As we demonstrated in ROTE this could provide opportunity for upside surprise on margins (as well as top-line surprise) in a development upcycle. Non-Energy Transition Commodities Capital is scarce and in a world of declining liquidity becoming scarcer. This is evident in the relative multiples the market is prepared to pay for non-energy transition (NET) commodities. The lack of capital being afforded to NET commodities has and will continue to create opportunities. At the extreme ends of the scale governments are now providing backing to select projects to assist in their development: Refer the loans program of the US Inflation reduction act (IRA) 2022[14] and the recent award of USD2.8bn in grants via the Infrastructure Bill to boost US production of EV batteries and associated minerals including up to USD220m to Syrah (SYR). Or closer to home the Australian Government's AUD1.05bn non-recourse loan to Illuka (ILU) to assist in the construction of the Eneabba Rare Earths refinery. On the alternate side of the ledger many banks including Australia’s Big 4 have ceased lending to coal miners and governments globally are imposing price caps on oil and gas, dislocating markets and stunting their development. Not covering any revelationary grounds we think this differential in costs of capital will continue to see an underinvestment in hydrocarbons and provide long term support for coal and oil and gas prices. We aren’t sure that is necessarily reflected in long term consensus oil price forecasts of USD65-70/bbl. We believe a similar phenomenon to the underinvestment in oil and gas may be occurring in precious metals, particularly the gold mining space where globally multiples have contracted, production has recently been declining, reserves depleting and grades reducing. Despite recent strength in the USD, the gold price is back around 2011 highs and yet gold miners are trading at multiples akin to trough periods like the GFC. This is despite unprecedented strength in gold miner balance sheets, record share buybacks and healthy dividends. We believe this could provide the backdrop for a strong period of gold performance and for gold miners to rerate. Sources: Chester Asset Management, Bloomberg Recovery Optimisation Given the imperative to extract more commodities than we have historically, beyond mine development there is also opportunity for resource recovery optimisation. 2 key areas that stand to benefit are: Recycling. Neometals (NMT) is the key name here we believe that stands to benefit from transition metal recycling but at this stage we are unsure of the business model they will eventually utilize. Sims Metal (SGM) may also benefit however we are unsure of their ultimate exposure to energy transition metals. Technology providers. There are a host of technologies eloquently referred to as ‘precision mining’ tools which have the benefit of extracting more metal with less waste. Forms of precision mining include but are not limited to: Ore sorting technology, Autonomous trucks (SVW), Novel assay services (C79), Orebody intelligence and mining optimisation (RUL, ORI, IMD, PRN), Blasting solutions (ORI, IMD). BLASTING SOLUTIONS - BLAST DOG (IMD) EXAMPLE For those uninitiated Blast Dog is a commodity agnostic, semi-autonomously deployed blast-hole sensing and measurement technology providing real time orebody knowledge for logging material properties and blast hole characteristics. It can facilitate improved blast designs and optimize explosive costs. It also enables IMD to enter the mining production space, providing revenue away from purely exploration, enhancing the visibility and reducing the cyclicality of future earnings. When we first invested in IMD in late 2019 part of our thesis was the material upside from new technologies: Corevibe, Xtracta, Maghammer and Blast Dog. Over the past 3 years the lack of progress with this new tech has disappointed with these technologies, ex Blast Dog now largely written off. On face value 3 of the 4 technologies ceasing would presumably mean the majority of future upside diminishing but the reality is[15] Blast Dog was by far the most material and accounted for ~2/3 of our upside assessment. In contrast recent Blast Dog progress has hence been pleasing and we found the latest AGM updates encouraging, in which IMD reported an acceleration of Blast Dog’s roll-out at Iron Bridge. Additionally, the fact there are now 6 commercial prototypes planned for FY23 (and multiple more opportunities in the pipeline) highlights momentum with the technology. Source: IMD FY2022 AGM Presentation, October 2022 Although yet to claim Blast Dog a guaranteed slam dunk, these updates arguably point to higher probability of commercial success and partial derisking of the success case in our valuation. Source(s): Chester Asset Management, Imdex announcements Closing Whether the projected dip in exploration expenditure eventuates in 2023, analysis is clear that the world is nearing an inflection point in the development of energy transition metals. We trust this has provided some insights into the opportunities available from this potential boom and hope despite S&P’s forecast, 2023 can be a year of development for us all and our football teams. Appendix – ASX Explorers / Resource Delineation and Development Plays Sources: Chester Asset Management, various company announcements [1] As S&P’s own analyst, Kevin Murphy per the introductory quote stated not less than 12 months prior [2] We do point out though that the gold price has rallied over 10% since S&P’s analysis which may be one reason to reconsider the expected decline [3] Quarter ending October 31 [4] FY22 Q3 and Q4 are estimates, Currency assumes ~spot for the remainder of the year [5] But we may be wrong on IMD revenue and global exploration spend here. [6] In 2020 and 2021 market share appears to have increased 20bpts and 10bpts respectively [7] In Constant Currency [8] vs IMD ~15% of volumes being from Juniors [9] BGL, JRV, MCR, RED, MCR, PNR, TUL, STA (April 2022) [10] Which is reused from ROTE [11] Based on measuring graphs in WOR FY2022 Results material, assumes graphs are to scale [12] To which we see upward bias [13] Which we have relied on for the data in the first graph but [14] (VIEW LINK) [15] from an investigation of TAM, customer proposition and potential price

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