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  • Quarterly State of Play

    Rob Tucker, Managing Director of Chester Asset Management, shares his thoughts on three key macro questions that help shape the Chester High Conviction Australian Equity strategy. What has been the main theme driving markets in the most recent quarter? Globally, the first quarter of 2022 was overshadowed by the Russian invasion of Ukraine. Perhaps the Russians underestimated the sense of tribalism of the Ukrainian people in defending their homeland. The world has significantly changed in the past 8 weeks, as this conflict has bought into sharp focus the delicate balance between economic trading partners and autocratic leaders with ulterior motives. The overreliance of Europe (Germany in particular) on Russian energy highlights the risks surrounding a lack of self sufficiency in primary production (both food security and commodity security). The lack of short term alternatives puts much of the European population at significant risk of fuel and heating shortages come winter. Australia as a significant exporter of both food and energy is blessed with an abundance of primary production. The lucky country. This enviable position cannot be underestimated over the next decade. What are the longer term implications of countries adopting greater self-sufficiency in their economies? This shift in thinking amongst global policy makers around self sufficiency (or localisation) has been talked about for the past 2-3 years, but has significantly accelerated over the past 6 weeks. Shifting semi conductor manufacturing out of Taiwan, localising defence spending, reducing reliance on crop protection ingredients sourced from China, to ensuring rare earths are sourced from western nations, this thematic has only just started. It will play out over the next 3-5 years as many of the decisions taken this year, will really only come into play by the middle of the decade. Our most significant takeaway from the tragic events in the Ukraine, outside the humanitarian crisis is that globalisation is very much a thing of the past. Companies and consumers will willingly be paying higher prices for the security of supply rather than the lowest cost of supply, which of course only plays into the notion that the 2020’s will incur higher inflation than the preceding decades. How real is the inflation threat and how is Australia positioned? Geopolitics aside, the current narrative around inflation is well and truly the biggest dilemma for policymakers. Cost inflation is rampant and a level of demand destruction is needed to reign in inflation expectations, so much so that market expectations for US interest rates have risen from 3-4 hikes in 2022, to 8-9 hikes this year. Adding balance sheet contraction (QT) to the mix suggests that financial conditions are tightening very quickly. Credit spreads need to be watched closely for broader financial market stress, but this is not apparent yet. While the bond market has reacted to the change in interest rate expectations, we are not so sure the equity market has. It appears to us the RBA has decided to let the upcoming Federal election play out over the next 6 weeks before changing monetary policy course, whereby interest rates will be going up. The key variable obviously becomes “for how long?”. With the prospect of financial conditions getting tighter in 2022, the focus will be very much led by stock specific earnings drivers, hence the most in demand stocks will be those that have earnings, dividends or cash flow tailwinds, valuation support or very strong pricing power. Outside commodity producing tailwinds, earnings strength looks far tougher from here, while Australia looks to be a wonderful place to allocate capital from a global perspective. DISCLAIMER: Past performance is not a reliable indicator of future performance. Positive returns, which the Chester High Conviction Fund (the Fund) is designed to provide, are different regarding risk and investment profile to index returns. This document is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific individual. As such, before acting on any information contained in this document, individuals should consider whether the information is suitable for their needs. This may involve seeking advice from a qualified financial adviser. Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia) is the issuer of the Chester High Conviction Fund. A current PDS is available from Copia located at Level 25, 360 Collins Street, Melbourne Vic 3000, by visiting or by calling 1800 442 129 (free call). A person should consider the PDS before deciding whether to acquire or continue to hold an interest in the Fund. Any opinions or recommendations contained in this document are subject to change without notice and Copia is under no obligation to update or keep any information contained in this document current

  • Have you got enough food in your bunker?

    The main facts in human life are five: birth, food, sleep, love and death, E M Forster It is one thing to run out of cars and have to wait a few extra months for your new Volvo but what happens if we run out of food? A sensationalist comment we agree and virtually unfathomable in the western world but a stark reality for billions of people globally. A recurring theme since the onset of COVID has been the robustness (and fragility) of global supply chains and with battle lines drawn there is a heightened focus on securing the world’s most strategic resources. The global dominance in semi-conductors is a well-documented motivation in China’s attempts to “unify” Taiwan but as Russian troops intensify their assault on Ukraine we and the rest of the world are asking what are Russia’s or namely Putin’s key motives? In the past few weeks, we have all seen some of the hard commodity exposures of Russia and Ukraine impacted by the current invasion. I.e., Russia produces: >10% of global oil at 11 mmbbl/d (7.8 of which is exported), ~22.5Tcf p.a. of gas (~40% of Europe’s needs), ~400Mtpa of coal (6th largest coal producer globally), 3.8Mtpa of aluminium (~6% of world production), 920ktpa of refined copper (~4% of world total), 193ktpa of refined nickel (~7% of global production), 40% of global palladium at 2.6Moz and about 90% of global neon production which is used for chip lithography. Less documented (initially at least) was the soft commodity exposures impacted by the conflict, but that has changed as wheat and corn prices have surged to record highs. Russia controls ~50Mtpa of key fertilisers: potash, phosphate and nitrogen; representing ~13% of global supply or ~25% of European supply. Combined Russia and Ukraine account for approximately 29% of global wheat exports, 20% of global corn and 80% of world sunflower exports. Prior to the conflict Ukraine supplied ~15% of global corn. It now feels very likely they will miss the key April/May planting season, putting a lot of that supply at risk. Truth is we don’t know the full extent of Putin’s motives however food security, even if not intentional, has taken on increasing significance as the conflict has ensued. By controlling Ukraine’s food supply, on top of Russia’s, and its strategic energy reserves places the Kremlin in an interesting negotiating position with the rest of Europe. Maybe pre-empting the conflict, in early February Russia announced an ammonium nitrate export ban, in order to “protect” domestic supply, putting a strain on the already tight global fertiliser market. This could significantly impact other growing regions (such as Brazil) who would be trying to increase supply to offset the loss of Ukrainian and (Russian) supply. These events are raw and it’s perhaps early to draw implications on their lasting significance, particularly for a novice on European politics such as myself, but it is abundantly clear that both companies and countries are having to rethink their global commodity and food supply chains, in addition to their defence budgets. As a reminder, at Chester, we are bottom up stock pickers, but we like to fish in pools with macro tailwinds. One of those pools we have historically gravitated to is agribusiness, or more specifically the theme of feeding the world. With the macro (omicron, inflation, interest rates and now geopolitics) increasingly challenging and our view food supply chains are becoming strategically more valuable we have found it interesting to find some opportunities in the space trading as genuine value stocks (< book and or low double digit multiples) exhibiting catalysts and blue-sky upside that any growth investor would find appealing. We present 3 examples of these below, within the overall food thematic but underpinned by strong sub-themes. Notably each of these businesses in the past 12 months have provided some form of medium-term guidance/aspirations which in an environment of truly unpredictable trading conditions support a view of potential asymmetric opportunity. Clearly execution is required to unlock the upside, and we may also be misinterpreting management statements, but trading below book value or on discounted multiples, success is certainly not being priced in. Land Productivity (reduced arable land) With a rising global population comes increased demand for food, we’ve all got to eat, but as population increases obviously there is an inverse relationship in the land available for cropping. Hence as a world we need increased land productivity and increased yields. The need for increased yields becomes even more apparent if Ukrainian production is removed from the market for an extended period of time. It comes as Yara cuts production in Europe from rising gas prices and is in conflict with many European (and global nations) trying to limit and even eradicate synthetic farm inputs. Potential exposures: Elders - ELD Incitec Pivot - IPL Nufarm – NUF (refer below) Nufarm Nufarm (NUF) is an Australian based chemical company that produces a large range of primarily off-patent crop protection products and has developed a diversified portfolio of seed technologies. Crop protection products include herbicides, phenoxies, fungicides and insecticides which are sold through the Asia Pacific (namely Australia), North America and Europe across over 3,300 registered products. In the past NUF has struggled with: a stretched balance sheet, tough weather conditions (Australian drought 2017-2019), glyphosate concerns, and a challenging European environment exacerbating the underperformance of acquisitions. However, the sale of Latin America to Sumitomo (Sep 19), strong Australia conditions (2021, 2022) and a potential environment where food security is prioritised over organic farming have potentially turned those headwinds into tailwinds. The momentum of their seed technologies business has also been evident from a range of announcements and management’s aspirational targets, discussed below. At the February 2022 Investor Day NUF highlighted they are actually exposed to 4 key global agribusiness trends, being: global nutrition, land productivity, sustainable agricultural practices and the rise of sustainable crops. We have listed NUF here as our preferred exposure to the theme of land productivity as it relates to their core business but the blue sky really sits within sustainable crops (Nuseed) which we have also discussed below. Insight Potentially a function of a good season and strong soft commodity prices, in February 2022 NUF announced Q1 FY2022 (December Quarter) revenue had grown 36%. Associated with this statement was vague guidance that NUF expects revenue and earnings growth in FY22 with the market now projecting 6% and 9% revenue and EBITDA growth. Consequently, we performed a review of NUF historic results as well as analysing competitor announcements for potential insights. Historic comparisons are somewhat challenging given changes to reporting periods for NUF and the divestment of LatAm but loosely the historic margins for NUF are tabled below and suggest outside of FY2020 a pretty steady gross margin between 26 and 30% and EBITDA margin between 11 and 13%. Source: NUF financial statements The 2 industry participants we could find that have reported December Quarter results were UPL Ltd and FMC Corporation. FMC Corporation had even issued a guidance statement for CY2022 of 7% revenue growth, 6% EBITDA growth which has somewhat assisted us in forming views around NUF’s potential FY22 earnings. Source: Chester Asset Management, NUF announcements, UPL Ltd and FMC announcements I.e., our projections are ~11% above consensus on revenue and ~7% above consensus on EBITDA but note that there are a wide range of possible outcomes in the current environment. Sustainable Crops Sustainable crops really plays into NUF’s Nuseeds business with the 2 key technologies being Carinata and Omega-3, in addition to core seeds (Sorghum, Sunflower and Canola). Both of these two technologies offer a sustainable cropping solution for a global challenge. By way of background Carinata is a biofuel feedstock grown between main crop rotations to help with the decarbonisation of the planet. It is effectively a sustainable alternative to inputs such as diesel and aviation fuel which in itself is a 57bn gallon annual market. Importantly it is a non GMO plant protein source. Nuseed’s Omega-3 Canola solution has been developed as the world’s first land based source of DHA essential ingredients, currently derived from fish oil. Hence this Omega 3 solution has the potential to relieve the pressure on our oceans and reduce the number of fish required to supply the world’s demands for Omega-3, believed to be in material deficit. The Omega-3 canola is processed into 2 oil ingredients: Aquaterra for aquafeed and Nutriterra for human nutrition. NUF estimates the market supports AUD850m EBITDA future market potential i.e., each 1% share of the deficit could be worth AUD8.5m EBITDA. The ‘aspirations’ of the Nuseeds business were recently defined at the investor day, to grow Nuseed revenues to AUD600-700m by 2026 and AUD1.5bn by 2030 at 25-30% margins. The targets for Omega-3 have been around for a while but adding Carinata into the portfolio mix is somewhat new and there are a few recent developments that we see providing validation to the commercial prospects of both technologies: Omega 3 – In addition to USDA and CAN regulatory approvals FDA has recognised Nutriterra as a safe new dietary ingredient. Commercial orders have commenced and NUF recently announced that AUD30m of sales orders had been achieved Carinata – Nuseed announced a long term commercial offtake and market agreement with none other than BP, providing funding and marketing for Carinata development Valuation We most recently re-entered NUF in October 2021 when the stock was trading at ~AUD4.50/share or ~80% of book value, which compares to our current DCF derived valuation of ~AUD6.40/share (WACC10%). There are 2 key points with our valuation that we point out a) It includes a heavily risked valuation for Nuseed, that we suspect will derisk over time b) We have discounted the whole business at the same cost of capital however we believe ultimately the Nuseed business deserves to trade at a higher multiple given the proprietary nature of technology and stronger growth potential than the core crop protection business. These 2 points are addressed in our alternative valuation scenario tabled below, based on management’s aspirational targets, (which are not guidance statements). They rely on execution, weather and the general range of other uncertainties that come with any projection. However, based on these aspirations, if NUF were to achieve these, under our assumptions there is material upside to the current share price and our risked valuation. Plant Based Protein We first wrote about this theme in 2019, with respect to Select Harvest, as Beyond Foods was coming to market (refer a different kind of protein). Today it continues to be one of the fastest growing areas within agribusiness. As of 2021 as many as 6% of US consumers classified themselves as vegan versus 1% in 2014 (1). Australian supermarkets also now offer more than 250 plant based meat products. Hence we think picking a particular brand in this trend may be challenging but taking a “pick and shovels approach” to the theme such as a nut producer or a B2B manufacturer could provide a less risky exposure. Potential exposures: GrainCorp - GNC Select Harvest – SHV (refer previous article) Synlait Milk - SM1 (refer below) Synlait Milk Background Synlait (SM1 ASX or SML NZX) is a dairy processing company located in Canterbury New Zealand that commenced life as a B2B operator, most famously as the original exclusive infant formula (IMF) manufacturer for A2 Milk (A2M). SM1 controls the supply chain with farmer relationships and processing facilities while also controlling the SAMR (China’s equivalent of the FDA) processing licences on behalf of its customers. Theses licenses are significant as customers such as A2M can’t sell Chinese label IMF into China without them and to highlight their strategic worth it’s important to note that no new SAMR manufacturing licences have been issued globally for the past 3 years. Over the recent past SM1 has purchased Dairyworks and Talbot Cheese to offer retail brands for the first time and diversify their product offering. SM1 now offers products across 4 key product lines: Ingredients (whole and skim milk powder and milk fat products), Nutritionals (predominantly infant formula and lactoferrin), Liquids (exciting opportunities in long life consumer packaged beverages and ready to feed infant formula) and Consumer Foods (manufacturing fresh milk, cheese, butter and yoghurt products) under their own or private label brands. As noted above SM1 has been the exclusive supplier of IMF for A2M in Australia, NZ and China with a contracted minimum 5 year term, while A2M has also cemented the long term arrangement with SM1 by holding a 19.9% stake in SM1. Plant Based Protein Insight: Over the past few years SM1 has been on a trajectory to diversify away from an overreliance on their key customer A2M, investing in a liquid’s facility, acquiring consumer goods businesses Talbot Cheese and Dairyworks and entering a relationship with an unnamed customer (2) to manufacture, blend and package nutrition products including plant based products at their site in Pokeno. This diversification strategy has been somewhat vindicated by the painful results of the past 2 years, exacerbated by volatility in A2M inventory management and planning. This led to a “Bull-Whip Effect” in FY21 of an unforeseen curtailment of A2M IMF production leading to unrecovered overheads and unoptimized production levels i.e., significant losses. In FY22 Management are anticipating a return to “robust profitability” from a horrible FY21 loss of NZD29m. Furthermore, SM1 has stated that “by the end of FY23, the recovery plan will have seen Synlait return to similar levels of profitability, operating cash flows, and debt ratios as the years leading into FY21”. Despite this optimistic statement SM1 seems to remain friendless. Famous last words but the worst appears behind SM1 particularly as commercial production of plant based protein for this unnamed customer ramps up later this year. The problem with this agreement however is that the customer and terms are a mystery so it has been a challenge for the market to properly recognise potential value from this agreement (SM1 clearly isn’t Nanosonics). We have looked at this agreement two ways: Commentary derived: An estimate based on the commentary around volumes and comparison of historical product margins; and ROCE approach: Profitability based on capital employed and SM1 generating an acceptable return on that capital commensurate with historic returns, targets and commentary These two approaches lead us to a guess that this customer could bring in anywhere from NZD30-60m of earnings to SM1 in FY24. It is further expected “volumes, markets and products associated with… (the) agreement will grow over time”. Source: Chester Asset Management For SM1 to be trading below book value the market is implying SM1 won’t be able to generate economic returns (> WACC) on capital employed, i.e., assets will remain underutilised. To this end we note the following comments from SM1 in anticipating high levels of utilisation from the Nutritionals business over the next 3 years, driven by: Some recovery in A2M’s IMF volumes; New volumes from SM1’s Pokeno customer; and Rebuild of SM1’s IMF business as demand emerges from large Chinese manufacturers whose market share growth exceeds their own manufacturing capacity The last point we find extremely interesting for a business that although has multiple customers has production so heavily dominated by A2M. One thing we have learned from years investing with an eye to China is that the Chinese Government follows through on its policies. Hence in 2019 when the government announced they would increase domestic IMF production from ~43% (2018) to 60%, we were cautious to share the market’s scepticism but even we have been surprised as to how quickly they now sit almost at that 60% target(3). Part of the reason for the market’s scepticism was the lack of local manufacturing capacity which obviously hasn’t hindered the progress but is now presenting potential challenges for Chinese producers, particularly if the birth rate goes the way of the Western world post COVID and stops declining! We see SM1 with its strong relationships (Bright, New Hope and other ingredients customers) as well placed (with available capacity) to potentially supply these Chinese customers. Was this image from 12 months ago a teaser to a long term B2B contract? Source: SM1 1H FY2021 Results Presentation Valuation Our assessed value of SM1 currently stands at AUD5.00/share DCF derived (WACC 10%). Chester projections imply 10x FY23 earnings, based on current share price (~AUD3.00/share). Notably net equity stood at NZD3.51/share at 31/7/21, based on net operating assets of NZD1,152m. I.e., SM1 is currently trading below book value. We see reason why SM1 can trade back towards a ~15x PE multiple as the organic cash flow de-gears the balance sheet and the market regains confidence in their diversified business. If we consider FY23 guidance as returning to a similar level of profitability as the years leading into FY21 we can develop a view as to what that might actually mean for value. Source: Chester Asset Management, IRESS I.e., if: a) SM1 is able to return to levels of profitability similar to pre FY21; b) the Pokeno customer is incremental to that profitability and c) SM1 Is able to fortify the longevity of that profitability by entering new LT customer contracts we see a case for SM1 to be valued materially higher. Pescatarian Diets This writer has for the past 12 months removed meat from their diet and experimented with pescatarianism with the encouragement from my wife. I.e., I have joined the ~3% of the population that have removed all meat from their diet bar seafood. This writer is acutely aware that living a sustainable existence would probably also extend to removing seafood from one’s diet but there are arguments that it is a more sustainable source of protein than protein derived from animal farming. Pescatarianism is also arguably seen as a healthier diet than one including meat. Potential exposures (in addition to plant based protein) Clean Seas – CSS Murray Cod - MCA Ridley – RIC (refer below) Seafarms Group – SFG Tassal - TGR Ridley Corporation Background Ridley Corporation (RIC) is Australia’s largest provider of animal nutrition solutions across both bulk stockfeeds and packaged feeds and ingredients across a wide range of monogastric, ruminant, aqua and other species. RIC operates an extensive supply chain throughout eastern and southern Australia with a total capacity of ~1.7Mtpa across 14 feedmills, two rendering sites a packaging site and a supplements facility. RIC also has a number of novel feed opportunities, of which Novacq is the most prominent. We have seen a marked improvement in the quality of RIC since 2019 that led to us making our investment in the company. In August 2019 Quentin Hildebrand was appointed CEO and MD with Mick McMahon being appointed Chairman the following year as part of a board refresh. We were familiar with Quentin and Mick as the ex COO and CEO of Inghams (ING) a company we had previously invested in. We regard Management and the board highly, sentiment echoed to us by industry contacts. When Quentin became MD of RIC it had a stretched balance sheet with net debt >AUD140m and leverage >2.5x (ND/EBITDA). Since then, however a marked improvement in working capital management and divestment of their recently constructed extrusion plant in Tasmania, Westbury has led to net debt at 31/12/21 of only AUD17m (0.2x) well below the 1-2x target. With the change of management in 2019 also came a new “Growth strategy” which management has executed on to optimise return on existing assets, achieve market growth and expand RIC's offering. Literally using a ruler to estimate the FY22 earnings we measured an AUD82m run rate in FY22 plus potentially an additional AUD9m in Project Boost earnings to flow from FY23 i.e., >AUD90m in FY23 vs ~AUD84m consensus. For 2 years this slide hasn’t really changed hence we believe Management has been extremely transparent and granular and we believe we have witnessed continued outperformance vs targets, a point we felt the market was underappreciating. We also noted over 12 months ago that the LTIs per RIC’s FY20 Remuneration report had an upper band ROFE target of >30% which we calculated would require >AUD80m earnings by FY2022, a number well north of consensus at the time. This along with our views on management execution has led us to hold an above consensus view on earnings. Pescatarian Insight Although we appreciate that RIC is a play on all forms of protein and we see the core business as underappreciated we are also attracted to the upside from their Novacq opportunity. Given the risks evident in investing in aquaculture (TGR and HUO have both almost gone bankrupt in the past) we see Novacq as a novel "picks and shovels" way to play the pescatarian thematic. By way of background Novacq is a microbial biomass ingredient produced from the use of a carbon waste stream. Novacq was originally developed by the CSIRO in the late 90s and since 2009 RIC has worked with the CSIRO to evaluate the commercial product of Novacq. Essentially it is helping prawns grow bigger (~30%), more sustainably (with less nitrogen discharge), faster and cheaper (with reduced wild fish products in their diets) and with an increased survival rate. Novacq is still early into its commercial life and its book value was notably written down to zero by management in 2020, but note it has in the past been a key pillar to the RIC story and still represents meaningful upside to the investment case. Despite the FY2020 impairment, in FY2021 RIC tripled production of Novacq from their Thailand site at Chanthaburi and have the business on a pathway to break-even in FY22, after delivering an ~AUD2m loss in the 1H. Notably all 15 Australian prawn customers of RIC have Novacq included in their diet which we see as very strong validation for the product. Although it is suggested Novacq could be used in diets of species beyond prawns, RIC has previously estimated the total feed market for prawns/shrimp in excess of 6Mt (4) which we now estimate may have grown closer to 8.4Mtpa now, with Ridley licenced in all regions bar China and Vietnam (3rd Party Licenced) to sell the product. This represents ~half of global supply requirements. It is our belief RIC aren’t targeting the whole of this market but rather the early stage lifecycle for prawns, equivalent to maybe 1/6 of the market so ~700ktpa TAM. It is our understanding the Chanthaburi facility in Thailand has current capacity of 30ktpa of Novacq output which could potentially produce 100ktpa of feed at expected Novacq inclusion rates. The facility was originally envisioned to be expandable to 140kt of capacity or 467kt of finished feed capacity (4). We see it likely RIC partner with 3rd parties to assist in the global penetration of Novacq rather than go it alone. Valuation At the time of our initial investment in RIC it was trading at ~15x P/E and since that time has delivered: An improved balance sheet and cash flow conversion, through improved working capital, profitability and the divestment of Westbury; Growth through strong execution of the 3 year strategy; Further opportunities for growth including project boost; and Commercial sales of Novacq demonstrating customer acceptance of the product. Hence, despite ~30% increase since our initial entry RIC has actually de-rated to ~14x. Our assessed value of RIC currently stands at ~AUD2.40/share and is based on a DCF of the core business (~AUD2.30/share) plus nominal upside for Novacq. We could go into detail around our core valuation but thought it more interesting to present a potential upside scenario for Novacq. Unlike SM1’s plant based protein customer and NUF’s Nuseeds business we don’t have commentary with which to base our valuation assessment on however we have trawled through historic releases and formed our own guesstimates to arrive at what we deem a plausible scenario. Given the highly subjective nature of this however we risk it heavily. Source: Chester Asset Management, IRESS, Various RIC announcements We further note that although we see this as meaningful blue sky for RIC we are attracted to the valuation appeal of the core business alone and did/ do not see Novacq as a core part of the investment thesis but an area of prospective future upside. Closing In these unprecedented times we spare a thought for those genuinely struggling without access to the liberties we are blessed with. We deeply appreciate the value there is in global food supply chains. (1) View link (2) We do know from announcements the customer is a “Global category leader in the Asia Pacific region for spray dried and consumer packaged nutritional powder products including plant based proteins. We believe the customer to be Nestle or Danone (3) View link (4) View link DISCLAIMER: Past performance is not a reliable indicator of future performance. Positive returns, which the Chester High Conviction Fund (the Fund) is designed to provide, are different regarding risk and investment profile to index returns. This document is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific individual. As such, before acting on any information contained in this document, individuals should consider whether the information is suitable for their needs. This may involve seeking advice from a qualified financial adviser. Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia) is the issuer of the Chester High Conviction Fund. A current PDS is available from Copia located at Level 25, 360 Collins Street, Melbourne Vic 3000, by visiting or by calling 1800 442 129 (free call). A person should consider the PDS before deciding whether to acquire or continue to hold an interest in the Fund. Any opinions or recommendations contained in this document are subject to change without notice and Copia is under no obligation to update or keep any information contained in this document current

  • Not a sequel but an Origin story

    A company trading at a discount to book value with tailwinds in key end markets: Is that something you might be interested in? In our last public note, we commented that we were going down the Marvel track with a couple of consecutive sequels. Weeks later we observed another Livewire contributor emulate one of our publication franchises and we thought, "Why not embrace the Marvel moniker?". So here is our Origin story. I was fortunate to commence a career in financial markets over 10 years ago(1) with an Adelaide based firm called Core Energy. It was there that I tuned my skills in financial modelling, report writing, business acumen and conference etiquette (2), advising clients on energy markets and energy companies. One of those companies was Origin Energy (ASX: ORG) – so I deeply appreciate how complex it can be to maintain a detailed model and live valuation of the company. Truth be told, it was the analysis of ORG that brought the founding Chester team together back in 2010. Over 10 years on, we were once again drawn to the company. For those who haven’t heard our pitch, at Chester, we are style agnostic investors that invest within a portfolio construction framework that includes "predictables," "cyclicals" and "defensives". Despite half of the business being a utility (predictable) and half an E&P company, we classify ORG as cyclical. For stocks that we define as cyclical, our dominant assessment lens is value (3). True value buyers love when the share price is below book value, but often that book value is stale and impairments see it eroded over time. Below we explain that ORG is in somewhat of a unique position in that literally all of its assets have recently been "marked to market", which has helped solidify our conviction around value. We formalised that view in mid-October 2021 by updating our internal ORG valuation and comparing it to that of the sell-side (the street) book value, and comparable market values (where appropriate). Since then, we have seen a transaction announced in APLNG (at above-market) and seen the street upgrade valuations. The summary of that comparison is tabled below with supporting notes on each of the key assets following. Valuation comparison Sources: Chester Asset management and various anonymous broker reports October 2021 APLNG In October 2021, ORG owned an effective 37.5% interest in the 9Mtpa APLNG CSG to LNG project in QLD. Our analysis at the time revealed limited variability between the street’s APLNG valuations, likely a consequence of management’s granularity around: forward costs expected production levels, break-even costs, etc. and the street using fairly consistent assumptions to value the asset(4). Additionally, APLNG was impaired in FY2020 so the book value approximately equalled ORG’s latest view of valuation then, however since that time(5): Oil prices have increased from around US$40/bbl to more than US$70/bbl, slightly offset by an increase in the AUD/USD foreign exchange rate (from 0.69 to over 0.70) APLNG has demonstrated improved well productivity, at Talinga and Orana in particular Project breakeven costs have improved (19% FY21 versus FY20) Obviously, numerous swing factors exist but we specifically note the following key negative and positive: Tri Star reversionary rights. Per 30/6/2021 relates to 20% of 2P reserves for which 45% would revert. ORG share of 2P = 4,252PJ, hence reversion relates to 850PJ (20% x 4,252PJ) of which 45% would potentially revert (340PJ). Within the Chester valuation, we have included a risked contingent liability of AUD340m (~AUD1/GJ) to account for some of this risk. Infrastructure monetisation. There are mixed reports as to the willingness of JV parties to entertain a sale and leaseback of APLNG infrastructure but there are transactions in the marketplace to support a potential value uplift. If we think about the EV of APLNG as ~AUD10.5bn and then accept our FY2021 EBITDA assessment of around $1.75 billion APLNG is effectively being valued at 6x EV/EBITDA. APA is on around 12x EV/EBITDA so we would think any deal would be around that mark (10-12x EBITDA). Gross PP&E in APLNG is around $31 billion(6) with more than 50% of that in the downstream. So, if we assume $15 billion of booked PP&E was ‘liberated’ the uplift could essentially be between $5 billion and $7 billion (ORG share 37.5% = AUD1,875m to AUD2,626). I.e. AUD1-1.50/share Sale of APLNG interest After our assessment, ORG announced the sale of a 10% APLNG stake to EIG for AUD2.12bn, taking ORG’s interest to 27.5%(7). On 9/12/2021 ORG announced ConocoPhillips had exercised their pre-emptive rights for the stake. A comparison of the sale price to our value assessment in October is tabled below. Source: Chester asset management and ORG announcement 25/10/2021 Some thoughts from the transaction: Valuation Premium. With a highly levered balance sheet and market ESG concerns, you could be forgiven for thinking that anywhere from 80-100% of NAV would be a good result for ORG. But the sale price was 6% above the street’s valuation of APLNG, 4.5% above Chester’s and 21.7% above book value. That is, it would add 25 cents a share (ignoring transaction costs) against the street or 81 cents a share to book value Upgrade. ORG had previously indicated more than $1 billion of cash flow from APLNG for FY2022 at 37.5%. That guidance is unchanged and by simple maths, if we assumed the cash flow was split evenly across the two halves, that implies guidance of around $1,200 million (at 37.5% for the full year). Reversionary rights. Anyone acquiring a stake in APLNG has to gain comfort with the position on Tri-Star’s reversionary rights. The premium to (street) NAV is a good sign, particularly given reversion is about to get tested in court EIG. EIG was previously a substantial shareholder in Senex Energy (ASX: SXY). The company has also been reported as underbidders on stakes in the QCLNG infrastructure sell down. We suspect the premium reflects some confidence of EIG to monetise assets via a sale and leaseback within the APLNG JV Optionality. ORG noted the capital injection provides flexibility to deliver returns to shareholders and pay down debt while allowing ORG to accelerate investment in growth opportunities. Is there an acquisition lined up? Pre-emption. Pre-emption provides us greater comfort that EIG’s offer wasn’t just a one-off bid from a cashed-up suitor but reflective of reasonable market value Beetaloo and Other E&P assets The bulk of ORG’s upstream assets were called Lattice Energy and were divested to Beach Energy (ASX: BPT) in 2017. The remaining assets, as evident in the table above are often overlooked by the market, except for perhaps ORG’s 77.5% interest in the Beetaloo project, which consists of potentially four stacked unconventional plays within 18,500 sqkms. To date 6.6Tcf of contingent resource has been booked related to just the Velkerri B (dry) shale gas play. ORG’s JV partner, Falcon Oil and Gas is actually listed so we can perform an implied valuation based on their market cap. Source: Chester Asset Management, IRESS and broker reports The market only really considers Beetaloo of what’s left partly because ORG wrote down it’s Poseidon asset(8) in 2017. But as Santos proved with Barossa those assets can have value in the right part of the cycle and Asian LNG prices have recently topped USD30/mmbtu. We add an addition AUD50m+ for Poseidon (+ ORG’s Canning basin interests) but note upside risk to this as we see Poseidon as potential Darwin LNG feed, reminding that ORG did pay Karoon USD600m in 2014 for its stake in the asset. The difference noted between us and the street’s/book value, for ORG’s E&P assets is ~AUD350m (~AUD0.20/share), again it’s not huge but it adds up. Octopus Energy For those unfamiliar with Octopus Energy, it is a UK based, global retailer of gas and electricity that specialises in renewable energy. The company operates an energy tech platform (Kraken) which is built around a scalable, cloud based architecture specifically for the energy sector. Kraken has been licensed to support over 25 million accounts worldwide (including ORG’s retail base) with plans to exceed 100 million accounts by 2027. ORG currently owns 20% of the business. We recently heard from Octopus Energy’s founder Greg Jackson and simplistically it sounds like Octopus (through Kraken) are taking existing energy markets from a ‘taxi-like’ state with fixed pricing and limited visibility for customers to an ‘uber-like’ model where the grid is becoming: more flexible, with customers able to access variable pricing; more distributed, with rooftop solar, storage batteries and other generation; and more transparent, allowing greater information flow of data. For the historians amongst us on an interesting side note, the founding company of the oil and gas sector, Standard Oil was often famously depicted as a sprawling, grasping octopus. We are unsure if Greg made the link when founding and naming the company but we appreciate the full circle nature of the symbolism. Per above we did note a variance in street valuations of ORG’s Octopus Energy interest, with some analysts completely ignoring it. We admit to finding this somewhat unusual given the recent transaction by Generation Investment Management (GIM) providing a ‘mark-to-market’ value for Octopus Energy to ~AUD5.5bn, meaning ORG’s stake is worth ~AUD1,100m, refer table below. The sample of us vs the sell side in October showed a difference of ~AUD500m in average valuations (AUD0.33/share), ~6% of the current share price. The difference to book is even more pronounced at ~AUD690m (AUD0.39/share). And just as we finish writing we are reading of Canada Pension Plan Investment Board taking a 6% stake in Octopus for USD300m, implying a further AUD0.15/share increase to ORG's stake per the GIM transaction. Source: Chester Asset Management and various announcements Although we don’t model Octopus separately we would imagine given: the current growth trajectory, material interest in the company and SaaS nature of Kraken the valuation could continue to grow. We have assumed an upside case of AUD500m beyond our base case valuation within the waterfall chart below. Source: Origin Energy FY2021 Results Presentation Energy Markets (EM) In the preceding paragraphs we have presented over AUD0.70/share of incremental mark to market value to the street’s (October) ORG valuations and over AUD1.30/share to book values, but the biggest swing factor in valuation is Energy Markets (EM). The market generally values EM using an earnings capitalisation approach (which ignores what point of the cycle we are in). We have observed some analysts realise the risk in doing this and progress to an average capitalisation of the next 3 years. This still potentially understates the true value of all components of the business, as it is capitalising the trough year of FY2022 (~AUD525m EBITDA at guidance midpoint) within the valuation, which compares with FY19 and FY20 EM EBITDA of AUD1,574m and AUD1,459m and earnings guidance in FY2023 of ~AUD725m. What we do know is that ORG impaired both the PP&E in generation and EM Goodwill during FY21 such that: Generation closing book value was AUD2,793m at 30/6/2021 EM Goodwill was written down to AUD3,812m at 30/6/2021. This was on top of net book value of remaining EM assets of AUD932m taking the written down non Generation assets to AUD4,744m (AUD932m + AUD3,812m). The total of these two (Generation + EM Other) is AUD7,537m(9) This is well above the average sell side valuation of the division, sampled at AUD6,209m i.e., AUD0.75/share (~15% of current share price). We have essentially tried to address this difference by performing 2 separate exercises: A valuation of EM’s subcomponents, with where possible reference to market transactions A detailed analysis of the earnings movements year to year (Earnings bridge) A warning that we may offend some detailed readers with this crude exercise by trying to simplify what can be relatively complex(10)/ opaque subsectors of EM. EM VALUATION EXERCISE Generation Source: Origin Energy FY2021 Annual Report As is evident in the list of generators, beyond Eraring, ORG’s fleet is predominantly OCGT and CCGT(11) assets. Valuation of these assets is complex as ORG provide limited details, but historically we have modelled each of these generators separately. One of the key challenges in performing any valuation is this peaking generation provides insurance against price spikes in the NEM to the cap of AUD15,000/MWh which can save the company millions of dollars but projecting when and the value of the cost of that insurance can be complex. Hence beyond our DCF we have considered book value (AUD2,793m), replacement cost and comparable market transactions as a valuation cross check. The most notable current (replacement cost) is the proposed, Federal Government backed Kurri Kurri, 660MW OCGT project which has a proposed price tag of AUD600m (AUD0.9m/MW). This price tag is actually below other quoted OCGT plants of ~AUD1.1m/MW and CCGT of AUD1.4m but notably is the most recent cost of a new plant we can find. Given ORG’s peaking fleet is quite aged we view the Smithfield transaction from May 2019 as a more reasonable comparison. This deal saw Infigen acquire the Smithfield OCGT plant 109MW for AUD60m (AUD0.55/MW). ORG's internal generation is 3,167MW, ex Eraring, which would equate to ~AUD1,740m at AUD0.55m/MW. This is reasonably in line with our valuation of ORG’s non Eraring Generation fleet. To that we need to add Eraring an valuation, which we derive by assuming AUD60/MWh NSW electricity price from FY2025 onwards, generating a margin of ~AUD10/MWh on ~12TWhpa which gets us to ~AUD400m for Eraring. Hence our generation valuation (~AUD2.1bn) is below ORG book value, with the upside to our valuation vs book value (AUD700m) captured in the waterfall graph below. As a side note, adding ~AUD5/MWh, i.e., assumed AUD65/MWh real long term in NSW increases our Eraring value by ~AUD400m so represents a key area of sensitivity in our valuation. Retail We model each of ORG’s electricity and gas businesses separately including cost to serve. For more detail on the earnings of the subcomponents refer ‘Earnings Review’ below. We do note that there has been increasing desire for service providers to bundle packages, to avoid regulation requirements and amortise the cost to serve across a greater denominator with both ORG and AGL offering white label broadband, and Telstra offering energy services and pay TV. Intervention by Governments makes it harder to earn super profits in the space but the question remains what is a reasonable profit and what does that mean for the valuation of retail assets? There are many inputs into our valuation but the key variable we employ is long term EBITDA margins of ~5%. To our valuation we have performed a cross check based on comparable market transactions for energy retailers. By way of reference lower quality retail customers have historically transacted at AUD400-500/customer(12) but stronger more attractive books have transacted at >AUD1,000/customer. ORG itself paid ~AUD1,300/customer for Integral and Country Energy back in 2010. In November 2021 Shell and ICG group paid AUD729m for Powershop’s 185k customers and energy infrastructure (~300MW renewable capacity). This would be a relevant comparable transaction but annoyingly we don’t have the split in value between the infrastructure and retail assets. If we make some general assumptions like ~AUD1.8/MW of renewable capacity implied by the Infigen takevoer, ICG could be paying ~AUD540m for the energy infrastructure and Shell could be paying AUD189m ~AUD1,000/customer for the retail book. In a cleaner comparison, in June 2021 Mercury acquired Trustpower’s retail business of 416k customers for NZD441m (~AUD1,000/customer). The drawback for this comparable however is that it is NZ, but NZ retailers do have similar profitability per customer as Australia. ORG had 3.855m gas and electricity customer accounts at 30/6/2021 (4.266m if we include LPG and Broadband). At AUD1,000/customer that equates to AUD3,855m, compared to our net retail valuation of ~AUD3.2bn I.e., Chester retail valuation (electricity + gas) equates to AUD830/customer. Hence we are comfortable with our retail valuation(s) and see upside (>AUD600m) if we were to assume valuation towards AUD1,000/customer. C&I including merchant electricity and gas operations C&I we rely on our DCF valuation but notably there isn’t much visibility to valuation. Further challenged since ERM power was acquired by Shell we have lost public visibility into margins available in C&I or ‘Business’. We assume longer term ~2% EBITDA margins in this part of the business plus the impact of existing books particularly the margin on the APLNG gas contract, refer to Gas GM in Earnings review below. LPG Origin supplies LPG and propane to residential and business customers across Australia and the Pacific. We value the LPG business as relatively steady, continuing to generate ~AUD90m p.a. On 7-8x EBITDA we see the LPG business being worth ~AUD600-700m which represents the core of our ‘Other’ valuation. Solar and Energy Services + Future Energy Within Solar and Energy Services ORG provides installation of batteries and solar systems to both business and residential customers as well as ongoing support. Plus, the supply of electricity and gas to apartment tenants through embedded networks and hot water. Future Energy is ORG’s business unit that focuses on developing and commercialising new technologies and products in a changing energy environment. Included within operations are ORG’s virtual power plant of connected services, 159MW from 79k at 30/6/2021 of which 56k were from the Spike program. We value the combination of these business at ~AUD300-400m EM – EARNINGS REVIEW If we assume 7-8x EBITDA as the appropriate multiple(13) under a capitalised earnings approach FY2024 earnings and beyond would need to increase AUD250-300m on FY23 to justify the ORG book value and Chester Valuation (AUD7,537 / 7.5 = ~AUD1,000m vs FY2023 guidance of ~AUD725m). Kraken is set to deliver a further AUD100-150m in operating cost savings (with the bulk of that in FY24) leaving a further AUD150-200m to be achieved. With the closure of coal plants like Liddel we could see a >AUD10/MWh increase in base NSW electricity prices(14) noting Victorian prices averaged ~AUD30/MWh higher following the 3 years post Hazelwood closure. This is as contentious an argument as monetary inflation and we have come across both electricity price deflationists (renewable SRMC ~0) and electricity price inflationistas. Putting that argument to one side through, from our sell side sample the average for what we can see is a AUD200m(15) increase in EM earnings from FY23 to FY24, which isn't necessarily captured within valuations I.e., we can see why valuations would need to rise by AUD0.50-AUD1.00/share as FY2023 and FY2024 earnings are capitalised rather than FY2022 and FY2023. We have performed an exercise below demonstrating how we can see EM EBITDA back above AUD900m p.a. by FY2024. Source: Chester Asset Management Source: Chester Asset Management and various other sources Cash / Net Debt + Corporate Net Debt is a function of our earnings and cash flow projections. Corporate Costs is an after tax valuation of the ongoing cost of corporate overheads for which we value at ~(AUD650m). Notably to compare apples with apples we arbitrarily took the average across our sample of AUD700m and isolated that for the analysts that didn’t account for it separately. Closing At this time of year when everyone is trying to make unknowable predictions about the year ahead, in a highly uncertain macro environment, we are focusing on individual stock stories and emphasising why we have conviction in the value of assets we are investing in. We trust the above has helped provide clarity as to why we were comfortable acquiring ORG in the low 4’s with a view to a base case valuation of ~AUD6.50/share. Source: Chester Asset Management It’s also worth pointing out that if we marked to market ORG’s assets that have recently transacted: APLNG, Beetaloo and Octopus and added them to the book value of remaining assets we get AUD7.12/share(16). Happy holidays and hopefully there’s some coal leftover for ORG after Santa’s visits. References (1) This writer is ignoring the painful 4 years he spent as an auditor (2) (VIEW LINK) (3) Of the 3 lenses we consider, Quality and Edge being the other two (4) USD60-65/bbl brent price LT and a WACC of ~10%. (5) For those unfamiliar with the accounting treatment, you don’t write back these improvements (6) At 30 June 2021 (7) (VIEW LINK) (8) 40% interest in Browse Basin field – previously reported as 7.6Tcf of gas and liquids (9) i.e., ORG’s internal updated view of Energy Markets EV, supported by their auditors at 30/6/2021 using a discount rate of 9.6-9.8% pre-tax (10) In doing so, for simplicity we have chosen to spend little time on RECs (11) OCGT = Open Cycle Gas Turbine and CCGT= Combined Cycle Gas turbine (12) AGL’s takeover of Australian Power and gas being notably around this mark (13) ~Historical AGL multiple prior to its issues) and the ~average the street is capitalising ORG EM EBITDA at (14) Note this was written in October and we have started to witness coal and gas price increases putting upward pressure on the wholesale electricity price (15) AUD986m – AUD778m (16) AUD5.57/share + AUD0.81/share + AUD0.20/share + AUD0.39/share + AUD0.15/share = AUD7.12/share

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  • Build Generational Wealth | Chester Asset Management | Melbourne

    Investing to protect and grow generational wealth Growth Seeks a return of 5% pa above its benchmark ​ Conviction A concentrated portfolio of 25 – 40 best stock ideas Defence Defensive allocation helps preserve capital Outperformance Greater than 7% p.a. alpha since inception Chester High Conviction Fund Research house ratings “The Manager (Chester) has demonstrated willingness to make full use of its risk management tools and has successfully protected the Fund on the downside.” Lonsec Product Review October 2021 See disclaimer in footer “Zenith's conviction in the Fund is underpinned by Chester's differentiated investment process, which has been successfully implemented over the longer term”. Zenith Product Assessment Report June 2021 See disclaimer in footer We're invested with you The Chester team invest their personal wealth in the same fund as clients. With skin in the game they are driven to perform and aligned with investors’ interests. Meet the team Chester Asset Management Apr 28 3 min Quarterly State of Play Rob Tucker, Managing Director of Chester Asset Management, shares his thoughts on three key macro questions that help shape the Chester High Anthony Kavanagh, Portfolio Manager Mar 17 16 min Have you got enough food in your bunker? The main facts in human life are five: birth, food, sleep, love and death, E M Forster It is one thing to run out of cars and have to... Anthony Kavanagh, Portfolio Manager Dec 12, 2021 13 min Not a sequel but an Origin story A company trading at a discount to book value with tailwinds in key end markets: Is that something you might be interested in? In our... Anthony Kavanagh, Portfolio Manager Oct 30, 2021 9 min Why it pays to follow the insiders – Part 2 “In the race of life, always back self-interest – at least you know it’s trying” – Jack Lang Anyone who has listened to my colleague Rob... Stay up to date with the latest performance

  • Chester High Conviction Fund | Chester Asset Management

    Chester High Conviction Fund Investing to protect and grow generational wealth The Chester High Conviction Fund is designed for investors who aim to grow their wealth while preserving their capital. The fund’s investible universe is the S&P/ASX 300 Accumulation Index. ​ Our experienced, dedicated investment team has worked together since 2013. We take a high-conviction approach, choosing investments where we have confidence in the high quality, predictable cash generation of the company, or we have strong confidence in the valuation margin of safety. Finding unloved, underappreciated or undiscovered investments has been the most consistent source of capital growth for our strategy over 8 years. How to invest Fund Documents Product Disclosure Statement (PDS) Fact Sheet Latest Monthly Report Latest Quarterly Report Target Market Determinations Fund Facts Performance Ratings Unit Prices Distributions Fund Forms Platform Availability ​ 1 Mth 3 Mths 6 Mths 1 Yr 3 Yrs 5 Yrs 7 Yrs Since Inception Chester High Conviction Fund ​ ​ ​ ​ ​ ​ ​ ​ S&P/ASX 300 Accumulation Index ​ ​ ​ ​ ​ ​ ​ ​ Outperformance (after fees) ​ ​ ​ ​ ​ ​ ​ ​ Past performance is not a reliable indicator of future performance. Returns greater than 1 year are per annum. The total return performance figures quoted are historical, calculated using end-of month mid prices and do not allow for the effects of income tax or inflation. Total returns assume the reinvestment of all distributions. The performance is quoted net of all fees and expenses. The indices do not incur these costs. Inception of the Chester High Conviction Fund for performance calculation purposes is 8 October 2013 (based on the underlying High Conviction strategy returns). The inception of the Unit Trust is 27 April 2017. Gain access to outstanding Australian investment opportunities Invest with us

  • About Chester Asset Management | Chester Asset Management

    Chester Asset Management High conviction equity specialists Chester Asset Management was founded to help investors protect and then grow generational wealth. Formed in 2017, Chester is a dedicated high conviction equity fund manager led by Portfolio Manager Rob Tucker. The company was named after Rob’s grandfather, Chester Raymond Tucker, who introduced Rob to investing with a parcel of shares for his 18th birthday. ​ The Chester name represents a life-long commitment to staying curious, a deep passion for investing and building generational wealth. Our journey Chester Asset Management is 100% owned by its staff, who invest in the Fund alongside clients. Rob is supported by his long-term colleagues Luke Howard and Anthony Kavanagh, both of whom are experienced portfolio managers. Meet the team Partnership with Copia We are a proud investment manager partner of Copia Investment Partners, an independent multi-boutique investment management group. ​ Copia provides the resources and infrastructure our team needs to prosper, including distribution, marketing, operations and compliance services, enabling us to focus solely on delivering our investors superior long-term investment outcomes. ​ To speak to someone about the Chester High Conviction Fund, contact a member of the Copia Distribution team. Visit Copia

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