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In this short video, Rob answers some common questions about Chester: Who is Chester? What is the Chester investment approach? What is the Chester High Conviction Strategy? What attributes are you looking for in a company?

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 Kogan.com (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: https://www.chesteram.com.au/investment-process

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.

Chester Asset Management are honoured to announce that the Chester High Conviction Fund has won Money magazine's Best Australian Shares Fund 2023 at this year's Best of the Best Awards. 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

Portfolio Manager Anthony Kavanagh discusses one of Chester Asset Management’s highest conviction stocks, and why it represents an exciting opportunity for the Australian equity fund manager. It’s a company that has two streams, one being generic crop protection and the other a seed business with two new products going to market that have significant growth potential. It’s proven to be an Australian success story and one part of this business in particular presents strong upside potential for the Chester High Conviction Fund.

"The best place to hide something is in plain sight" Edgar Allan Poe We have spent countless hours these past few years hunting for asymmetric opportunities. We have uncovered these in many forms but 2 common sources have been: Companies trading below book value (ORG, NUF, ASB, SM1) and Companies with underappreciated/hidden property value (Ramsay, Casinos, Aged Care, Energy, Agribusiness, etc) Source: Old El Paso Commercial Meme, the Internet In a recent review of Real Estate Investment Trusts (REITs) we were struck with the thought that the most obvious example of underappreciated property value might actually be hiding within a property stock, trading at less than book value. We detail this company below. I preface this work with a disclaimer that along with my love of food, movies and mining, I love property but am a generalist on the topic and hence have (potentially crudely) attempted to generalise this note. Background to Stockland As we know it today Stockland (SGP) is a stapled security and represents a combination of passive income streams within a trust: Retail ‘Town Centres’, Office ‘Workplaces’, Industrial ‘Logistics’ and Retirement / Land lease communities; and development income streams within a corporation: Residential is mainly master planned communities (MPC), Commercial Developments and Land lease communities. Stockland is regarded as one of Australia’s most recognised brands and develops on average 6,000 lots p.a. sold within MPCs. In June 2021 SGP announced the appointment of a new CEO, Tarun Gupta whose appointment has coincided with a refinement in the company’s strategy. This refinement in strategy includes a reallocation in sector capital and a refocus on targeted returns. This has seen SGP divest its Retirement Living business and acquire Halcyon a land lease communities business, as well as enter into multiple (capital) partnerships to accelerate SGP’s development pipeline. A summary of these targeted measures is presented in the images below. Source: Stockland Investor Update, November 2021 We are cognisant of the rising interest rate environment and implications it may have on Australia’s property market and hence SGP’s earnings (predominantly the development earnings) but the argument presented herein is both an absolute and relative valuation argument vs REIT 'peers'. Underappreciated Land Value For those that have never looked at REITs, simplistically the majority of a REIT’s value[1] is marked to market at each reporting date via external valuations predicated on the capitalisation of recurring income streams, i.e., cap rates, which adjust according to market conditions including changes in yields. This is true of SGP’s trust assets. The component of most REITs that isn’t as simple is the development portfolio[2] which is often recorded at cost. As noted above SGP is a combination of a trust and a corporation[3] and is somewhat unique in the weight of the business towards development. Lend Lease (LLC) and Mirvac (MGR) are possibly the only 2 other ASX property stocks that are development heavy. With the uniqueness of SGP’s development pipeline vs REIT ‘peers’ it is understandable that its upside value is potentially being overlooked. If we consider the net tangible asset (NTA) or book value of SGP, notably the landbank is recorded at cost and being approximately 10 years old the land recognized on SGP’s balance sheet grossly understates its market value. This clearly begs the question how much the land is actually worth which we have attempted to answer below. Source: SGP FY2022 Results Presentation Annexure On our first attempt at estimating land value, we considered what is being reported by SGP, being a AUD3.5bn cost base for the ~10 years old landbank (refer image above). From review of prior announcements and company discussions however we have discovered that the AUD3.5bn of book value at cost included development and other costs, interest capitalised, etc. Hence we needed to refine the true cost of land we were considering, refer below. Source: SGP FY2022 Account Statements, note 6 Inventories page 126 I.e., Of the AUD3.5bn of book value, AUD2,737m of that is ‘cost of acquisition’. Per the accounts that includes legal, valuation and stamp duty costs which we have assumed at ~7.5%, hence our estimated raw acquisition cost (AUD2,546m below) is adjusted for these estimated costs. Furthermore, the average age of SGP’s landbank, although stated at 10 years, is being inflated by project Aura on the Sunshine Coast, which was effectively purchased as part of SGP’s acquisition of Foster’s Lensworth Group in 2004 (for AUD846m)[4]. Ex Aura the average age of the landbank is actually closer to 8 years. The image below which shows select land value movements across Australia since FY2011 highlights the material uplift in land seen over the past 10 years which we have utilised in our analysis. Source: Stockland FY2022 Results Presentation, page 29 Below we have tabled our estimate of what this might mean for the current value of SGP’s landbank, relying on the average move per city (representative of the respective state), presuming[5] that the landbank was acquired on average 8 years ago. We further note that it is important to realise that SGP make acquisitions with a through-cycle acquisition price assumption (3.5% p.a.) embedded into the acquisition to justify the price paid for the land, hence we need to adjust for this. In addition there are also liabilities (of ~AUD1.4bn) that offset this gross value of land on SGP's balance sheet that reflect cost to complete provisions and deferred payments, some of which are revenue based and adjust with land price movements. I.e. there are definitely some complexities in calculating what the land is really worth! Source: Chester Asset Management with sources referred to in Notes above * On Aura, it was reported Terry Snow’s Capital Property Group (CPG) invested ~AUD175m (AUD150-200m) for 50% of the project at a reported 30% premium[6]. Hence we presume book value for the remaining 50% is recorded at ~AUD135m (AUD175m/1.4). From a similar exercise to that above we estimate this land is now worth ~AUD270m vs AUD205m implied by the ~50% (75%x70%) factored above so we add an extra AUD65m. NTA The first point to make about SGP trading at a discount to book value is that this is the case for almost all REITs. Hence for comparison below we present our REITs database, removing fund managers (CHC, CNI, GMG and HMC) and included SGP at the adjusted NTA calculated above. Furthermore, this table excludes retirement living operators/developers (LIC and INA) and property developer LLC. Source: Chester Asset Management, with data from IRESS and company accounts, as at 15 September 2022 The comparison table above highlights that when adjusting SGP NTA for a more appropriate view of land value we observe a 32% discount to NTA vs the REIT average of 22%. I.e., If our estimate of SGP’s land value is correct SGP has ~15% upside just to trade at the average of the REIT’s index (AUD4.00/share). Or put another way SGP is currently trading at <0.7x our estimate of adjusted NTA. Property Developer Premium Above we noted that SGP on an adjusted basis trades at a material discount to the average of REIT peers[7]. Arguably, as has historically been the case, developers should trade at a greater premium[8] to NTA than pure REITs. This is because the NTA doesn’t capture the value of future development earnings (outside of the land value being realised). Hence why LIC has traded at >3x NTA, INA 1.5x and LLC has traditionally traded at an ~30-50% premium. SGP itself currently trades at an ~20% discount to its reported NTA vs a long term average premium of 10-15%. We could have left it there and said SGP has >35% to trade back to its historic premium to NTA but why make it easy? Instead we have performed an additional exercise to the land adjustment above to consider ‘development value’. The challenge in doing so though is in defining what is the development profit, particularly when we believe land value is being grossly understated. If we were to count development profits on top of adjusted NTA we would effectively be counting the land uplift twice. In the table below we have attempted to isolate the profit attributable to the land mark-to-market and the residual development profit and quantify this value. For simplicity (and somewhat materiality) we have only included development upside for standard residential lots (i.e., excluded any development upside for land lease and commercial portfolios). Source: Chester Asset Management with sources referred to in Notes above This compares to the NAV/share reported in IRESS for each of these companies below. Source: Chester Asset Management, with data from IRESS and company accounts, as at 15 September 2022 Notably Rural Funds Group (RFF) present in their accounts adjusted NAV per unit which adjusts the book value of water entitlements to an independent valuation rather than at cost. Unlike SGP RFF trades reasonably in line with this adjusted NAV. The discount of REITs is ~21% to their NAV. Assuming this average discount applied to SGP the comparable price would be ~AUD4.90/share, +40% to where SGP is trading. I.e., SGP is trading at ~0.55x this adjusted NAV. Cap Rates above peers We appreciate comparing the cap rate of one property play to another doesn’t necessarily account for differences in asset quality but per Chester analysis in aggregate SGP have cap rates above the average of the REIT peer group: Retail 0.78% higher than peers, Office in line. and Industrial ~0.23% lower than peers. Assuming this is just conservatism and not due to lower quality assets than peers SGP’s investment properties should trade at a lower discount than peers (i.e., <21% discount). Source: Chester Asset Management, with data from company accounts Gearing more conservative than peers With the sale of Retirement, divestments and capital partnering deals SGP’s pro-forma gearing is actually 500bpts better than last reported at ~18%. Given this is below SGP’s targeted gearing of 20-30% the company may re-gear but SGP is also looking to scale further via the use of 3rd party capital to obtain better operating leverage and generate recurring fee income. For comparative purposes below we have tabled how SGP’s balance sheet compares to peers. Source: Chester Asset Management, with data from company accounts As is evident in the table above vs peers SGP has: a lower level of gearing; a higher level of hedging; longer dated maturity; and also, a higher starting debt cost, which we see as a positive as there is less of a future headwind from debt repricing. Higher Yield It is worth pointing out the difference in dividend yield vs peers. We had heard the bear argument that with the sale of the Retirement business SGP is entering a tax paying position that the market wasn’t on top of. This came through at the FY22 results with FY23 FFO guidance inclusive of tax payable at 5-10%. With Development targeted to represent ~40% of profits this would mean as a stapled security the normalised forward tax rate would increase from ~7.5% to ~12% (30% x 40%) which should now be in consensus. We further note the dividend could be franked to ~33% so the gross dividend would be higher than this vs REITs (Trusts) that pay unfranked distributions. Source: Chester Asset Management, with data from IRESS as at 15 September 2022 Developers should be paying a lower dividend so it doesn’t really make sense that the SGP dividend, despite now incorporating tax payments (and hence potentially franking) is still materially above that of pure REITs (except if the buyside are anticipating material downgrades to consensus). Closing You could argue that development profits will dry up in the near term and the market may need to adjust FY23 to FY25 earnings expectations for the recession/property market downturn but we still see a pretty asymmetric opportunity for SGP on a valuation basis. We have tried to represent this in the graph below that if we were to adjust land on SGP’s balance sheet for its hidden value we see upside to at least AUD4.00/share at the absolute minimum (to reflect the average REIT discount) and upside beyond that dependant on how much additional value to include for SGP’s development pipeline(s). Source: Chester Asset Management, refer note above for detail [1] And we are ignoring Funds Management REITS here [2] Which is generally a nominal component of asset value [3] Which houses SGP’s development portfolio [4] (VIEW LINK) [5] with the exception of Aura which we have factored in below [6] (VIEW LINK) [7] Non-Fund Manager REITs [8] Or lower discount (to NTA)

We are pleased to announce that the Chester High Conviction Fund is a finalist at the Lonsec and SuperRatings Fund of the Year Awards, for Active Australian Equity Fund of the Year. The finalist nomination coincides with the five-year anniversary for the Chester High Conviction Fund in 2022 (9 years for the strategy). Now in its 20th year, the awards recognise the best providers across the managed fund and superannuation sectors.

In this AFR Fundie Q&A, Chester Asset Management’s Rob Tucker answers some crucial questions that the high conviction equity manager has about the current reporting season. Rob discusses which 30-year Australian success story now represents an ‘asymmetric payoff’ - meaning the risk is skewed to the downside rather than the upside. Rob also discusses with Alex Gluyas which stocks appear well positioned in the current inflationary and higher interest rate environment. The Q&A also includes stocks expected to surprise on the upside, as well as stocks that Rob believes the market is undervaluing, and what portfolio actions the Chester team are taking. An opinion is also provided on gold stocks, given they form an important part of the defensive sleeve in the Chester High Conviction portfolio - to help smooth out volatility. To read the Q&A, click here.

We’re pleased to announce our investment partner Chester Asset Management has been recognised as one of Financial Newswire’s Australia’s 10 most consistent fund managers (Star Manager). The Star Manager status recognises the “performance and consistency of fund managers who outperform their peers and have consequently gained a notable reputation”. Industry publisher Financial Newswire has collaborated with SQM Research to compile the list of Star Managers, drawing on 3-year track records across 500-600 funds. The Chester High Conviction Fund, distributed by Copia has been identified as one of the best-performing funds. Click here to read the article by Oksana Patron in which Rob Tucker, Managing Director explains the principals guiding the Chester team. “We have fine-tuned our portfolio construction framework over the past 21 years, and continue to learn new things every day,”

“As the man once said the harder you work, the luckier you get” - Ted Lasso Warren Buffet was once asked how he became so successful in investing and his response was “we read hundreds and hundreds of annual reports every year”. Despite the Oracle being the most emulated investor of our time, for a host of reasons we are certain the accounts aren’t as widely read as they should be. As part of our ESG focus, we analyse remuneration reports of research library companies and compare them to that of their peers. From this exercise, we have stumbled across plenty of useful insights. The "rem" report is a well-understood area of insight. We have written in the past about information content that can be gleaned from insider transactions in Why it pays to follow the insiders. In the lead up to the FY2022 reporting season, we look at information content that can be gleaned from the account notes, particularly a less well-understood area of insight, the impairment testing note. Prior to my time in funds management, I spent four (long) years as an auditor at KPMG (2006 to 2009). In this role, I was a first-hand witness to the endless hours invested in preparing, reviewing, auditing, correcting, editing and submitting financial reports. Given that time was headlined by the GFC, there was increased audit focus on analysing a company’s cash flows and balance sheet, including testing intangibles for impairment in accordance with Australian Accounting Standard 136(1). “An entity shall assess at each reporting date whether there is any indication that an asset may be impaired and test goodwill acquired in a business combination for impairment annually…” In most cases, the above exercise was performed considering value in use, determined via discounting future cash flows based "on the most recent financial budgets/forecasts approved by management and (which) cover a maximum period of five years…” Hence in some cases in the annual report, for companies with goodwill we can infer the internal budgets of an organisation for up to five years. Below are some examples of annual report notes that provide this information. DOWNER (ASX: DOW) Starting the examples with diversified services company Downer, we found the information contained within its FY2021 accounts quite informative as it provided a three-year compound annual growth rate (CAGR) for EBIT of Cash Generating units (CGUs) that comprise the key segments. Source: Excerpt DOW FY2021 accounts (Note C7 of page 93) In August 2021, this information was particularly useful given DOW didn’t provide any formal quantitative guidance for the market and the accounts were complicated by the transition to an Urban Services business and hence included: 'Core' and 'Non-Core' operations, businesses in wind down, businesses to be sold and acquired amortisation. Below we have extrapolated these projections out to FY2024 and sampled three (sell-side) analyst reports from August 2021 to contrast internal views at the time to those of the market. Notably, these projections are likely to have changed materially since then due to 10 months of challenging performance and deteriorating labour markets, but we feel it provides some interesting comparisons, nonetheless. Source: Chester Asset Management, Various anonymous sell-side reports, DOW FY2021 annual account information. For the three key divisions we make the following observations: Transport Analyst C’s projection was almost identical to that computed from our analysis however analysts A and B were more than 15% higher. The key reason for this is potentially due to recency bias, with the Transport Division beating expectations at the FY2021 results. Fast forward six months and the Transport Division actually increased by 16% in the 1H FY22, but Analysts A and B have updated their projections for the division to $272 million and $295 million. Utilities Looking at Transport, we suspected that Analyst C may have been a fellow account note enthusiast. But Analyst C's (and B’s) projections were 9% below the EBIT implied within our analysis. The reason for this is probably also due to the recency bias given the recent declines in the division from the runoff of NBN capital contracts. Fast forward six months and the Utilities Division actually decreased by 27% in the first-half of FY22 due to a deferment of work as a result of COVID and a change in mix away from higher-margin capital projects. Notably, $20 million of FY21 EBITA has been reclassified away from Utilities, which now makes the comparison even more complicated! Including this reclassified ($20 million) of EBITA, Analyst A’s updated projection is around $100 million, Analyst B’s projection is $86 million, and Analyst C’s $87 million. Facilities The market was projecting increases in Facilities but not to the extent DOW was internally. This saw the average FY24 projection for Facilities 11% below our implied calculation This could be a function of a few things, including the impacts of COVID, the expected recovery being hard for the market to comprehend, the growth potential of Defence being underappreciated by the market or a range of other factors. Fast forward six months and the Utilities Division actually increased by 7% in the 1H FY22 and Analyst A’s updated projection is around $214 million. Analyst B’s projection is $212 million and Analyst C’s is $198 million. At the half-year, $38.6 million was reclassified towards Facilities (from Utilities and Asset Services). Ultimately, the internal budgets provide no guarantees of achievement. The first-half performance is a prime example of that, and can be prepared and/or reviewed by a management team and board that are frankly more optimistic than other teams. But we believe it provides a good place to start when making our own projections. As noted above, we think the near term environment remains challenging for DOW, particularly a labour perspective. This means higher near term earnings risk, but the longer-term view from August 2021, validated by internal budgets remains the achievement of around $500 million of EBITA from a core Urban Services portfolio. The success of these budgets (which may be pushed out by 12 months now) to us supports a share price target of more than $7. Source: Chester Asset Management, IRESS QBE INSURANCE GROUP (ASX: QBE) In trying to understand and develop projections for QBE recently, we asked ourselves a several questions around the rates of return achievable across operating and investment operations. This included “what is the appropriate long term investment return to assume for their investments portfolio?” This question was somewhat answered by management in the notes to their accounts. Source: Excerpt from QBE 2021 Accounts, Note 7 Page 140 Projected returns The key driver of an insurer’s investment returns is obviously interest rates. At 31/12/21 the duration of QBE’s portfolio was 2.1 years with 93.8% of the portfolio in fixed income assets and 6.2% in ‘risk’ assets. QBE are targeting taking risk assets to 15% which theoretically would increase returns of the portfolio, (by ~50bpts). QBE has traditionally earned a margin of ~50-100bpts above government bond rates. At the time the annual report was prepared the US 2 year bond rate was ~1.5% which has since risen to ~2.5%. Hence it reasonable to expect ~3.0-4% investment returns (assuming stable yield) in 2024+ for QBE. But what does 3.43% imply for investment returns? We have addressed that question in the table below and performed an analysis comparing the implied investment return to that of a handful of sell side analysts. Source: Chester Asset Management, various analyst reports, IRESS There are a couple of points to make about this analysis. It was completed prior to QBE’s AGM update on 5 May 2022, in which QBE announced a 1Q22 exit total investment return of around 2% (hence we have already started to see the sell-side upgrade projected investment income) The above analysis assumes that there is no deterioration in combined operating ratio as a result of higher interest rates. For example, it could be argued that given the strong returns on equity available on investment returns, the underwriting margins are competed away What's the edge or insight on the stock? We believe the market was potentially underappreciating the earnings benefit to QBE from higher rates, and there's a good chance of substantial valuation upside. Healius (ASX: HLS) The healthcare firm Healius is not a name I've spent much time deeply analysing and although it probably offers the least variance to market from our analysis, given relatively predictable revenue streams, we still found its FY21 Goodwill (B2) note more informative than most and have presented our analysis of it below. Source: Excerpt from HLS FY2021 Accounts, Note B2 Page 91 This compared to a sample of analysts at the time: Source: Chester Asset Management, various analyst reports We can only see FY2024 as the outer year so have had to presume the revenue growth rate is reasonably consistent over the time period. The reality is probably more nuanced given the decline in PCR (polymerase chain reaction) testing from an elevated FY2021 base. Thinking about this another way, presuming industry growth rates stabilise at around 5% (pre-COVID levels) and discount back FY26 budgeted revenue ($1,627 million), this level implies FY24 budget revenue of $1,475 million, a level still 9% higher than the sample. Since this release in August 2021, we have seen a half-year result from HLS and started to get greater clarity over the path of PCR testing in Australia to help shape our view of the future. We have probably not captured all the recent downgrades as Medicare data has come through, and HLS updated the market last week. But in late May, Analyst A was projecting FY2024 Pathology revenue of AUD1,466m while analysts B and C had both lowered their projected revenue by a few percent. At the very least, HLS's Goodwill note will be one worth keeping an eye on in August. CLEANAWAY (ASX: CWY) The waste management firm Cleanaway is the original of Goodwill notes for us and it probably represents the most detailed of the impairment testing notes we see in the market, providing a wealth of useful information. It should be apparent by now, but we’ll repeat that CWY’s note uses board approved budgets. In CWY’s case, the coming years should provide a better forecast of future earnings than any external parties (including ourselves) can conjure. Source: Excerpt Cleanaway FY2021 annual report, Note 22, page 85 Analyst comparison - EBITDA Source: Chester Asset Management, CWY FY2021 Annual report, Various analyst reports As we noted below, we have compared a sample of sell-side analysts in August 2021, following the company's results to the implied EBITDA of divisions. As we note below there are a couple of issues with this: As we noted below, we have compared a sample of sell-side analysts in August 2021, following the company's results to the implied EBITDA of divisions. As we note below there are a couple of issues with this: It doesn’t include value of the recently acquired Sydney Resources Network (SRN) from Suez, Waste to energy opportunities (presumably not generating earnings in FY24), Container Deposit Schemes (CDS) or other circular economy opportunities. We have adjusted for the first of these, noting SRN delivered net revenue of $193 million and EBITDA of $77 million in CY2020, assuming this level in FY2021, compounded at the same rate as Solid Waste Services Similar to our comment for HLS the visibility on sell-side projections beyond the next 3 years is limited. Hence we assume a consistent level of compounding to compare to FY2024 levels rather than FY2026 levels Despite these issues, the analysis implies that the sell-side (particularly analyst C) sat below internal CWY projections of earnings for a business that has a history of exceeding budgets. Interestingly now though is that FY24 consensus EBITDA is at AUD741m, reasonably in line with the FY24 EBITDA implied by the above analysis. Analyst Comparison - Capex Source: Chester Asset Management, CWY FY2021 Annual report, Various analyst reports Chester has projected potential revenue for each of the segments in FY2024 including SRN, this is within 3% of FY24 consensus revenue. To segmental revenue, we have applied budgeted capex percentages. We have had to assume a percentage applied to SRN (assumed lower than Solid Waste Services) and an amount dedicated towards Corporate / Other comparable to FY2021 D&A. The analysis suggests that CWY capex spend is potentially budgeted to be higher than market projections (not even including the added spend on Waste to Energy Projects). Goodwill Headroom + Net Assets = Implied Internal valuation Source: Excerpt Cleanaway FY2021 annual report, Note 22, page 87 Source: Chester Asset Management, CWY FY2021 Annual report, IRESS The above table implies the market cap is at a premium to the value implied by the internal valuation calculation. There are a number of aspects that potentially account for this, including its failure to include the following areas of upside: SRN Assets. The acquisition of these assets was completed on 18 December 2021, but the forecasts above do not include these assets or synergies from these assets. Waste to Energy Opportunities. CWY’s first project in Western Sydney was blocked but they are still considering projects in Sydney, Brisbane, Melbourne (and elsewhere). Waste to Energy will be NPV accretive so likely provides upside to the value assessment above. However, it must be remembered that Waste to Energy earnings will also be used to replace landfill earnings (which have a finite economic life) CDS and other circular economy opportunities. There are additional Container Deposit Scheme or circular economy (recycling opportunities) not included above Some boards/management teams can be more conservative or optimistic than others, CWY may outperform budgets and the valuation could exceed that presented in the notes As noted above the market potentially underestimates the capital investment required in the business over the next five years. The market is also prepared to pay a higher multiple for the utility-like nature of the assets than that inferred by a discounted cash flow valuation Closing While having insight into a company’s internal forecasts doesn’t guarantee results against those budgets, it is a meaningful reference point for anyone looking to prepare forward projections of a company’s earnings. Hopefully, this note has inspired more people to join us in analysing the accounts in August, for that little bit of extra luck going forward. (1) Or International Accounting Standard 36, (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 chesteram.com.au 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.

The most recent COVID inspired emergency response has seen 20 years of US central bank debt accumulation double in 12 months. It is very unclear how this ever gets repaid. We have arrived at a juncture of financial repression, for governments themselves can not afford materially higher interest rates, but are effectively forced to run budget deficits, for the greater good. The control of the supply of money is changing from central banks to governments as they grapple with the moral hazard of looking after their citizens’ way of life. The consequence of this appears to be that short term interest rates will not reflect inflation expectations and any sign of significant asset price volatility will see the effective capping of long term interest rates. This line of thinking outlines the playbook for a decoupling of inflation and interest rates for the first time since the 1940s. This is actually a necessary policy setting to have any chance of governments solving the current debt crisis. The pathway to this outcome may not be smooth, but essentially this is the most probable scenario, given so many others (materially higher interest rates, austerity or even sovereign debt default) are far more unpalatable, with far greater social consequences. Hence we see a problematic period ahead whereby central banks are facing the prospect of slowing economic growth, while grappling with meaningful inflation for the first time in almost 40 years. The inflation issue appears to be far stickier than most pundits had expected at the start of the year, and looks set to continue into 2022. This challenge of unwinding the easy monetary policy settings suggests to us that uncertainty will create more volatility, and with that the desire to own a portfolio of stocks that can insulate the portfolio from significant drawdowns, while still offering strong valuation support. We’ve made changes to our portfolio in the past quarter to find companies that will trade in a non-correlated manner to the broader market. We’re looking at a few key areas including: Real assets – We believe inflation will drive real asset valuations higher. Valuation margin of safety – We’re not overpaying for long-duration assets or concept stocks. Instead, we’re focused on the near-term. Pricing power – We’re considering how long companies will be able to hold their prices stable before being forced to pass on inflation costs to consumers. Gold – There is extreme value emerging in gold equities, as it’s the most unloved sector across global equities right now. The current trends in markets are bringing the focus back on our core philosophies: backing ourselves when it comes to unappreciated assets, maintaining a high active share and investing in companies with strong, predictable cash flows. We seek to continue to deliver a portfolio that generates stronger alpha, with lower beta than the market.\ 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 chesteram.com.au 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

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 chesteram.com.au 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