Firetrail Australian High Conviction Fund MARCH 2020

PERFORMANCE (AFTER FEES)

Fund 3 yrs 5 yrs 7 yrs 10 yrs Strategy Month Quarter FYTD 1 yr 2 incept incept (pa) (pa) (pa) (pa) (pa)4 Fund1 -22.97% -28.54% -24.72% -21.65% -11.55% - - - - -

Strategy composite3 -22.97% -28.54% -24.72% -21.65% - -2.62% 5.18% 7.51% 5.60% 7.20%

Benchmark -20.65% -23.10% -20.74% -14.42% -3.42% 0.83% 3.28% 5.88% 5.01% 5.20%

Excess Return -2.32% -5.44% -3.98% -7.22% -8.12% -3.45% +1.84% +1.62% +0.59% +2.00%

ABOUT FIRETRAIL FUND DETAILS

Firetrail is an investment management boutique which is Unit prices 31 March 2020 majority owned by the Firetrail investment team. Application price $0.7542 Additionally, the investment team is invested alongside Redemption price $0.7504 clients in the investment strategies. NAV price $0.7523 AUSTRALIAN HIGH CONVICTION FUND Fund Details The Australian High Conviction Fund (“Fund”) is a APIR Code WHT3810AU concentrated portfolio (approx. 25 companies) of our most S&P/ASX 200 compelling equity ideas. The strategy is built on Benchmark Accumulation Index fundamental, deep dive research guided by the philosophy Inception date 14 March 2018 that ‘every company has a price’. Number of Holdings 29 INVESTMENT OBJECTIVE Fund size $281m Management fee* 0.95% p.a. The Fund aims to outperform the ASX200 Accumulation Index over the medium to long term. Performance fee* 15% of outperformance *Please read the Product Disclosure Statement for more details PORTFOLIO POSITIONING 31 MARCH 2020 THEMATIC POSITIONING 31 MARCH 2020 Top 3 Overweight Holdings (Alphabetical) Relative to the Benchmark Ltd 15.00% Airways Ltd 10.00% Corp Ltd 5.00% 0.00% -5.00% -10.00% -15.00% China Global Yield

Past performance is not a reliable indicator of future performance. 1. Firetrail Australian High Conviction Fund (‘Fund’). Net Fund returns are calculated based on exit price with distributions reinvested, after ongoing fees and expenses but excluding taxation. 2. Fund inception is 14 March 2018. 3. The Fund has been operating since 14 March 2018. To give a longer-term view of our performance for this asset class, we have also shown returns for the Firetrail Australian High Conviction Strategy Composite (‘Strategy’) which has been operating since 29 November 2005. Strategy performance has been calculated using the monthly returns (after fees) of the Fund from 14 March 2018 to current date, as well as the monthly returns of the Macquarie High Conviction Fund (after fees) between 29 November 2005 to 23 November 2017. The Fund employs the same strategy as was used by the same investment team that managed the Macquarie High Conviction Fund as at 23 November 2017. Firetrail has records that document and support the performance achieved as the Macquarie High Conviction Fund. The composite returns for the Strategy and the S&P/ASX 200 Accumulation Index (Benchmark) exclude returns between 24 November 2017 and 13 March 2018. During this period the investment team did not manage the Strategy. As such, the annualised performance periods stated are inclusive of the combined composite monthly returns, and do not include the period when the team were not managing the Strategy. For example, the annualised return over 3 years for the Strategy and benchmark are inclusive of 36 monthly performance periods available in the composite return period, excluding the period between 23 November 2017 and 13 March 2018. For additional information regarding the performance please contact us through the link on our website. Net Fund returns are in AUD terms. Net Fund returns are calculated based on exit price with distributions reinvested, after ongoing fees and expenses but excluding taxation. Past performance is for illustrative purposes only and is not indicative of future performance. 4. Strategy inception 29 November 2005. PORTFOLIO COMMENTARY

The Fund returned (22.97%) for the month ending 31 March 2020, underperforming the ASX200 Accumulation index by 2.32%.

The best contributors for the month included , and (new position). Detractors for the month were Virgin Money, and Qantas. Unprecedented downturn / Unprecedented stimulus

There is no real playbook for what is going on at the moment. Businesses aren’t set up to deal with environments where there is potentially no revenue. For many companies out there, it’s all about survival.

Minds immediately go back to the GFC for a recent downturn. There are some similarities, but there are some key differences:

1. COVID-19 is a cashflow crisis while the GFC was a liquidity crisis. o In the GFC, if you fixed your balance sheet, your problem was solved. In COVID-19, the key question centres on how long your business can last with revenue down a lot. 2. For COVID-19, the impacts have felt almost instant, with far reaching impacts happening very quickly. Unemployment is likely to spike higher than the GFC quickly. 3. The stimulus, both monetary and fiscal, is unparalleled, and the fiscal stimulus is even higher now than in the GFC. o Stimulus doesn’t solve COVID-19, but it certainly helps cushion some of the blow for many. 4. COVID-19 is really affecting SMEs. o The GFC impacted the big end of town, although that eventually trickled down into other businesses and consumers.

How else can we get a read on how it plays out?

We can look to China. Everything needs to be caveated with the fact that this is a fast-changing situation. But speaking to people on the ground in China, things are returning to normal. Some of the key points include:

• Heavy traffic jams on the road as people shun public transport, preferring personal transport • China focusing mainly on the health of SMEs and consumers rather than big bang stimulus, at this stage • Steel mills are back up and running • Activity has largely returned, and likely to be at close to full tilt by mid-April • Some scepticism as to whether China has really solved COVID-19. More likely the economic pain became too much to bear, so China decided to get back to work.

Any signs of life?

Today the situation is very negative. It’s hard to see through the fog of pessimism. It’s just so tough for so many out there, with all our friends and families being impacted. But there are some reasons for optimism:

1. Demand surge? There is a real chance of huge pent up demand for many products and services that will be unleashed once the worst of COVID-19 containment measures pass 2. More market share? Many listed companies are market leaders, and as tough as it is for them, it is much tougher for many of their smaller, less capitalised peers 3. What is in the price? Share prices have factored in a lot very quickly. To be clear, this situation can get worse, but few share prices imply the virus situation will get much better 4. Medical advances? Much work is being done on a vaccine. An announcement of a vaccine would see a step change in the outlook for the world economy 5. Whatever it takes? Governments and Banks seem to be in a ‘whatever it takes’ mentality. They can’t fix all the problems, but can cushion the blow for many

Consider just how much stimulus is being pumped into the economy:

Source: CitiFX Are there any certainties?

Our team, now working seamlessly from home, has been very busy. Company and industry calls have been the team’s biggest focus. Through our analysis and company contact, we believe there are two key certainties:

1. Raisings still likely a. Cochlear and Ooh! Media both raised money for investors b. At time of writing IDP Education and Kathmandu are running raisings c. / are still looking at funding options and may involve equity, convertibles and even private equity d. There are many others out there that we believe could potentially raise. It will be liquidity rather than covenants that are likely to drive raisings given most banks / lenders seem willing to look past temporary dislocations for good businesses.

2. The pain is being shared a. Normally defensive businesses like private hospitals, landlords and even telcos are going to be negatively impacted b. On private hospitals, it is likely the Government will utilise beds to help with overflow. Certain elective surgeries will be cancelled. The biggest question is how much the Government will pay the private hospitals, like Ramsay, to use the beds. c. On landlords, this week Premier (owner of Smiggle & Peter Alexander) announced the closure of all retail stores until 22nd April 2020. Premier does not intend to pay rent globally during this period! d. Telstra announced they were delaying layoffs to avoid inflicting more pain on an otherwise fragile economy

Opportunities in many places

This is a once in a decade opportunity to buy great businesses at great prices. Our philosophy of “every company has a price” remains at the top of our minds in uncertain times like these. In fact, during times like these, it becomes more important than ever. The natural tendency for investors is to seek safety. When it comes to balance sheets, we totally agree. But we do not believe the COVID-19 impacts we are currently seeing should be extrapolated forever. Perhaps you will feel safe buying a business that hasn’t been impacted by COVID-19, but what price are you willing to pay for that safety? Our view is you need to have some balance in your portfolio because the future remains unknowable. But our strong view is the best allocation of capital right now is buying good businesses, that have been sold off on short term headwinds, and are most likely to emerge in a stronger position on the other side. It is as simple as that.

An interesting way to understand where the market may be pricing a lower for longer scenario, is to consider changes in PE ratios looking out two years. The assumption here, is that we are facing primarily a single year event, which can be debated. The results are quite intuitive:

• Utilities, Staples and Healthcare are fetching close to the same multiples for earnings they were 2 months ago • REITs, materials, energy, financials and industrials have all been materially de-rated

Source: ASX data, Firetrail There are at least 3 explanations why the market is willing to pay much less for certain sectors in a more normal year of earnings:

1. Perhaps year 2 estimates are too high and need to come down further. This is very likely, but from what we know today, it’s unlikely to explain most of the move. 2. The gearing of some businesses is too high and the current balance sheet settings aren’t sustainable (i.e. more equity is required) 3. The fear of the unknown has pushed valuations too low for risky assets

Most likely it is a combination of all scenarios.

What is the worst-case scenario?

This is a question we get a lot, but it’s hard to answer without appearing flippant. The worst-case scenario is that life as we know it has changed forever. Our working assumption is that isn’t the case. The real question for us is, “what will it take to raise equity?”. When a company is forced to raise equity, that is when you can see permanent capital impairment. So how do you determine if a company will raise? It involves looking at:

1. Understanding the operating environment and which costs are fixed and which are variable 2. Understanding covenants, knowing that sometimes these aren’t publicly accessible 3. Considering available liquidity from committed debt facilities 4. Understanding the Board and Management – how much are they willing to take to avoid dilution? 5. Current or potential Government intervention or stimulus into the industry 6. Banks willingness to look through temporary weakness

Having gone through each stock in the portfolio, we feel comfortable. We have trimmed certain positions where we believe there is a risk of raising, giving us the capacity to support future raisings. But raising equity isn’t always the end of the world. During the month, Cochlear (not owned) raised almost $880m at $140 / share vs the previous close of $168. At the end of the month, the stock closed at $187 / share, meaning a very successful experience for shareholders, although they did need to put their hand in their pocket.

STOCK NEWS

Nufarm, with a January 2020 year end, delivered a result in line with recently updated expectations. Most importantly, post month end on the 1st April 2020, Nufarm closed the sale of their Latin America business to Sumitomo and received around $1bn of cash to settle on the transaction (not an April fools joke!). Nufarm is a very 2nd half driven business, in fact 99% of the earnings are derived in the July half given the planting seasons in Europe, America and Australia. The weighting of earnings means that 1H earnings have very little meaning, even more so with Latin America now sold.

Some of the key points from the result included:

1. The seasonal conditions are more positive than they have been for quite some time with Australia a chance of running short of product given recent rainfall and the US looking like having a better year after 2019 floods 2. COVID-19 is likely to see Nufarm carry more product in countries, rather than more central, to avoid the risk of running short 3. The seeds business continues to develop. More on that below.

The seeds business continues to progress, and our research suggests it is the sleeper asset for Nufarm. First sales of Omega 3 (marketed as ‘Nutriterra’) are expected this half and things are progressing. A few key points made on the conference call include:

• Strong results – “We are utilising data from our extensive fish-eating customer trials to reinforce the value proposition of Aquaterra with commercial preparations progressing very well. The trial data is being recognised by the industry as demonstrating important benefits over and above sustainability, reliability of supply, and ease of use, and also include key results pertaining to fish health and quality” • Doubling Omega 3 oil production – “The positive response from our target customers underpins the decision to more than double our targeted oil production this year through increased farm planting and introduction of higher yielding varieties” • FDA approval – “While it has taken longer than expected, a regulatory filing with the US FDA is progressing and we have a high degree of confidence that an approval is close at hand”

Source: Firetrail

PORTFOLIO POSITIONING

When it comes to economic downturns, the strong get stronger and the weak get weaker. The weaker players often have to cut costs more, remove more salespeople, and scrimp on R&D, just to survive. That opens up market share opportunities, both organic and inorganic, for the market leader. We are prioritising capital towards those who can win in the current situation.

The portfolio is tilted towards cyclical businesses, as that is where we continue to see the most value on offer. Having said that, the portfolio also has some defensives where we believe their market leadership is underestimated by the market.

When you put it all together, here is some examples of where the portfolio sits today:

• Cyclical leaders: Qantas, Worley, SEEK, Lend Lease • Defensive leaders: Telstra, , , , Aristocrat Leisure • Low cost commodity producers: Newcrest, Rio Tinto, Oz Minerals, Alumina, Evolution • Unloved and deeply undervalued: Nufarm, Treasury Wine, Downer, , Virgin Money

We are also still working on some current opportunities, which we will be in a position to discuss in the coming months.

Put simply, the portfolio remains highly active, benchmark unaware, and we are seeing some of the biggest opportunities we have seen in a long time.

PORTFOLIO CHANGES

We have made some changes to the portfolio this month. And they can be split into three main categories:

1. Increasing conviction in existing opportunities - This has mainly occurred in the cyclical area where we see deep discounts to our estimates of valuation, low chance of equity raising, and unsustainable equilibriums. The two key examples are Qantas and Worley. 2. New opportunities – We introduced a new stock during the month, gaming business Aristocrat Leisure. The stock has fallen from $33 to as low as $15 during March. The fall was caused by news that casinos globally were being shut down by Government decree. 70% of Aristocrat revenue comes from casinos, so it’s challenging in the near term, and perhaps even for a period after, as casinos reign in capital budgets. But, as tough as it is for Aristocrat, it’s much tougher for their competitors like Sci Games, IGT and Everi. Those businesses have gearing of 3.3-6.5x ND / EBITDA pre COVID19 impacts. For reference, Aristocrat has gearing of 1.4x. The implication is Aristocrat can be a material share winner and it already has significant market share moment. We believe their liquidity position is solid, and looking out three years we see material upside. 3. Selling for better opportunities – Here we reduced our positions in , CSL and . All are great companies, but we see better opportunities for returns in other areas. To buy something, you have to sell something.

In addition, we have built up significant liquidity in the funds to participate in potential recapitalisations that we expect to take place over the coming weeks. We cannot rule out that some of the companies we own raise equity, but it won’t be the end of the world if that occurs, as we have seen with Cochlear. We also have our eye on a few select opportunities, with good assets but bad balance sheets, and would be willing to participate in opportunities should they arise.

FINAL WORD

This is an amazingly difficult time for so many out there. We wish you, your families, your colleagues and your communities the best of luck in this very difficult time. Please reach out to us if we can help in any way.

ONE INTERESTING THING THAT HAPPENED THIS MONTH…

The volatility in the market was out of this world. Some of the intraday moves on large companies like CBA were absolutely extreme.

* An estimate of the total distance travelled between the open, high/low and close of the day, in percentage terms.

Source: FactSet

Firetrail Investments Pty Limited (ABN 98 622 377 913) (‘Firetrail’) is an Authorised Representative No. (1261372) of Pinnacle Investment Management Limited (ABN 66 109 659 109 AFSL 322140). Interests in the Firetrail Australian High Conviction Fund ARSN 624 136 045 (the ‘Fund’) are issued by Pinnacle Fund Services Limited (ABN 29 082 494 362 AFSL 238371), the Responsible Entity. The Responsible Entity is not licensed to provide financial product advice. You should consider the Product Disclosure Statement (‘PDS’) in its entirety before making an investment decision. The current PDS of the Fund can be found at https://firetrail.com/products/firetrail- australian-high-conviction-fund. Firetrail is the investment manager of the Fund. Firetrail and Pinnacle Fund Services Limited believe the information contained in this communication is reliable, however its accuracy, reliability or completeness is not guaranteed. To the extent permitted by law, Firetrail and Pinnacle Fund Services Limited disclaim all liability to any person relying on the information in respect of any loss or damage however caused, which may be suffered or arise directly or indirectly in respect of such information contained in this communication. Any opinions or forecasts reflect the judgment and assumptions of Firetrail and its representatives based on information at the date of publication and may later change without notice. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This communication is for general information only. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice before doing so. Past performance is not a reliable indicator of future performance.

MORE INFORMATION

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