High Conviction Portfolio

Endeavor Asset Management High Conviction Portfolio

September 2018 Quarterly Newsletter

Performance Month Quarter One Yr 2 Yr p.a. 3 Yr p.a. 5 Yr p.a. 7 Yr p.a. Inception

High Conviction 1.9% 2.7% 19.3% 8.8% 15.2% 14.3% 18.2% 247.6%

All Ordinaries Accum -1.1% 1.9% 14.7% 11.6% 12.3% 8.4% 11.2% 92.3%

Outperformance 3.0% 0.9% 4.6% -2.7% 2.9% 5.9% 7.0% 155.3%

Investment Objective The High Conviction portfolio is positioned for capital growth with a relatively high risk tolerance. The equity portfolio aims to consistently deliver strong returns and outperform the All Ordinaries Accumulation Index over the medium term.

High Conviction Portfolio All Ords Accumulation Index 280%

247.6% 230%

180%

130% 92.3% 80%

30%

-20%

1 Yr Return 7 Yr p.a Return Return Since Inception (Nov '10) 19.3% 18.2% 247.6%

Top Contributors Top Five Holdings Investment Strategy Alphabetical Alphabetical Highly concentrated strategy of investing in Money3 Corporation AMA Group emerging small and mid-cap companies for capital Lifestyle Communities growth. We typically invest in companies that have Panoramic Resources strong organic earnings growth, a defendable Vocus Group Lovisa Holdings competitive advantage yet trading at a compelling Medical Developments valuation. We prefer businesses growing into a Money3 Corporation large market that are backed by a credible and aligned management team. Analysis of companies is fundamental bottom up and we invest for the medium term with a 3-5 year view.

Bottom Contributors Asset Allocation Alphabetical Portfolio Construction Decmil Group Typically holds 15-20 ASX listed equities. Typical Lovisa Holdings company weightings are 3%-7% with a maximum

Netcomm Wireless target weight of 10%. No exposure greater than 15% to any particular sector or thematic. No limit on cash weighting which provides flexibility to Equities 82% Cash 18% preserve capital and invest when highly convicted.

Note: Endeavor High Conviction Portfolios were initiated on 1st November 2010 Although the performance of the strategy group is representative of individual client portfolios, performance can differ due to inherent differences between clients’ portfolios. For example, the initial timing of investments, legacy holdings or individual client requirements such as stock exclusions can alter performance. Performance measured is before fees, brokerage, and after franking credits. Top holdings and contributors are listed in alphabetical order.

Quarterly Review

Portfolio review We also added Nanosonics, an ASX200 company, back into the High portfolio during the September quarter. The High Conviction portfolio was up 2.7% for the Nanosonics manufactures and sells disinfection September quarter vs the All Ordinaries Accumulation index equipment for ultrasound probes to prevent infection. up 1.9%. The rolling 12 month return is 19.3% vs All Ordinaries Nanosonics’ technology has global expansion Accumulation index 14.7%, an outperformance of 4.6%. We opportunities, is well placed to take market share away have been holding a relatively high cash weighting in the from traditional cleaning procedures due to its High Conviction portfolio which was approximately 20% at automation, cost effectiveness and faster cleaning start of the quarter and ended at 18%. process. Adoption in US is strong and strengthening. There remains a high customer conversion rate and the Afterpay was the standout performer for the High Conviction pipeline remains strong. portfolio for the September quarter, contributing 4.5% to performance. Afterpay was the best ASX200 performer in Key detractors during the September quarter were September quarter, up 92%. Afterpay has been one of the Netcomm Wireless (contributed performance -1.7%) and most impressive performers on the ASX in recent times as Medical Developments (contributed performance -1.2%). the expansion into the large US online retail market is Netcomm suffered from a deferral of revenue showing signs of strong early traction along with continued expectations for existing contracts with NBN and AT&T in strong growth in Australia. We were initially attracted to the US. We initially invested in Netcomm on the Afterpay with it having what we regard as the hallmarks of a expectation it will be successful in winning value adding great tech stock, that is first mover advantage combined contracts with tier 1 telco’s in US and Europe and we are with a strong network effect between the retailers and retail still confident this will play out. Medical Developments consumers for Afterpay’s easy-to-use online instalment was weaker, mainly due to the uncertainty surrounding payment offering. Whilst we remain optimistic about FDA approval for its pain relief Penthrox in the US. Afterpay’s future, we have significantly reduced our portfolio Medical Developments were able to provide clarity of the weighting based on valuation. additional information required by the FDA in late August which doesn’t appear particularly onerous. We increased Spookfish +72% for the quarter (1.1% contributed our holding in MVP during the quarter and remain performance), Vocus +30% from initial entry price confident in the opportunity and the management (contributed performance +1%), and Money 3 +13% for the team’s ability to deliver on strong growth expectations. quarter (contributed performance 0.7%) were the other top contributors to performance for the September quarter. Site visits & company meetings

Spookfish, a geospatial imagery capturer, performed well on In the September quarter we met with most the back of a takeover bid from US partner Eagleview. We management teams of our existing holdings following initially invested in Spookfish in mid-2016 at around 6 cents results and in addition we met with over 30 companies per share and we have been rewarded with patience, that we have interest in. despite the takeover price being a bit lower than we had initially envisaged the company to be worth. Following a busy period in August, in September we were able to visit the assets of a number of prospective We added a position in Vocus, an ASX200 telco, during the new investments. We also travelled interstate to meet September quarter. Vocus is a company we have followed with the management of companies we were invested in for a number of years and our interest was sparked recently and also potential new investments. We are preparing for due to a change in management and with it a renewed a busy couple of months ahead where we will be strategy, in particular a focus on return on invested capital. attending a number of broker conferences for company As many of our investors would be aware, we place great updates and meetings. emphasis on return on invested capital as an important factor before we invest in companies. Vocus struggled over What we’re looking to invest in the past couple of years with systems that couldn’t cope following aggressive acquisitions, and a management team We are mindful of the recent strong equity returns and that wasn’t focussed enough on return on invested capital subsequent higher valuations in the market and we will which led to capex blowouts for little return. Under new continue to be selective with the companies we invest in. management, we understand there is a renewed focus on For this reason, there are times when our prudent return on capital and unlike many of the other telco’s Vocus approach sees us holding higher cash weightings while isn’t under threat from the NBN. We took a contrarian view we assess opportunities and remain in a position to take and started investing in Vocus around $2.50 per share advantage of new investments when we see more during the September quarter and the holding is 30% since compelling valuations. All our decisions are driven by our we first invested. goal to preserve and grow your capital.

Quarterly Review Earnings growth continues to be the key driver of equity product that has proven itself in the Australian ambulance returns and we see share prices of companies delivering and hospital market) with a clear competitive advantage strong growth to continue to outperform the broader (the best solution to pain relief being administered without market. But we continue to be mindful of those companies the need of a nurse) and a significant large addressable where valuations do not justify the risk reward return. market (worldwide in ambulances and hospitals).

We remain attracted to companies that have sustainable With a major issue of addiction to opioids when used as pain growth opportunities run by great management. Companies relief, an issue that has been making headlines in the US, that are forging their own pathway of growth include Penthrox is shaping up to be a suitable alternative in certain payment processing platform Afterpay, medical infection cases and as such the thematic is working in Medical control manufacturer Nanosonics, and fast fashion jewellery Developments favour. Medical Developments has an retailer Lovisa. We like businesses which are in control of experienced Board and management team and are aligned their own success and are not necessarily tied to the general to shareholders with 32% ownership. Medical device economic fluctuations. We continue to look for companies rollouts such as Medical Developments can be very that can deliver strong growth regardless of the economic rewarding for shareholders if done successfully. cycle. If these businesses pass our key investment criteria they are perfect for Endeavor’s investment strategy of Featured Portfolio Holding - Afterpay investing for a 3-5 year view. Touch Group (APT.ASX) The majority of our investments need to have a strong competitive advantage with demonstrable evidence of Afterpay is this quarter’s featured portfolio holding for the growing market share in a large addressable market High Conviction portfolio. Afterpay allows retailers to offer (supporting strong organic earnings growth) and high their customers the option to buy now and pay later without barriers to entry, aligned management, sound financials and a credit card and for zero cost. Afterpay’s head start came strong return on invested capital (ROIC). ROIC is very through its initial joint venture with Touchcorp which has a important to us as we like investing in companies that are system to quickly assess the risk profile of customer. The reinvesting free cashflow back into the business to drive business model is simple, the cost is worn by the retailer for higher returns. A great example of this has been Lovisa, a similar fee between 4-6% and in return they receive a which continues to invest in expanding stores globally with a higher average basket size, which in the case of some new store payback of only 1 year representing a very strong retailers is 40% higher than a traditional customer. If the ROIC. We are wary of investing in companies with a low customer pays on time, they pay nothing more than the ROIC that can potentially destroy shareholders equity. Case retailers’ price tag. in point is Vocus. Vocus has been in the doldrums for the past 18 month as previous management lost sight of the Afterpay has been popular and growth in customers and importance of ROIC. Under new management with an retailers has been explosive. In less than five years Afterpay understanding of the importance of ROIC, we recently has attracted 2.3 million customers and 18,000 retailers. initiated a position in Vocus and is already up 30% since initial With less than $100,000 spent on advertising Afterpay is purchase price and was up 41% for the September quarter. now processing one quarter of Australia’s total online fashion spend and over $3 billion in annualised sales and We are regularly coming across emerging companies that growing quickly. meet our investment hurdles but exceed our internal valuation (attractiveness of an investment opportunity) in In January 2018, US venture capital fund Matrix Partners which case we remain patient. We feel one of the key invested $19m in Afterpay to support its entry into the US benefits of being a smaller and more nimble investor means retail market. After meeting management several times and we can move quickly if a correction presents a buying gaining comfort in the valuation if the US expansion was opportunity. A recent example of this has been our additional successful, we invested in the business shortly after this investment in Medical Developments, which is rolling out deal at approximately $8/sh. Afterpay launched in the US in globally a non-narcotic fast acting pain relief known as May 2018 and by July 2018 the share price was $16/sh after Penthrox. Medical Developments was a detractor in the announcing that the platform had processed more in the September quarter, detracting -1.2% from performance. To first month than the first 16 months of operation in Australia. us this was a buying opportunity. Penthrox is widely used in After pulling back from $16/sh and consolidating around Australia and has been approved for use in the majority of $14/sh the share price increased to $23/sh following a European countries and is currently going through the FDA capital raise to fund an expansion into the UK due to retailer process for approval in the US. We saw the weak share demand. Afterpay closed the quarter at $18/sh, up 115% price as a buying opportunity, particularly after meeting from our initial entry. management. We took profits for clients during the quarter but Afterpay We are attracted to Medical Developments as they have a remains a high conviction investment for Endeavor and an exciting Australian business that we look forward to watching closely. Note: Endeavor High Conviction Portfolios were initiated on 1st November 2010 Although the performance of the strategy group is representative of individual client portfolios, performance can differ due to inherent differences between clients’ portfolios. For example, the initial timing of investments, legacy holdings or individual client requirements such as stock exclusions can alter performance. Performance measured is before fees, brokerage, and after franking credits. Top holdings and contributors are listed in alphabetical order.

Market Commentary

The All Ordinaries Index was up 1.9% and the Small Ordinaries Index up 1.1% in the September quarter, led by the Communications sector which was up an impressive 22% and followed by the Information Technology sector which was up 10%. The major laggards were Utilities down 6% and Materials down 3%.

The declining AUD/USD continued to be a predominant theme with increasing inflation expectations in USA resulting in international money flows into the USD in anticipation of a higher bond yield. In 2017 we were in a period of synchronised global growth prior to interest rate hikes but now the economic data in the United States is supportive of higher interest rates and quantitative tapering as the Fed continues to unwind its balance sheet. Implications for Australia are continued downward pressure on the AUD/USD, as the cash rate remains steady, which supports our export economy coupled with global growth still fuelling demand for commodities. We feel there are a number of investment opportunities emerging due to this changing economic landscape. We are also paying close attention to the property market and implications for the Australian consumer but at the moment we expect a period of moderating price decline rather than an abrupt pullback.

Top and Bottom Performers Top and Bottom Performers ASX200 Index Small Ordinaries Index Company Quarterly Return Company Quarterly Return Afterpay Touch 92.0% Clinuvel Pharmaceut. 100.1% TPG Telecom Limited 65.2% Afterpay Touch 92.0% Mayne Pharma Ltd 49.4% Pro Medicus Limited 55.4% Vocus Group Ltd 42.0% Nearmap Ltd 52.0% Wisetech Global Ltd 41.1% Mayne Pharma Ltd 49.4% IPH Limited 35.3% Pinnacle Investment 47.7% Technology One 31.3% Mesoblast Limited 45.3% Soul Pattinson (W.H) 25.5% Vocus Group Ltd 42.0% Credit Corp Group 23.2% Wisetech Global Ltd 41.1% Brambles Limited 22.7% Myer Holdings Ltd 37.8% Nufarm Limited -24.4% Pact Group Hldgs Ltd -29.4% Evolution Mining Ltd -24.5% Westgold Resources. -31.4% Western Areas Ltd -25.3% Lynas Corporation -31.8% Regis Resources -27.3% Clean Teq Hldgs Ltd -32.3% St Barbara Limited -27.7% Bellamy's Australia -34.2% Estia Health Ltd -28.0% Speedcast Int Ltd -35.0% Pact Group Hldgs Ltd -29.4% BWX Limited -36.8% Lynas Corporation -31.8% Kidman Resources Ltd -43.0% Bellamy's Australia -34.2% Asaleo Care Limited -48.0% Speedcast Int Ltd -35.0% RCR Tomlinson -52.4%

Looking at stock specific performances during the quarter the strongest performances in the ASX200 were from Afterpay +92% (invested), TPG +65%, Mayne Pharma +49% Vocus +42% (invested), Wisetech +41%. It was pleasing to hold two out of the four top performers for the quarter. There is a new generation of companies emerging on the ASX which is exciting to see. Seemingly high valuations for these companies at times are the main deterrent to investors but it is important to realise they have strong capability to exceed growth expectations priced in by the market.