Cadence Capital Limited (CDM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the September quarterly update for Cadence Capital Limited. For the financial year-to-date, the fund has returned 13.2% against the ordinary accumulation index, which is up around 1.1%. I think the significant outperformance that we've experienced has been delivered both on new and existing positions and both on domestic and international stock. So it's been a combination of different exposure that's delivered a significant outperformance. As I'm sure you are aware, the global markets have recovered now from that period of a massive fall in the markets around March due to the first signs of COVID. And then, of course, the quick recovery and then from then on the gradual recovery to where we find ourselves now. I think it's fair to say there's been a fair bit of water under the bridge since the beginning of this calendar year 2020. We have, as we've indicated in previous webcast, but importantly, to remind our shareholders, we have scaled out of positions into high levels of cash during this period, creating a conservative position with lots of cash in a period of great uncertainty. And then we, once again, scaled back into positions, and both of those 2 initiatives have caused significant outperformance for the fund, and they're an important component of this fund. Not all funds have a mandate, allowing them to move to cash and then redeploy the cash so quickly. Over the past 2 months, our net exposure has dropped slightly as funds have scaled out of some of our positions, while simultaneously scaling into new positions. So you will see how exposure rise and fall, but those big falls in exposure and high levels of cash and then the deployment of that cash very quickly in such a short space of time, that is unusual, and we have been living in very unusual times. The liquidity and concentration of the portfolio has improved significantly over the last 18 months, and we will go into that in a bit of detail. So the year-to-date performance is a slide that you see in the monthly newsletter. This month, we've outperformed the market by 3%, year-to-date, 13% and on a 1-year basis, 16%. You can see importantly, our since inception numbers were up 453% against the market, that's up about 145%. So a significant outperformance over long periods of time. I won't go into the stocks that have performed well and those that have underperformed, we are going to go into those a little bit of detail over the following slides. By now, you would have seen the company has announced a final dividend of $0.02, fully franked for the period, bringing our total dividends paid to $1.04 and grossed up, that's $1.48 per share since inception of the fund. The payment for that dividend is going ex on the 19th of October and being paid on the 30th of October. Once again, there's no dividend reinvestment program in place because the board and management do not want to issue shares at a discount to NTA, and we are currently trading at a discount to NTA, which brings us on to the next slide and a really important slide at the moment for this fund. You can see that would have traded at a significant discount to NTA. Actually, the discount to NTA was worse than during the global financial crisis. We've outlined that period on the slide as well. And then we once again moved to a premium for 3 or 4 years. And again, this discount emerged and is now compressing again. Interestingly enough, as the NTA recovers and the performance recovers, it takes some time for the discount to NTA to recover. I guess what we call in economics, a lag indicator. And that, as always, I keep saying to people that creates an opportunity for people to buy into the shares at a discount to NTA. We have been buying back shares on behalf of all shareholders in the share buyback. And as previously indicated over several years now, I have been also buying shares, adding big discount to NTA. As -- part of my long-term strategy is obviously to add to buy positions over time and why not do that at a discount to NTA. So now to the pre and post-tax NTA. At the end of the month, it was a $0.90 pretax NTA and a $1.07 post-tax NTA against a share price of $0.74. You can see that significant discount to NTA in that share price there. And we do get asked a bit about that $0.16 differential between pre and post-tax NTA. That is an -- in actual fact, an asset. So it's going to allow us to earn profits in the future, which we're not going to have to pay tax on. And that could be up to $0.53 of profit that we're not going to have to pay tax on. Obviously, as we go along, we're going to be earning fully franked dividends on our portfolio, and we're still able to pay out fully franked dividends. And when we do realize profits where we pay tax on that, and we're able to pay fully franked dividends on that as well. But there is also going to be that added benefit at the moment of being able to earn significant profits without paying tax. So that not only are you buying into a stock at a 20% discount to NTA, you're going to have some tax asset buffer on profits in the future. And of course, that buffer will allow that portion of the tax -- those profits to be tax free. More recently, the discount to NTA has started to close. Interestingly enough, as the NTA goes up, the share price goes up. But sometimes the share price goes up more than the NTA goes up, sometimes less. So we're still, after all this time, trading at around an $0.18 discount to NTA, but the percentage discount is reducing. Obviously, over time, we are working on reducing and eliminating that discount to NTA, and we've spent significant amounts of time doing that. We're all going to talk now on the portfolio and composition and also in particular thematics that the portfolio managers have been working on. So let me introduce Charlie and Jackson to take over the next few slides. Thank you.

Thanks, Karl. My name is Jackson Aldridge, Portfolio Manager here at Cadence Capital. So first, we wanted to talk about the portfolio composition. The market capitalization breakdown of some of the positions, how the liquidity has improved over the last couple of years. And then we'll kind of go into a couple of the key themes that we've identified throughout the COVID process. So this first table at the top, you can see the portfolio significantly skewed to companies of $500 million market capitalization and above, and I think what naturally comes of that is higher liquidity in these stocks. And that's where we have really been focusing over the last 12 months. And in fact, the COVID drawdown in the markets was actually a significant opportunity for us to speed up this process. It provides us with ample opportunity to get out of some of the existing positions and then entering some of these new positions. So as you can see there, the second point, liquidity of the portfolio has significantly improved, with 80% of the portfolio being able to be liquidated within 1 week and 86% within a month. And then the bottom table, I've just compared the portfolio from 2018 to now and the concentration risk that we've reduced in the last 6 months. The top 5 positions actually accounted for nearly 40% of the portfolio in 2018 and now that's at 20%. And you can see down there, the [ feed ] is for top 10 and top 20. So we feel we've done a really good job at reducing the risk of portfolio concentration. On this next slide, it's the top 20 holdings in the fund at the moment. I think from our previous webcast, there's 3 new additions here, Costa Group, Nvidia and Pinterest, and we're continually adding to positions, true to the Cadence process, that continue to go up of stocks like ARB, AP Eagers, et cetera, have done really, really well for us, and we continue to believe in the story. And Charlie is going to touch on the thematic that is continually driving those stocks higher. Another thing to note across the portfolio is it's diversified across a number of sectors and geographies. We actually have 20% of the portfolio invested offshore at the moment. So we feel that provides investors with a significant amount of diversification. So in our last webcast, we addressed a number of themes that we saw emerging. And in fact, some of them were actually accelerating. So I guess, using the word emerging for the theme that I'll touch on first is probably not the right thing to do because it's actually just accelerated. The themes that we identified previously were the digitization of the world, payments, e-commerce, et cetera, the auto industry recovery, how smaller diversified financials we're taking away share from the big banks, and then our last one that we identified but, unfortunately, we didn't get correct, but luckily, with our scaling process, it's got us out of the position, was the oil price recovery. So the first slide is the move to digital. It's no secret there's structural trends that have evolved or accelerated from COVID and the work from home and the social distancing measures that have been put in place. And initially, we felt that established large incumbent technology providers would be the first to benefit from this or actually lean into the demand as they've been doing over the past 5, 6, 7 years. For example, Amazon has set up AWS over the past decade, and COVID has just accelerated this trend, but they've already made the investment. So we thought these large incumbents would see significant benefit early on. And we established new positions in a number of these players. Recently, we've trimmed a couple as they've rolled over and the recent kind of tech sell off, if you want to call it that. But we do still have positions in a number of these. The second trend that we saw was the emergence or the acceleration of digital e-commerce and social platforms. At that are earlier stage in their commercialization and monetization. And so we saw a step change in the profitability and the revenue growth and the user growth so a couple of examples in the portfolio is Redbubble and Pinterest. So for Redbubble, we saw pre-COVID revenue growth of 26% and in July, that had accelerated to 132%. And so we feel that there's been a significant shift of users using the products, the platforms and feel that's structure. There again, with Pinterest, you could see pre-COVID revenue growth was 23%, and that accelerated to 50% in July. Even as traditional kind of digital ad sales for the larger Facebooks of the world, they actually declined double digits. So Pinterest has had a significant increase in users and monetization, and then it's all accelerated throughout this COVID process. I guess in the other topic that I wanted to touch on related to the technology and the digitization theme was the infrastructure needed and the hardware needed to -- for these trends to emerge. The trends or the hot topics that people are talking about, Internet of the things, the cloud, or autonomous vehicles, et cetera, et cetera. It's not just the software associated with these technologies. There's a hardware that actually powers the technology. So we've seen a number of these have a pull-through and a significant increase in demand. A couple of the ones in the portfolio Nvidia. Nvidia is a hardware processing provider that is related to kind of online gaming and the new growth in the products coming through the data center demand. So as you've seen the cloud product for the Amazons and the Googles of the world, have significant pull-through demand that they need to power this transition. And Nvidia is providing some of the hardware to capitalize on this. Even a couple of stats related to the company, in the pandemic, most companies were cutting staff, cutting pay, et cetera, et cetera, employees at Nvidia actually got a pay rise and significant bonuses through this period because of there's just so much work. And another little point there is they sold out of their new gaming chip in 3 minutes just last week. So there's still significant demand, and we believe it's a structural trend that's going to continue. The other couple of companies that we've identified in the portfolio and taken positions in related to kind of the 5G technology and the ramp-up in the cycle. Semiconductors are quite cyclical in the ramp-up of the cycles of the 3G, the 4G, and now we're kind of leaning into the 5G cycle now. So a couple of companies that we've taken a position in a Qualcomm and Xilinx. Qualcomm seems to be past a lot of the legal issues and patent issues that had plagued them in the past, and that seems to be transitioning. And the EPS growth, the supply deals that were held up in court have all been eliminated. So it seems quite positive for them. So I'll now pass on to, charlie to touch on a couple of the other themes, and we'll provide an outlook moving forward.

Thanks, Jackson. My name is Charlie Gray, Portfolio Manager here at Cadence Capital. The first theme I'll be speaking about would be auto industry recovery theme. And we touched on this in June, but really since then, it's stepped up a gear. It's really been fascinating. Just to rewind, I guess, for some context since March and April, originally, it started out as a theme, driven by the social distancing restrictions, people preferring personal transport some of the stimulus measures that we saw coming in feeding into the industry. But there was always some uncertainty of how that would play out exactly. We initiated positions in some of the company's ARB, car sales and Eagers, in particular, that have had a history of performing in tough periods historically. And then really, as we've moved through the year, there's been a significant demand push into this channel. And we've really seen it across the consumer discretionary space, but in particular, in the auto space. And one factor in particular that I think, has been a more significant driver than we originally thought is this redirection of spend from -- people can no longer go to international trips, which is a big ticket for most families. Eating and drinking out. It's also another big category of spend that is now restricted to or has been restricted to a large degree. So this sort of redirection of reallocation of spend into these other discretionary categories has been a major factor and a big driver in excess of just the tax breaks, in excess of just the stimulus and the asset write-offs. The early super withdrawals have played a part as well. And in particular, if we're talking about more recently, what these companies are seeing, Arb Corporation actually recently provided an update and they're seeing demand for their automotive aftermarket accessories, both domestically and internationally. Melbourne is a bit tough due to lockdowns, but there's signs that, that is starting to improve as they remove those restrictions. But interestingly, the international business is growing much, much quicker than the domestic business, suggesting that it's -- that there's similar consumer behavior globally. It's not just the domestic government support packages then that are driving this demand. It's -- there's the biggest theme at play here. In terms of AP Eagers, they're seeing strong demand for their new cars, but limited stock in their [ senates ]. So this is leading to very strong gross profit outcomes for the company as the need to discount has been reduced. Limited stock across the country is really for the whole sector, reducing that or removing that need to discount to be able to move inventory to make sales. So the whole sector is really quite buoyant in terms of the gross profit numbers, not -- while volumes are down, the gross profitability is actually at all-time highs. Car sales is seeing a similar dynamic with less stock or less listing volumes on their site, offset by strong buyer inquiry coming through that channel. And used car pricing now at all-time highs. I think it's increased 15% to 20% in the last few months. In terms of the next thing, I think that we have been talking about for a few years now is the diversified financials taking share from the larger banks. And it's a theme that continues to play out. This was 1 sector that was, in particular, sold down very heavily in March and the positions that we've had for some time were also caught up in that sell off. This is the Resimac position, the Money3 position. We initiated new positions in Credit Corp. and AFG after March as well. And really, we're seeing a continuation of the same thing. As the big major 4 banks become more burdened with compliance, more burden with political and sort of social, I guess, oversight, less willing to take risk and removing themselves from a number of lending categories that they were in previously that's given an opportunity to these new players or smaller, more nimble players to take share and become more aggressive. In particular, in auto lending for Money3 and in Prime and near Prime for Resimac. So the point here we've made is in terms of general conditions now, most lenders still remain quite cautious. They have increased their lending standards. That remains the case. But we are seeing them starting to become more comfortable in lending, particularly to those customer segments or business segments that are less exposed to the pandemic. Another point we make about the housing market, that's obviously been quite resilient over the last 6 months. And with the federal budget, which Karl will touch on in a second coming out recently and looking to be quite supportive of our construction development recovery over the next 12 to 24 months. This last point here, it's really just a comment that these businesses and really any of these businesses that we've been speaking about, the ones that have adopted the quickest and the best to this new environment have seen the best market share gains and are seeing the best opportunities on the other side. If we turn now to one theme and the last theme that we'll touch on that didn't work was the oil price recovery. And really after our June update, we scaled out shortly after the positions as they rolled over. The stocks with oil search are Woodside and Santos, in particular, that we scaled out of or that were in the portfolio and we've really seen the demand for oil and not come back to the degree that's needed to balance the market. The supply side still -- they're still -- or don't have their house in order in terms of meeting the quotas. So this is one theme that we continue to like on a longer-term view, a deeply sort of cyclical recovery, but one that's not playing out at this moment in time, although we are 6 months closer to some recovery. Now I'll hand back to Karl to talk about the outlook.

Thanks, Charlie and Jackson. And of course, we're always limited by time. We haven't been able to talk about the agricultural sector. We haven't spoken about the base metals recovery. We haven't spoken about silver. There are a lot of areas that we have within the portfolio, early stage parking [ positions ], which we simply haven't had time to talk about. So really, just in summary, we know that there has been a strong recovery since March. We know the market reached a point of maximum pessimism in March when everyone was going to short capitalism is going to end, it was going to the end of the world. Once again, that didn't happen. We've had a recovery. And interestingly enough, over the last, say, 6 to 8 weeks, we've seen that recovery, and now we're seeing volatility. Volatility and uncertainty as the market tries to make up its mind, whether it's going higher or whether it wants to go lower. To complicate things further, we obviously have a big U.S. election coming up, which is creating more volatility and uncertainty. This -- the negativity associated with March appears now to be behind us. And the markets are functioning a lot more efficiently, and we're not seeing the deep disconnect in pricing. However, investors are still grappling with ongoing risks. And I think it's put quite well in his third sense here related to the pandemic and elevated valuations on one hand with low interest rates versus the unprecedented government support and central bank support and emerging signs of the economic recovery on the other. So you've got 2 of these forces playing off against each other, and that's really what's creating the short-term volatility. There's a significant market share opportunity in each -- in many sectors as the recovery takes progresses. And these gains will be best capitalized in businesses that have adapted to the new environment. Once again, smaller private businesses are suffering more than larger well capitalized businesses that can now take advantage of these uncertain times and opportunistic valuations as well. Importantly, we are a few days out now from the 2020 federal budget and this has been a significant positive for the Australian economy and will obviously support the recovery over the next 12 to 24 months. These are unprecedented budgetary measures, and they will cause a deficit of up to $200 billion over the medium term, amounts of money we simply don't normally talk about. This is not an Australian phenomena. This is a global phenomenon and should go a long way towards holding economies up globally. Obviously, our improved liquidity and diversification means that we're much better positioned to deal with the uncertainty, that is most likely going to continue for some time. But importantly, we're going to continue to look for new positions. We've outlined some that we'll no doubt be adding to. And as physicians are a rollover, we'll be scaling out of them. So we feel reasonably well positioned to benefit in this upcoming 12 to 24 months. Once again, ladies and gentlemen, I always encourage everyone to go to our website to see some of the editorial pieces that we're doing. And importantly, if you haven't joined our newsletter, please do. Thank you very much again for your time.