Cadence Capital Limited (CDM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the half yearly webcast for Cadence Capital Limited. Hopefully, by now, you've seen that we've released our half yearly results onto the ASX. We've had a record profit of $69 million and an after-tax profit of $48.5 million. That's come about through a gross performance of around 28%, outperforming the All Ordinaries Index by 12%. We've also announced at a Board level the $0.02 fully franked dividend, which equates to around a 4.5% fully franked dividend. And when you gross that up for the franking, it's around 6.5%. The top contributors for the period -- the 6-month period were Resimac, Pinterest, Lynas, Money3, AP Eagers, Pointsbet, Credit Corp, ARB Corp, Redbubble, Qualcomm and Reece. As you can see, that's a wide spread of companies that have been the top contributors, which is pleasing to see. And the largest detractors from performance were WiseTech Global and Jumbo Interactive, and they were obviously much smaller losses as well. The following slide is a year-to-date performance table, which should be familiar to anyone that reads our newsletter. You can see our long-term numbers there. Since inception, we've done about 12.5% per annum against the market's All Ordinaries Index of 7%, with 5.7% outperformance against that index. More recently, we're outperforming the index by around 16% year-to-date and over the year, around 25%. The continued outperformance has occurred in January and February. This was the December year-end and January and February have been particularly strong months for the market and for our fund, I'm pleased to say. This strong performance has been delivered across both new and existing positions and domestic and international positions. So it's good to see a diversification of performance across different sectors and marketplaces. Turning now to the pre- and posttax NTA. You can see on the 19th of February here, our pretax NTA was $1.08. Our posttax NTA was $1.18, and our share price was $0.93. So we're still trading at a significant discount to NTA. We were trading at a much larger discount to NTA. In fact, at the point of maximum pessimism during the COVID crisis or panic in March, we were at about 40% discount. And I remember talking to everyone then and saying, look, we're actually trading below cash in the bank at this stage. Now we've had a buyback in place, and we've been buying shares back. We bought back a total of 23 million shares at an average price of $0.73 to $0.74. And that discount is trending lower and lower. Interestingly enough, just before Christmas, the discount to NTA got to around 13% and then has more recently blown out again as our performance has improved. So we hope over time that, that will once again contract as we continue to buy back shares. Obviously, the -- I think you'll see in the ASX announcements that come out on a regular basis, the Board and management of the company continue to buy back CDM shares as well. So we're also of the view that it's better to buy these shares at a discount to NTA. Our tax asset position is now $0.10 per share. And with these profits, we've actually used up a significant amount of our tax asset, which is pleasing to be able to announce as well. So we're eating away that tax asset very quickly now. Turning now to the composition of the portfolio. We've spoken about this slide before at the full year and actually the half year before that. This is really more or less an 18- to 24-month project we've been working on, which is the improvement of liquidity across the entire portfolio. And you've heard us talking about this on a semi-regular basis. Our liquidity has significantly improved, with around 78% of the portfolio being able to be liquidated within 1 week and around 87% of the portfolio being able to be liquidated within 1 month, and that's usually 30% of traded volume. That is a very, very good improvement in liquidity. We currently have around 55 positions, and the largest position in the fund is a 7% position. All of this is pointing towards improved liquidity. As we stand here now, we're holding 15% cash. You would have seen that we went to almost 100% invested coming out of the COVID crisis, and a number of our positions have rolled over slightly, and we've reduced our exposure. So we're sitting at about 15%, with our long-term average cash holdings usually around 20%. I'd like to turn now to Jackson and Charlie to take you through the top 20 positions and also the important themes that are emerging for our invested portfolio.

Thanks, Karl. I'll now touch on our top 20 holdings as of 31st of January. And as you can see, across the portfolio, there's a number of domestic and international stocks across a number of different industries and sectors, giving a nice diverse exposure across the portfolio. Given that we're maybe halfway through the reporting season, I'd like to call out a couple of standout results that we've had across the portfolio. First one being Costa, we touched on this stock in the previous webcast and called out that they may experience some significant tailwinds that were previously issues, given climate issues and prior pricing issues across the company. So the company talked towards a really good FY '20 outlook across a number of the produce segment and international and citrus harvest has been off to a good start. The second stock I'd like to talk about that's had a good result is Uniti Wireless. The company came in 10% of consensus estimates, and has talked to earnings doubling over the next 5 years, given the strength in the order book for the Wholesale & Infrastructure business. And then lastly, the result that was really good for us was Credit Corp. Management has proven the ability to navigate a tricky environment, once again, coming out of the GFC and then once again coming out of COVID, making smart bolt-on acquisitions and continuing to make accretive growth in the business. So just on a couple of themes. Last webcast, we touched on a few, and I'd just like to revisit one of the themes that we kind of outlined, which is kind of the digitization of the economy and different ways that people transact and kind of lead their day-to-day lives. So the first one is e-commerce continues to boom, but there's been a bit of a divergence between international and domestic stocks. We've seen some of the domestic companies start to show a little bit of deceleration. So it might have been a significant pull forward through COVID, whereas some of these offshore companies that we've invested in a much earlier stage in kind of the monetization and commercialization of the business model, and they've actually continued to accelerate throughout this period. So we believe there's still significant potential for these businesses to grow. And I guess the one I want to allude to is Pinterest, which has been one of our big holdings and one of the top performers, as Karl mentioned before. The business, in its most recent quarterly earnings, has kind of outlined that it's accelerated again from 60% revenue growth to 76% revenue growth in the previous quarter. We believe that the company has a unique value proposition. The people are on the platform to buy and make a purchase, whereas on other social media platforms or other social platforms per se, they're actually just browsing through. So we believe that the user is a much more directed buyer, and therefore, advertisers are starting to notice this and spend much more targeted advertising dollar towards this consumer. And just recently, just last night, Snapchat, which is a -- it's a similar business, but has just talked to -- they've guided towards 50% revenue growth for the next 5 years that they can foresee. So you can see the significant shift away from some of these traditional platforms such as Facebook, that has been caught up in a little bit of the political issues and things there. So I guess the point there is some of these international businesses may have a longer growth trajectory than some of the domestic ones that we previously mentioned. The second point, and there's a few different segments, the point is that a number of technologies are helping consumers and businesses in the reopening phase. I think it might be a bit naive to think that technology is just a work-from-home thing. We're seeing a number of these developments and entrepreneurial businesses assist with the reopening phase. It is no secret a large chunk of Google's revenue comes from advertising spend. So as small and medium businesses start to experience a bit more activity, they can spend money back onto the platforms. And then I guess the other point I want to make there on Google is it's the first time they've split out the Google Cloud segment, and it's showing 50% revenue growth. So the whole shift to the cloud, a number of people are saying it's in the early innings, and Google continues to show that. In fact, they're actually -- it seems that they're winning share from AWS. The second point, I'd like to make a note of, we have a couple of holdings kind of relating to this theme is there's a number of things that are helping state governments deal with deficits and kind of through tax revenue. And one specific one is the U.S. gaming and 2 specific stocks related to that is Pointsbet and DraftKings. So what COVID has done is it created a significant deficit in a lot of state budgets. And by legalizing the gaming, they can deal with this budget deficit. And it seems as if a number of states have brought forward the legislation from 2024, 2025 into 2021. Specifically, Texas is talking about doing it this year, where I think a number of people were thinking 2025. So according to our estimates, we believe that the total addressable market is 2 to 3x the size of what domestic and international analysts are projecting. The last point that I'd like to make is relating to the housing, Charlie will touch on that, the housing recovery as well. But yes, specifically, the U.S. housing market hasn't seen a significant bull run for a number of years, and we're seeing early signs of that. And I think what a lot of domestic investors could potentially relate to this business called Redfin is the platform such as Domain and realestate.com, which provide the access for buyers and sellers to kind of transact. The U.S. market in terms of housing is much more old school or dated in that sense. And then even the model for agents, agents actually receive 6% commission when they're selling a house. So we believe this industry is ripe for disruption. And Redfin and Zillow is another holding of ours, which is playing a key role in disrupting this industry. So I'll now pass on to Charlie to touch on a couple of other themes, and then Karl will wrap up with an outlook.

Thanks, Jackson. Now I'll discuss 2 more investment themes that we're seeing emerge in the portfolio and that we believe will play out through 2021. The first theme is the consumer spending boom, certainly which was a force in 2020, but we think can continue to play out and broaden this year. And some data to consider in this slide was released by the federal government, which show that to the end of November, businesses and Australian households have accumulated over $200 billion of additional savings. This is going to take some time to work its way back into the economy. Consumer confidence has also recovered, albeit from depressed levels. And Aussie dollar is, obviously, very strong, which benefits retailers, importers and anybody buying goods from overseas. International border restrictions obviously are going to be a big factor on exactly where this spend is directed. And for the near term, it seems they'll be in place. But with the successful vaccine rollout progressing, this is something certainly there's some light at the end of the tunnel here, and we should keep track of that. In terms of actual stocks in the portfolio benefiting from this theme, the first is ARB Corporation. This stock we've touched on a few times previously, and they continue to see sales accelerate into 2021. In particular, the global business has been very strong, but the domestic business is now starting to catch up. ARB, their order book continues to hit record highs, and management have commented that it's actually in absolute terms 2 to 3x the size of their usual order book. So it gives them a fair degree of visibility going forward. Also supporting the outlook for the company is a swathe of new product releases, a couple of partnership agreements with OEMs in North America and the potential to expand their U.S. distribution. The next stock I'd like to discuss is Baby Bunting. And we think that they could benefit from a potential baby boom through 2021. We've seen in MBS data, ultrasounds up 10% in the December quarter versus the prior year and also hearing that chemists are seeing strong double-digit growth in prenatal products. So Baby Bunting in January and February saw sales accelerate when they've -- which they reported recently. And despite -- they will have to cycle quite strong results coming through the next 6 months, given they, as an essential retailer, were not closed down that we think the Baby Bunting -- plus other internal initiatives that -- and a small online business, we'll see that the sales are relatively well supported. The last stock in terms of this theme is Sonos, a relatively new holding that we added late in calendar 2020. Sonos was impacted quite severely by the pandemic as their major channel to market was the professional installation channel and that was all but shut down really in COVID. But it was a blessing in disguise for the company as it really forced them to go and develop the direct-to-consumer market. And as sales have rebounded and demand for their wireless sound systems has been quite strong, that this is now about 1/3 of the business. The good thing about this channel is that it's much, much higher margin. So the profitability is -- for the group has increased materially. From a low -- very low single-digit EBITDA margin, now they're well into the double digits, and there's been 2 upgrades over the past few months. Another interesting for Sonos is maybe intentionally or unintentionally, there's been a degree of forced sort of product replacement cycle, where they've done a software refresh and some of the older products are no longer supported. So it's pushing people to buying new Sonos products. And there's been a fair degree of investment in the new product pipeline to aid that. The last point on Sonos is they're making investments into building out their subscription and advertising revenue streams through the radio and podcast products. And now on to the next theme that I'll discuss, which is the property recovery, obviously, also benefiting from the significant savings that households have built up, but also the historic lows in mortgage rates that we're seeing sub-2%. It's also benefiting from the government's fiscal stimulus, including the HomeBuilder program, where we've seen building approvals up 50% year-on-year in December. And across the financial sector more broadly that we're seeing in this reporting season, our bad debt experience has been a lot better than expected, which is leading to a number of banks and other companies reversing some of the provisions that they were taking. And the implications of this is really that -- just that these companies can now be more aggressive in returning to loan book growth and lending. Refinance activity for mortgages, as you'd expect, has also been very high. AFG, a holding in the portfolio, is benefiting from this. So they've seen home finance lodgements in the December quarter up 30% year-on-year. Resimac is obviously well positioned, well, to continue growing the loan book and also on its NIM -- on the net interest margin, which continues to benefit from the RBA policies. Lifestyle Communities is another holding in the portfolio that's seen sales reaccelerate into the new year as restrictions have come off in Melbourne and Greater Melbourne, and they're well positioned as they've been investing in product through the COVID period. So they've got a lot of stock ready to go. I also want to touch on Maas Group, a recent addition to the portfolio. We participated in the IPO in December. It's a business with a founder-led CEO that's got significant leverage to the regional New South Wales infrastructure and property demand dynamic. One thing that we did like about that offer is that employees in the business subscribed for a significant amount of shares at the IPO price with other new shareholders, which is always a good sign. And just the last point here, just making about M&A activity, where, obviously, it's clear that M&A activity is picking up across the board. Low rates are also driving this, it's allowing private equity funds and other super funds to be able to -- to access debt very cheaply and to be able to buy assets and leverage them up, pay relatively high prices. And we think that, that will continue. That's affected the whole Bingo Industries, which is under a nonbinding, indicative bid at the moment, which is a position in the portfolio. So those are the 2 themes that I was going to touch on, and I'll now pass to Karl to wrap up with the outlook.

Thanks, Jackson and Charlie. We thought it was important to give our investors an update on the DeepGreen investment now as well. We invested in DeepGreen several years ago. And at the time, the company was to list on the Canadian Stock Exchange. Now that stock exchange listing was delayed. The company was then going to list on the NASDAQ, and that was delayed. Now the company announced on the 4th of March that is intended to list through a merger with Sustainable Opportunities Acquisition Corporation, New York Stock Exchange code, SOAC. The company will, at the same time, change its name to a metals company and have the New York Stock Exchange code TMC. This position is approximately 2.8% of our portfolio and is carried in our portfolio at the average cost that we paid for those shares. The proposed listing is at a valuation substantially higher than it is currently being held on our balance sheet. The transaction reflects a pro forma valuation for the business of $2.9 billion and an enterprise value of $2.4 billion. The recent raising in America of USD 330 million was done at a price of USD 10 per share. Our position is held in our portfolio at USD 1.38 per share. Upon listing, this would equate to a substantial uplift in pre- and posttax NTA for CDM shares. The transaction is subject to the usual shareholder and court approvals, and that will come to fruition over the next little while. Once the TMC shares are listed and trading freely, we will value this investment at market price. So it's important for shareholders to realize that the weekly NTA and the monthly NTA at the moment will not include the uplift for the DeepGreen shares until such time as that uplift is actually trading on the New York Stock Exchange. Turning now to the outlook for the period ahead. Obviously, the press and the paper and everything you're seeing at the moment is that the All Ordinaries Accumulation Index is about to make new highs. And when you think of the massive lows that we had in March last year and the significant move from those lows to these new highs, there's obviously a lot of nervousness that the markets have moved so significantly in such a short space of time. And that nervousness creates nervous energy and angst and worry and that ongoing daily noise that you see in the newspapers and in journals on the news -- and on television. But if we cut out the point of maximum pessimism from that COVID scare last year, actually, there's nothing spectacular going on in the All Ordinaries Accumulation Index at the moment. It's just drifted up a bit compared to its previous high. And as we reach those new highs, we will hopefully be catching the rest of the world like the American indices, for example, that have hit new highs a long time ago and are making new highs almost every day. Why is that? Well, the theme continues. Interest rates are extremely low and governments around the world are throwing as much money and stimulus at the problem as is required. And to a large extent, this has actually worked, especially in terms of asset prices and reflating or inflating asset prices. Of course, the real worry, which people are starting to look at in detail, is those moves in longer-term interest rates. If we see a move from -- and of course, Australia has been experiencing 30 years of falling interest rates. And if we start to see that reversal and a move up in interest rates or a stabilization in interest rates first before a move up, then, of course, commentators are saying they're very worried about what that might do to asset prices. I think as we see things at the moment, interest rates are extremely low, by historical standards. Access to capital -- to capital at this prices is almost unprecedented in modern times. And this is, of course, keeping stocks, properties, bonds at very high valuations. We have to watch this very closely. And of course, our process, much like it took us out of stocks going into the COVID period and put us back into stocks coming out of that COVID period, we are seeing a few of the stocks on high valuations already rolling. And I think for people that are watching our cash levels closely, you would have seen that our cash levels went to almost fully invested, and we are now holding about 15% cash. And so this process will just continue. We'll find new stocks that are cheap. And as stocks become expensive and roll over, we'll be scaling out of those positions. We are actually -- because there's so many of us, the 3 of us now are looking at companies and doing so many company visits, we are actually finding a lot of new positions that are meeting our criteria. So as we see things at the moment, it's probably steady state. And the market is performing very well. The factors in place for the market to perform well are there. And until they change, I think we're going to see a period of stability and actually, a period of relatively good performance with low volatility. Ladies and gentlemen, thanks very much for your time. And as always, we'd encourage you to join our newsletter and look at a lot of the editorials that we have on our website and a lot of the updates that we put on our website to help you understand the Cadence Capital funds better. Thank you for your time.