Cadence Capital Limited (CDM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the June Year-End Webcast for Cadence Capital Limited. We've had a record profit this year of $106.1 million and a record after-tax profit of $75 million. We ended the year at 43.2%, outperforming the All Ordinaries Accumulation Index by 13%, whilst on average holding 12.5% cash during that period. The share price was up 83.5%, including dividends, but excluding franking, which was a very pleasing return to share price, which is very -- trading it fairly close to NTA now. And we have had a number of new and existing shareholders as well as past shareholders buying additional shares. We continued with our on-market buyback and have now bought back 24.3 million shares for a total consideration of $18.4 million, which means we've paid an average price of $0.76 per share during that buyback, and the share price is around $1.12 now. And the Board and Management, who are the largest investors in the company, have continued to add to their positions in CDM. Our tax asset is currently around $0.09, which is down from $0.18 per share. We have the ability to utilize that tax shield as and when we choose. The following slide is the year-end performance numbers, which you should see every month in the newsletter. You can see 43.2% for the year, outperforming the All Ords by 13%. And our since inception numbers of around 13%, outperforming the All Ordinaries Accumulation Index by 5.3%. This performance has been delivered across both new and existing positions and both domestically and internationally. The stocks that have performed well for us have been Resimac Group, Lynas Corp, Uniti Group, ARB Corporation, Pinterest, Money3, Cettire, Bed Bath & Beyond and Pointsbet Holdings. Stocks that have underperformed during the period were EML and Redfin. The Board has just announced a final dividend of $0.03 per share, fully franked, which is an increase of 50% in our dividend compared to the first half dividend. This brings our full year dividend to $0.05 per share, which is an annualized 4.5% fully franked yield and 6.4% when grossed up for franking. This is based on the share price at close of business yesterday of $1.12. The ex date for the dividend is the 18th of October 2021, and the payment date will be the 29th of October 2021. The DRP will be active for the final dividend with no discount applied to the final dividend's DRP. The following slide shows our top 20 shareholdings. You can see good diversification in the portfolio there as well as good diversification in market cap, country and sectors, which is a pleasing situation to begin. And an additional slide we've provided here, you can see that the composition of our portfolio has a large percentage of our investments being above $1 billion market cap, and the next biggest part being $500 million to $1 billion. In fact, there are not that many shares of the portfolio at the moment with less than AUD 250 million market cap. Liquidity has significantly improved, with 82% of our portfolio being able to be liquidated between 1 week and 92% within the month, and that's using 1/3 of volume for each of those shares, naturally traded volume. 62% of the portfolio is invested in companies with obviously greater than $1 billion market cap. Concentration risk has improved dramatically, and we currently hold around 60 positions, with the largest position being 5% of the fund and the largest short position being 2% of the fund. I will now hand over to Jackson and Charlie to go through stock-specific examples within the fund.

Thanks, Karl, and hello, everyone. I hope you're all well. The first talk I'll touch on today is ALS Limited or ALQ. ALS is listed on ASX with a $6 billion market cap, and it's a global leader in testing services, mainly in geochemistry or mineral samples and in life sciences. There's 3 main reasons that we'd like to stop. The first of which is that we believe we're in the midst of a strong global exploration cycle. If we look to global mining capital raising activity, whether it's on ASX or in Canada, it's been very strong. For example, on the Toronto Venture Exchange, which is very minor and exploration company heavy, capital raisings are up over 180% so far this year versus last year and versus an 8-year average. We've got some data on this on the next slide, we can flip to it later. So this is important as capital raisings lead to drilling and then to sample flow for ALS. And this typically takes 6 to 9, sometimes 12 months, in terms of lag to start to play out. So this is a lead indicator that suggests that we're going to see a significant pickup into the end of 2021 and into 2022. And the second point is that ALS is already performing very well so far this cycle. If you look at the results over the past 6 to 12 months, it shows that they're taking significant market share from peers. So they've kept investing in the facilities and keeping them operational through the COVID period. We believe this positions them well to keep taking more than their fair share as the cycle progresses. And the third point is we think that the market is underestimating the leverage in this business. We've already seen some strong results out of the company, and this is before the 2 real drivers of leverage have started to come into play. And this is pricing and mix. So as the cycle progresses, ALS is able to put up its prices per sample, and this falls straight through to the bottom line for the company. And they'll also charge a premium to customers who want to skip the queue and get their sample analysis results back quicker. And on mix. At the moment, they're about 20% -- juniors is about 20% of the overall mix. In the last cycle, 10 years ago, this got to 35% to 40%. And juniors have less bargaining power and prepared to pay more than the majors, so these are much more profitable customers. In addition, the Life Sciences business has been turned around, is performing well, under [ Raj ], took over in 2007, and this has been a focus of the company and they're getting good traction here. 10 years ago, this was a headwind to the stock when the rest of the company was performing well. So putting it all together, we think the company is in an upgrade cycle. And we estimate it's currently on a PE of about 20x in FY 2022, with 40% EPS growth, leading to a PEG ratio of 0.5. We initiated a position in May and have added to the position as it's trended higher. Turning to the next slide, here are the 2 graphs that you can see the data over the last 10 years. In particular, if you look at the bright, you can see that we're nearly eclipsing the 2020 and most other years, aside from the mining boom, and we're only halfway through. So we're on track to get back up to levels as seen in the mining boom and potentially exceed them. Turning to the next slide. The next stock is Asana, a trade position in the fund. Asana is listed in the U.S. and has a $13 billion market cap. They provide a cloud software platform that allows teams to track, organize and manage work. So within the platform, you can create a project, you can assign work to teammates, specify deadlines and you communicate about tasks. You'll track all this in real time and give you the visibility on where your teammates are up to, and has a reporting functionality and a bunch of other integrations and add-ons. The reason that we like the stock, number one is the management team and Board. The cofounders having significant experience building technology businesses. The CEO and cofounder Dustin Moskovitz is one of the original Facebook cofounders, and he's been very aggressive in driving the growth in Asana. Also, Justin Rosenstein, the other cofounder, was the lead engineer in Google and Facebook in the early days, and he helped create Gmail and Google Drive. The stock is also under the radar. It's not well owned by institutions, and it's trading at a significant discount to peers. So we purchased the stock at $34 in April and scaled into the position. Then in early June, the company reported very strong results and provided revenue guidance of $340 million for 2021, which is up 50% on last year, at an annualized rate to quarterly results tracking more like above 60%. And importantly, we saw customers grow at over 30% within that quarter, which is accelerating from around 20% over the last year. There's significant scope to revenues to grow over time. If you look just at their existing customer base, they're only 3% penetrated within that. So it's very early days for the business. And if you look at their gross margins, around 90%. As they scale up, this could become quite a profitable business. So the big question next is really how structural is remote working? Will all going to go back to normal? Or is this going to be a permanent feature going forward? From what we're seeing in the market and in company results and in the way that they're structuring their IT infrastructure, it looks to us like hybrid work and remote working is definitely here to stay. So tools like Asana that help teams with planning and task allocation in that sort of hybrid work environment, we think are going to be very relevant going forward. We saw Dustin buy over 160 million in shares on market in June, which is a good sign, and the stock is currently around $70 and technically has been in an uptrend since May. Turning to the next slide. The next stock is Airbnb, which is also a trade position in the fund. Airbnb is listed in the U.S. and has a $93 billion market cap, and it's the global platform that's disrupting the hotel industry, nearly 6 million rooms or listings. If we look at the top 2 hotel operators in the world, Hilton and Marriott, between them, they have 2.4 million rooms. So within 10 years or so, Airbnb's over doubled the combination of these 2 networks. The business was impacted significantly by COVID over the past 18 months, and it's taken out hundreds of millions of dollars of fixed costs, and it's also restructured the business to become much more streamlined and profitable. So looking forward now, we think that the business has excellent profitability potential over the medium to longer term. First point here is that the market they're addressing is massive. It's really unlocking its own market, which is any person with the house and all the associated experiences that they're also offering a potential to stay in places where there's never been hotels. The company estimates their market to be approximately $3.4 trillion. This compares with consensus 2020 revenue estimates of around $5.5 billion. The company clips both sides of the transaction, both at the guest and the host level, and operates at over 80% gross margins. Further gross margin growth is also a focus, with the company focusing on increasing the proportion of long-term stays. This has moved from 14% to 24% of bookings over the last 2 years, and a long-term stay is a stay over 28 days. Next point is that 90% of traffic to Airbnb is organic, that's unpaid, and 25% of hosts. So nearly 1 in 4 hosts were originally guests on the platform. So there's significant network effects. There's minimal CapEx required to grow the business, and we believe it's well positioned in the structural changes underway in the travel industry, where a lot of the old business models are getting hollowed out. If we look at the March 2021 quarter, we saw Airbnb's revenues were $887 million, which is actually up on 2020 levels. While the other travel peers, such as Booking.com, Expedia and Marriott posted revenues that are still 40% to 50% down. So you can see that it's well positioned as well and a stronger for longer domestic environment. From the stock's perspective, the stocks rebased after it's had its IPO run and came off significantly. The second lock-up expiry occurred in May. So now that all the shares have had time to trade and the stock has had time to adjust, we recently initiated a small position as we believe the stocks now potentially recovering. Thank you for your time. Now I'll hand on to Jackson to go through another couple of positions in the portfolio.

Thanks, charlie. Today, I'm going to talk about 2 stocks, 1 being long and 1 being a short. So the first one is Bed Bath & Beyond, which is a U.S. listed retail, specializing in homewares. We've actually traded in and out of this position twice before over the last 12 months as we stumbled upon what was called the main mania. But the fundamental deep turnaround story with the stock and why we bought it in the first place truly remains. And so when looking for deep value turnarounds, a few key points to note I think are an experienced and incentivized management team, a bunch of low-hanging fruit or relatively easier wins to develop some momentum in the business and something in the business that the market is just really missing. So to my first point, Mark Tritton, formerly of Target, was brought in to turnaround the bricks-and-mortar homewares retailer about 18 months ago. He actually -- during his time at Target, he's spearheaded the development of what we call now in Australia of the Omni channel. He reduced what's called BOPIS, which is Buy Online, Pick Up In-Store, which is now what we know as Click and Collect. So he's done this before, and really he's been successful and has been brought in to kind of to rehash the strategy what they implemented at Target. So my second point around the business and around the turnaround is low-hanging fruit. And the company set out a road map towards its FY '23 target of $850 million to $1 billion of EBITDA. And to get there, what they've identified is, is roughly 200 underperforming stores that they'll close and also increasing penetration of the private label brands. Currently, it's 10% and they want to get to 30% of private label brand, which in itself could be a 200 basis point gross margin improvement or could be $200 million. And then streamlining the supply chain, renegotiating some of the terms with wholesalers and distributors and then superior inventory management systems. Management's target is another $200 million to $250 million. So between these two, there's probably about $500 million to $600 million of identifiable opportunities. And we think these are conservative estimates. And then another focus for management has been to kind of shift to this online and e-commerce world of doing business, especially in retail. Previously, before new management got there, they did less than 10% of the company's sales were online. And as of the quarter just ended, they're now 38%. And they've done a couple of things to shift this. Simple things like checkout, there used to be 7 steps, and now they've shifted to 3; faster web page loading time, so you're not waiting there; and then a website rebrand, just so it's easier to transact online. And then to my last point, what we think the market could be missing, I think there's 2 things with this stock. One is capital management. The company announced an $825 million buyback, which at the time was nearly 40% of the market cap. Now market cap is about $3 billion, and the buyback still got $550 million to come. So that's 15%, 20% of the company is going to be bought back under the current plan, and we believe this could be implemented further. And then secondly, the gem inside this business, what we think is, buy buy BABY, which is a baby retailer, similar to Baby Bunting here, does $1 billion in revenue. management target of $1.5 billion in the next 18 months. So it's growing 25%, 30%. And on kind of comparable listed baby retailer margins at 6%, this business could be doing north of $75 million of NPAT in 18 months. As a stand-alone business, this is really, I think, could be worth over $1 billion. So in terms of valuation and what it's trading on based on these factors and management's guidance, the stock is trading on roughly 6x PE of the numbers in 12 to 18 months, on a 25% operating cash flow yield and a PEG of 0.1, so it fits all of our core criteria. The second stock that I'd like to talk about is appen. So appen provides services to some of the largest companies on the planet, specifically cloud services for the development -- of labeled data, which is an input into machine learning and AI algorithms, and it's been a darling on the Australian Stock Exchange for a number of years. But we've just seen some early signs of the industry getting extremely competitive. It's a high-growth industry, and you're seeing companies all over the world spend billions and billions of dollars in R&D to find the next app and/or the next AI input. And we're seeing some things early signs of -- I've posted 2 links, 1 from Facebook and 1 from Google, which are suggesting there's a development of new technology or the transformation of existing technology, what's called self-supervised learning, which actually doesn't need any human interaction to label its data effectively. So this is going to reduce the time, cost and increase efficiency for the process that's input into kind of this machine learning technology. And we think that appen is highlighting a number of things at the top line, may be slowing. There's a number of research papers, comments from Facebook's Chief Technology on his Twitter, and then other open source kind of collaboration forums that suggest that this self-supervised learning is really gathering some sting. And look, we're not of the belief that labeled data will be totally replaced. However, we just think the growth trajectory that the company has previously experienced and that the market and the valuations may be extrapolating looking forward maybe in jeopardy. And there are a number of other red flags that suggest that maybe appen's growth is slowing down significantly. We're seeing a few things -- a couple of red flags in the sense of sell-downs. Firstly, the age old outage of insider transactions being a good indicator of business strength. In June 2020, the founder sold nearly $60 million worth of stock, which is 20% of their holding. And more recently, the CEO sold 20% of his holding in May 2021. Secondly, the company's adjusted its reporting segments in currency. And even though it was relatively opaque in the past, now they're trying to separate things out and change reporting segments, change currency, which actually gives them a bit of a benefit to reach kind of EBITDA targets that they've set out. But we just think this is a tactic that's sometimes done to muddy the waters for kind of near-term growth targets. Thirdly, it's quite rare to see a kind of multiyear high revenue growth business start ripping out costs. It's kind of the other way usually that they go after the target or the opportunity. As were with appen, they're ripping out cost in sales and marketing. We think it's to meet kind of internal EBITDA targets. And then lastly, for us, a bit of a concern is the recent rise of capitalization versus expensing, especially when taking into account what we're seeing the competitive threats in the industry, capitalizing some of the R&D costs can be quite dangerous and also kind of artificially inflate the P&L in the near term. So look, we just think the valuation that it's trading on right now and given the market's expecting 24% EPS growth in 2022, which we're not sure of, based on the valuation we have got a short position on appen. I'll now pass on Karl to wrap up presentation, talk about DeepGreen and give an outlook for the year. Thanks.

Thanks, Jackson and Charlie. Importantly, we thought it was -- we should give you an update on the DeepGreen Metals investment. And as you know, and we've extensively given ASX announcements on this, in June, DeepGreen Metals shareholders approved the merger of DeepGreen and Sustainable Opportunities Acquisition Corporation, or SOAC as it's called. The British Columbia Supreme Court has also approved the plan of arrangement between DeepGreen and SOAC. The merger now needs to be approved by SOAC's shareholders and need to satisfy the customer closing conditions for listing on the NASDAQ. The combined entity will be renamed The Metals Company and is expected to begin trading on the NASDAQ under the ticker code, TMC, and that is expected to occur in this quarter. CDM's DeepGreen Metal investment is, as we've said previously, approximately 2.8% of the portfolio. The most recent raising of $330 million by SOAC was done at a price of USD 10 per share, and our investment is currently valued at around $1.38 per share. So this is obviously a significant uplift in valuation for this investment. The proposed listing is obviously going to have a big effect on the NTA of the company. But as things stand at the moment, we are carrying that investment at cost, and that cost is currently 2.8% of the portfolio. Once these TMC shares begin trading, we will then use their share price that the company IPOs and its subsequent share prices as the correct value for that investment, and we will revise the valuation within the portfolio. And obviously, we'll make comprehensive announcements when that occurs. Turning now to the outlook, for what has been a very unusual year given the COVID-19 situation we've all been living through. And it's fair to say the World is slowly come to terms with COVID-19. And the second point here really is that financial markets have largely recovered from what were called the COVID-19 panic. In actual fact, markets around the world are making new highs and are on a longer-term trend that if you took out the panic that occurred due to the COVID-19 pandemic last year, we're on a fairly smooth trend at the moment. Corporate profits have rebounded in many cases and are at all-time highs. Interest rates continue to be very low and in some countries are at 0. And we have had progress in vaccinations in Western Europe and the U.S. Australia is behind, but it's catching up. The Australian dollar is down around 10% since this time last year, increasing export earnings and making imports more expensive. It looks like there's a possibility that the trade for gold, which has been -- which has performed so well due to uncertainty in the world, may have started to roll over and certainly in Australian dollars looks to have at least temporarily rolled over. Energy prices also continue to rise, and metal and minerals price trends are in an upward trend and continue to be in an upward trend. We, as a company, are continuing to find good investment opportunities for the fund across a broad range of sectors, both domestically and internationally. And what I have been saying in our recent newsletters and also reiterating in this webcast is that there are always opportunities through stock selection, but really that the opportunities at the moment tend to exist through stock selection rather than the situation we had a year ago, where all boats are rising in a rising tide with the recovery from that point of maximum pessimism after the COVID-19 collapse. So we remain optimistic that there are actually still a lot of opportunities, and there are many late lagging stocks in deep secular sectors that are starting to perform now. Ladies and gentlemen, thanks again for your time, and we look forward to hopefully presenting to you at least in webcast and eventually in person. And in the meantime, please take care of yourselves. Thank you.