Cadence Capital Limited (CDM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the half yearly webcast for Cadence Capital Limited 2021. You will have noticed that we've delayed this webcast by several weeks, and the reason for that is to give you an up-to-date picture of the portfolio and performance given the events of recent weeks. By now, hopefully, you've all seen the half year performance numbers and the half yearly results. We did the gross performance of 10.2% for the period, outperforming the All Ordinaries by 5.6% or roughly double the All Ordinaries Accumulation Index. Over the past 2 years, the fund's up 46.8%, outperforming All Ordinaries Index by 24.8%, again, roughly double the All Ordinaries Index. The top contributors to performance were TMC The Metals Group, Upstart, Digital Ocean, Johns Lyng, Life360, Uniti Group, Asana and Whitehaven Coal. The large detractors for the period were Resimac, Bed Bath & Beyond and Nitro Software. As we have previously announced to the ASX, 1/3 of our TMC The Metals Group Company has already been sold, realizing approximately 7x the cost of our original investment. And that 1/3 sale alone has realized a profit on the entire investment. Turning now to the slide on half yearly dividends. You will have seen that we have announced a $0.04 interim dividend for the first half of the 2022 financial year, bringing our total dividends to 113.2 cents. And when including the franking, that's at roughly 161 cents of dividends. Importantly, that $0.04 fully franked dividend is a 100% increase on the previous half year dividend and equates to an annualized yield of 8.2% fully franked or 11.7% grossed up, including franking, based on the share price at the time of the announcement of $0.98, I think we're trading around $1 now. Importantly, this equates to a 7% dividend yield based on the pretax NTA at the time of $1.14. And this is because the CDM share price is trading at a discount to NTA. Of course, our discount to NTA has contracted considerably, but it's important to say that there is still a small discount to NTA at the moment. The company is well positioned to pay an increased dividend going forward. After paying this dividend, the company still has $0.30 per share of profit reserves to pay future dividends. The ex date for this $0.04 is the 31st of March 2022 and payment date, the 14th of April 2022. The dividend reinvestment plan will be operational for the half year dividend, but there will be no discount to the DRP because we are, in fact, trading at a discount to NTA, as I just outlined. We are now able to reissue shares that we purchased in the on-market buyback at an average of $0.768 per share. Obviously, the profits from this on-market buyback benefit all existing shareholders. The pretax NTA on the 25th of February 2022 were pretax $1.08, post-tax $1.19 and a share price of $1. The share price discount to NTA has obviously been improving from the nearly 40% discounted reached at the panic lows in March 2020 brought on by the COVID pandemic. CDM is now trading at around a 7% discount to pretax NTA and a 16% discount to post-tax NTA. And we would expect that discount to continue to contract ideally for the company to trade in and around NTA. Obviously, the opportunity still exists to purchase CDM shares at a discount to NTA and receive a very high fully franked yield in this environment. As you would have seen from the ASX announcement, Board and management are still the largest shareholders in the company and continue to add to their positions in CDM at a discount to NTA. Importantly, we've been stressing over the last 24 months that our composition of the portfolio has improved dramatically in terms of liquidity. We have a very liquid and diversified portfolio now. Currently, more than 92% of the portfolio is able to be liquidated within 1 week and over [ 97% ] of the portfolio within a month. The company currently holds around 50 positions, with the largest position being 7% of the fund. And approximately 77% of the fund's exposure is in companies with a greater than $1 billion market capitalization. Now the next 2 slides are quite important given the current environment. As of the 31st of December 2021, you can see our top 20 shareholdings, a well-diversified and liquid portfolio, a combination of technology companies, industrial companies in Australia, finance companies, a number of resource companies and a number of energy companies. If we flip forward to the following slide, on the 28th of February 2022, which is just less than 2 months later, you can see a dramatic change in the portfolio, a very heavy bias towards resources, energy, oils, coals, gas and again of diversified and liquid portfolio, including both domestic and overseas shares. So what has happened in that period? Well, we've seen that technology bubble that went for 2 years roll over. And under our process, obviously, we scale into these positions on the way up. And when they roll over, we sell out of them. So we are essentially out of that sector, out of that bubble. And in many cases, we've seen huge retracement in technology PE compression, share price compression and everything that you would have already read about the financial press. At the same time, we were seeing the emergence of very strong cash flows and very strong performance for many of the energy and resource companies. And of course, as we've outlined in a number of our newsletters, this inflationary period, we'll see many of these companies making profits above normal, and that is, in fact, what's happening. So here we sit now with a portfolio performing in areas that are actually doing well, producing very strong cash flow and represent more than half of our portfolio. Importantly, we're also holding around 35% cash. So it's very important to realize that the portfolio has moved with this change in the environment and is really going to be in a position to benefit from a period of inflation and a period of pressure on the supply and demand sides for resources and energy. And in that sense, the portfolio is very well positioned. I'd now like to turn over to Jackson and Charlie to go into these themes in a bit more detail and then come back to you with the outlook statement. Thank you.

Thanks, Karl, and good day, everyone. My name is Charlie Gray, Portfolio Manager here at Cadence Asset Management. Today, I'll be speaking about 2 of the main things we've seen really emerge over the past few months, energy and resources, and these have become much more significant parts of the portfolio. To start though, we thought it would be helpful to put this in context with a brief discussion of the changing investment environment. After a period where we saw interest rates cut to 0 and significant stimulus injected into the system following the outbreak of COVID globally. We've more recently seen central bankers start to adjust their policies to remove stimulus from the system and talk more and more about raising interest rates in the months ahead. A key part of this change in attitude has been in response to persistently elevated inflation rates, which we've not seen for many, many years. This is a very important transition as it will mean the different types of assets will perform well compared to what we've seen in recent years. Whether we break the very long-term trend of declining interest rates, of course, we do not know, but this would have huge implications for asset prices and affordability that we should be mindful of. From an investment perspective for Cadence, in this sort of environment, we've noted a few typical features of similar periods in history. Firstly, companies that benefit from cost inflation and increasing prices will perform well, which is energy and resources, and we'll discuss this in more detail shortly. Also businesses with a decent degree of pricing power and high margins that are able to absorb the cost inflation, combined with a reasonable valuation or a low PE, these will also be certainly well placed to perform. Shorting will play a more active role as many businesses will find it difficult to perform in this environment and, in particular, those with low margins or high valuations. Another way of putting this is PE compression or valuation compression is likely to play out, particularly for the highest valuation companies. As Karl touched on, the portfolio has seen significant repositioning over the past few months as these trends have started to be reflected in financial markets. Turning to the next slide. The first area is oil and gas. And really, this is under the umbrella of a commodity bull market, a supply disruption-driven commodity bull market we believe that we're seeing globally at the moment. So for oil and gas, we're currently seeing demand recovering as world economies reopen. On the supply side, there's been severe disruption by the recent events in Ukraine clearly. And this has aggravated an already very tight demand-supply situation. Interestingly, looking at the 2 major swing producers, OPEC and U.S. Shale, we haven't seen them increase production in recent months. And actually, if you look at the data over the past 2 quarters, OPEC actually had issues, their members got issues producing at reduced quota levels. On the other hand, U.S. Shale after the bear market from 2014, '15, they're really singing from their CapEx discipline songbook where they're focusing on capital returns to shareholders and being a lot more disciplined of their CapEx plans going forward. So you can see this with the rig count down over 40% on pre-COVID levels, and well inventories are also down 50% on mid-2020 levels. In terms of wildcards, there's obviously sanctions on Russia which have been speculated and a possible deal with Iran. But our view overall for this market is that elevated oil prices are likely here to stay for much of 2022, at least. This is going to take time to change the attitude towards CapEx in the U.S. and even longer to bring any material projects on globally. In terms of specific stocks, Woodside Petroleum is our core oil and gas holding. We believe it's a globally strategic LNG asset. And the upcoming approval and completion of the BHP acquisition, we believe this is a game changer. It's going to double the size of the company and make it a much more high-quality, diversified global oil and gas company. It will be one of the biggest stocks on ASX. Stock, we entered early in January, but even after the recent run, it's still trading at around 10x earnings. And if you look historically, it's traded anywhere between 10 and 25x, and around the middle of that at the peak of the last oil bull. So even just on the rerate alone, we see over 50% upside. Now if you wanted to get really bullish, other holdings in the portfolio, I won't go into these in detail, but DVN and WLL US, they're both producers based in the U.S. Karoon is listed in Australia and SLB and HAL, Schlumberger and Halliburton, are the 2 major oil services companies and they'll benefit as the cycle progresses and CapEx does start to come back. It's quite interesting for these companies is they've invested quite significantly through the downturn to make sure that their IP and their product portfolio is at the edge of new technology. And so they're quite cheap still, growing very quickly despite CapEx still having a long way to go. And they've also divested a lot of their lower-margin businesses. So when the cycle does return, we believe there's significant leverage in those 2 companies. Turning to the next slide. The next area is thermal coal. And this is obviously a very out-of-favor sector that's come back into the spotlight recently with the current global energy crisis, particularly in Europe. Really, it's come off the back of a decade of underinvestment and neglect, which has led to limited ability for this market to respond to demand and any disruptions to the global supply chain, where we're seeing countries like Poland look for Australian cargoes which is quite remarkable. At the current spot prices, these companies are paying back their market capitalizations within 6 to 12 months. So there's significant scope, we believe, for big capital returns this year on the back of these super profits. And this is still to play out. Oil prices, we believe, are likely to moderate. We believe that the market is underestimating how long it's going to take to supply to respond in any material way. There's a number of restrictions that have evolved over the recent decade. Financing is very difficult. Environmental approval is very difficult. Obviously, there's a lot of social pressure on the politicians to not allow these projects to get up and more nationalistic attitude from major mining jurisdictions globally. So in terms of the portfolio, Whitehaven and New Hope have been core positions in our fund for some time, and these are really starting to perform now in this market. Turning to the next slide. We really grouped the rest into this slide. And a lot of the themes are similar. Supply disruptions are really ramping up globally and there's quite low inventories versus history across a number of these key commodities, whether it's aluminum, whether it's zinc and nickel, even copper, coking coals a little bit in this camp and also the previous slide, the same things I was talking about there. At the same time, demand is increasing, particularly in these minerals that are related to the green transition. So this is leading to significant supply/demand imbalances to these as well. In the portfolio, we own S32, which is the spin-off from BHP. And this company has made excellent progress in restructuring its portfolio in recent years to be future-facing, just to be invested or exposed to minerals and commodities that are going to be used in the green transition. Despite this, it's amongst the cheapest mines globally, still trading at 7x PE and well into the double digits in terms of free cash flow yields. The stock's acting strong technically, and we believe that it should re-rate closer to its peer set of future-facing mines which command higher multiples. Also in the portfolio, BHP, which I'm sure you're all aware of, Champion Iron, which is very, very cheap with iron ore mining with Q1 ] infrastructure in Canada, it's very well run and it's doubling production this year. Iron ore market is also quite strong. Teck Resources is mainly coking coal, but it's copper production is doubling this year. And it also produces quite a lot of zinc. And a look up where we'd see the catalyst there is the growing EBITDA coming from its rare earth business. EBITDA is increasing 50% on the back of the rare earths business this year and the company is coming out with a decision on its Phase 3 study for any other in WA. If it does pull the trigger on that, it will be a much high-quality rare earths business which we think can rerate the stock. And lastly, the fertilizer market. We've seen fertilizer input prices, ammonia and phosphate, surged after a long bear market of a number of years. And it's the same story again here, significant supply disruptions, particularly with the Ukraine situation, which is the ] bulk of Eastern Europe. Export restrictions as well, where we've got Russia, China and India all restricting exports of fertilizer inputs to use so they can use them and need them within their domestic economies. It's also energy cost escalation in terms of gas prices in Europe which are spiking, that's a key input to make these ingredients. So this is meeting on the other side, very strong demand given high crop prices and generally favorable growing conditions globally. So it's quite a strong cocktail there. In the portfolio are the global leaders, Mosaic and CF Industries, both listed on the NASDAQ. They're strategically positioned in the U.S. with low cost -- relatively low-cost U.S. gas supply. So they're able to supply into these global markets at a much lower cost than their European peers. These stocks showing strong technical action and they continue to trade cheaply despite performing well recently, both around 7x earnings, which is less than half the multiples that they reached in the prior bull market cycles. They're also both implementing significant on-market buybacks with scope for those to be increased over time as we go forward. So hopefully, that gives you a bit of a flavor to some of the commodity and energy-related names that are starting to enter and grow in the portfolio. I'm going to hand to Jackson to touch on a couple more things.

Thanks, Charlie. My name is Jackson Aldridge, Portfolio Manager at Cadence Capital. And I'll just touch on a couple of other themes that we've kind of seen emerge in the market at the moment. The first is kind of the reemergence of travel and leisure. We've all been locked up for a number of years. But the rest of the world is arguably significantly ahead of Australia. Just recently on the Expedia call, we heard the CFO kind of talking that comparable to 2019, early signs in kind of late January, February, they're up in terms of booking volumes, they're up from 2019. So we're seeing early signs of what we think there may be a travel boom, where we've all been held up and we've got -- there's plenty of disposable income around and people want to travel again. So vaccines and this concept of immunity has kind of helped the spread of COVID subside. And as I mentioned, we think there's going to be a surge in leisure and travel spend. And what we think is really interesting about the sector in general is the businesses had to really rightsize their operating cost lines, evaluate what they were doing from a strategic point of view. And we've seen Flight Centre closed down a number of retail stores, trying to push traffic online, which arguably costs less for them to serve that traffic and drive margins higher. So managements talk to nearly doubling their PBT/TTV margin in kind of the near to medium term. And then I guess the second thing we've noticed in the industry is Flight Centre and Webjet are listed entities that could easily tap the equity markets to recapitalize, but that hasn't been the case for some other unlisted players and we've seen the #1 player in the B2B inventory space in relation to Webjet, the business is called WebBeds, they're experiencing significant financial hardship. And so what we believe may happen in the industry is certain players may cede market share and then the well-capitalized ones who can push hard into this travel boom we think will take demand and that's Webjet. And then I guess the second theme that I wanted to touch on quickly is shorting. We mentioned it last webcast, and it's been a difficult short environment over the last kind of 2 to 3 years, even longer. But we're starting to see cracks emerge in a number of these kind of no earnings, thematic-type businesses. There's been a number of kind of one-off COVID beneficiaries that we kind of have noticed. But one of the things we saw over the last kind of 18 months was the expansion of multiples coming out of COVID, specifically kind of these EV to revenue businesses. We looked at one, we didn't short it, we think it's a really high-quality business but can't get the valuation anyways. But Cloudflare, which is the ticker NET, it traded at 114x revenue as the 10-year bond was trading in the depths of COVID. And now as it's recovered and central banks are talking about raising rates, the 10-year is closer to 2%. We've seen a significant margin compression for the same type of business. Nothing has changed for the business. The outlook is still good. But now it's trading on 45x revenue, which is still a massive multiple, but the share price has been hammered as a result of this margin compression. So we've been looking. We've been shorting. We're always looking for this multiple compression story. And then I guess, the second kind of key element shorting at the moment, we're looking for kind of one-off COVID beneficiaries that had a significant margin increase. Just for example, retailers didn't have to discount as the retail boom came so their gross margins were much higher. They had job keeper, job seeker to kind of help with the operating costs in the business. So we think there's a lot of over-earners or kind of beneficiaries. A couple that I've listed, DoorDash is the online delivery business that was doing deliveries for businesses all over the world that didn't have a delivery service. And now that people are eating out again, that's kind of switched off. Karl spoke about Peloton a couple of times. Align Technology, which is Invisalign. They have a massive pull forward in people wanting to get these invisible kind of braces in COVID because they didn't have to go see anyone. But now we're out seeing people again, there's been a significant amount of demand pull forward. Third thing we're looking for is structural or stock-specific issues, whether it be poor acquisitions, whether it be technology issues, whether it be even the way the stock is listed. So I've listed Teladoc, which made, we believe, a poor acquisition, a number of management have left and the share price has been hammered as a result. Appen , we've spoken about a number of times. The stock continues to fall. There's a number of these examples in the portfolio. And then lastly, I guess, is just the share price is distorted from reality. We've seen a number of these kind of meme stocks or no revenue stocks for that example or concept stock. So I listed a couple. We've been in and out a few of these. Your AMCs, your Rivians and then, locally, your Novonix and stuff like that. So we think that there's been a distortion in some of these stocks, and it's coming back to some kind of normality now. So I'll pass over to Karl to finish up on the outlook and where we're seeing things moving forward.

Thanks, Jackson and Charlie. And as we turn to the outlook, you can see how important those themes are that we have been describing for resources, oil, gas, energy in general and the concept of a higher interest rate environment and PE contractions and the rolling over of many trends in the final quarter of last year and the emergence of new trends which, of course, is the important thing to be on the lookout for when altering your portfolio and when divesting from positions and investing into new positions. And this last 2 to 3 months has seen significant changes in trends. The strong trends that we saw in high valuation growth-style stocks for much of the last 2 years have, in many cases, reversed. And in actual fact, the index is telling one story for those stocks, but the stocks outside those indices have experienced even more extreme movements and changing in the trends. And that's been very important. You will see in our portfolio, we've almost entirely exited from any of those technology style, high growth, high PE trading positions that in actual fact are not core. And we're seeing those share prices of those stocks significantly fall. At the same time, we've seen trends in the resources and energy sector have improved dramatically. And more recently, with the escalation of the Russian-Ukrainian war, this trend is really entrenched now. And we're seeing that the prices of some of the oil, gas and alternative energy stocks even have risen dramatically. And so we've seen a complete 180 in terms of technology valuations and the trends and some of those small and mid-cap industrial stocks. And on the other side, we've seen that trend for energy and resources, the upward trend continuing. And that's been very important for the construction of the portfolio. As we sit here now, we have almost entirely divested out of the trends that have rolled over, and we continue to scale into our positions in energy and resources and, importantly, hold very high levels of cash. At the time of the recording of this video. We are holding around 30%, 35% cash, so very conservatively positioned within the portfolio. And of course, in the environment we're in at the moment, with the uncertainty, uncertainty equals risk, it's good to hold high levels of cash. Having said that, the areas where we are invested are producing significant alpha and significant return. And we think that, that trend is we're now kind of entering the second phase of an extended trend. It does not appear that, that trend is ending anytime soon. And of course, this is against the backdrop that we've been writing to you about. On periods of increasing interest rates and elevated inflation, which leads to different types of stocks performing relative to what we have seen in, say, the last 2 years. And of course, everything we're reading in the newspapers at the moment and seeing on television and following up all these stories of inflation, more inflation, higher energy prices, higher resource prices, higher input costs, higher labor costs, everything points to inflation. And of course, ultimately, we're seeing that things are pointing towards higher interest rates as a longer-term trend. Of course, there will be opportunities in stocks that get caught up in all of the selling after they finish falling and begin to recover, but we're not in that phase of the market yet. We're still in -- with many of those stocks, that PE contraction, sharp short rallies and then falling off, those stocks their -- continued longer-term trend of those stocks going further and further down and they're just not sectors you want to be in. So there's a limited number of sectors that are performing. Fortunately, the trends have shown us those sectors. Energy, resources, stocks have performed well during periods of inflation are the areas you want to be in. We've been writing about this for quite a while now. And the other thing that's important is to hold high levels of cash. And of course, liquidity levels are very important, but we've been talking to you about that now for nearly 2 years because it's the [ illiquid ] positions that people are, in some ways, trying to panic exit that they're getting hurt the most. So for us, this period of holding positions with high liquidity in the right sectors and holding high levels of cash is working, and that will be probably the position of the portfolio for a while until the trends continue to emerge going for the years ahead. And it feels like with this, that these trends are going to be in place for quite a while. Ladies and gentlemen, once again, thank you for your time listening to our webcast and portfolio. And we would encourage you to, of course, join our newsletter, if you're not getting it electronically, but we are putting out our NTAs every week for the fund and we are putting out monthly newsletters. And during these times where the portfolio is changing so much and the construction of the overall risk in the portfolio has altered a lot, we would encourage people to continue to read those monthly newsletters to keep abreast of how we're positioning the fund. Thank you for your time.