Cadence Capital Limited (CDM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Cadence Opportunities Fund March quarterly Audiocast. On the first slide, you can see our performance for the month was a negative 4.3% return with our 3-year numbers at around 25% per annum and our since inception numbers up around 193%. The top contributors for the period were Patriot Battery Metals, Meta Platforms, Red 5, Stanmore Coal and Arafura Resources and Kogan and the largest detractors are Tietto Minerals, Health & Happiness, Syrah Resources, New Hope, Genworth Financial and Domino's Pizza. I think the underperformance in this period has been driven by the coal positions, which in the previous year were very, very good performance and had very good performance of the Fund for 2 years. But more recently, have rolled over, and we've been exiting those positions in the way that we outline in our investment process, and we have now sold out of coal completely. We have started investing in a number of potential turnaround situations, but that has proven to be too early, and a number of those positions have been closed out again. We are also holding around 40% in cash at the moment to be prudent and more specifically because as we've rolled out of profitable positions and have not found new positions to invest in, we're holding reasonably high levels of cash, which in the end is a prudent position to be in. You can see that we've just paid out a half year dividend of $0.075 fully franked. This equates to an annualized yield of 6.5% or gross of 9.2%, including franking, and that was based on a share price of $2.32 on the date of the announcement. Obviously, our share price is trading a lot lower than that at the moment. After paying this dividend, the company still has more than $0.36 per share of profit reserves to pay future dividends. And we had the DRP in operation for the half yearly dividend. Turning now to the CDO portfolio, you can see that we hold around 40 positions with our largest position being 5% of the fund and also holding significant amounts of cash in the portfolio. The top 20 positions that you see there are from the 31st of March 2023. So that's a slightly delayed a snapshot of the portfolio. But you should get a feel for the diversity, both in style of stock and also geographic diversification and also a very, very liquid portfolio. Turning now to some of the current investment themes. Well, you would have read in the paper that the global market sales have, of course, drifted higher in the new calendar year with the S&P 500 Index up 8.6% and the all-ordinaries index up 5.4%. I read somewhere the other day this has been considered one of the most unpopular bull market rallies of recent times. But the participation in this uplift has not been very widely spread. It's a narrow band of stocks. For example, as top 15 stocks in S&P 500 account for 97% of the S&P 500 year-to-date performance, Apple alone accounts for 26% of that performance. So that's a very, very narrow band of stocks creating that performance. Obviously, we are spending more time focusing on company fundamentals such as earnings and cash flow as opposed to the peak valuation metrics such as enterprise value to revenue multiples and other metrics that just simply do not equate back to actual cash flow that a company can earn. CDO portfolio holdings such as Helloworld Travel, QBE Insurance and Meta Platforms are good examples of this. And these companies have PEG ratios of less than 1 and strong earnings growth forecast for the next few years. A key change in trend over the last 12 months has been the directional change in interest rates, which fell for 30 years to near 0 for the Fed rate in America bottomed out and sold moving up again at the fastest pace in the history. In Australia, those rates are now 3.85%; in America, they're 5.5%. What has performed well in similar previous cycles are companies with pricing power, such as precious metals and energy. Insurance companies also typically have strong pricing power. And despite a cyber attack, Medibank Private has performed resiliently and shown the business strength to hold customers and put prices up. Boral, which is in the early stages of a multiyear turnaround has also successfully put through price rises and expect this to continue. Gold positions in the front such as Newcrest Mining and Resolute mining have performed strongly as the coal prices traded up to and over USD 2,000 per ounce, which equates to around AUD 3,000 at the moment and towards multi-decade highs. The following slide shows you interest rates over the last 220 years, then with the prediction of where they might move to over the next 20 to 30 years. And we presented this slide at our AGM last year and also had shown the slide in one of our earlier newsletters. So this is a theme that we've been showing to our investors for a long time now. What you can see there is that interest rates certainly trend. There is not a concept of terminal interest rates or low interest rates or high interest rates. Interest rates are in the cost of money and they go up and down. We saw from 1945 after the wars up until 1980s, interest rates rose dramatically and have been falling ever since to reach 0% a few years ago and have now rallied to 5.5%. Actually, the average rate over that 220 years is around 8.5% Fed rate. So that should give an indication of what interest rates look like over the longer term. So all the short-term commentary that's taking place around interest rates at the moment, whilst interesting, it is more important probably to step back a little bit, take more of a helicopter view of what interest rates do over long periods of time. Of course, you've heard me say before that from 1980s to 2020 was a beautiful time to be alive in a period of falling interest rates, which meant that all assets, generally speaking, went up in value. The next slide is the Australian dollar, which I think is also worth having a look at over a longer period of time. And as we sometimes say, the Australian dollar is a $1.50 currency every day of the week, which means it moves from about $1 -- against the U.S. dollar to being worth USD 0.50 for an Australian dollar back to around $1 and it looks to be trending again down towards $0.50, currently around $0.66, $0.67, which is about just below halfway between those 2 extremes. I mean, the halfway point between $0.50 and $1 mathematically $0.75, which is about the average that has traded over the long period of time. Australian dollar is very important for some of the smaller cap companies in Australia who often tend to be importers and exporters. The next slide, again, talks about the gold price having moved from around $500 an ounce to USD 2,000 an ounce. And you can clearly see the price picking up around 2006 when it's been widely reported on that the central banks around the world have been accumulating large amounts of gold since 2006. Next slide, I'll just take you to a trade that we've had on, which is Newcrest Mining, which was taken over recently by Newmont. It's the largest gold takeover in the world and has created the world's largest company. We benefited from this trade as we own the stock. And as the bid came through and as the bid was increased and is being consummated, that has led to performance for the fund. And I think that there is still some performance left in that trade, but not very much now because the majority of the money has been made on the takeover by Newmont. You can see on the following slide how the stock has performed since the takeover first was muted. The next slide is -- talks about Meta Platforms, which Chris Garrard and I have been working on together and is a core position. Now what's really interesting about this position is it's very unusual to see such a big large cap global stock perform in a situation where it reaches a PEG that satisfies our criteria. Generally speaking, these stocks tend to be very, very expensive and not meet our criteria. But after the lower-than-expected results in 2022, the company's share price fell dramatically associated with higher CapEx to do with investing in the metaverse. Mark Zuckerberg has called 2023 the year of efficiency as the company reduces its cost base and reduces growth CapEx. The company has also announced a $40 billion increase to its existing share buyback program, bringing the total to $80 billion. This has resulted in a company that has around 20% earnings growth on a PE of around 20% and a PEG of 1%, very good operating and cash flow yield, net cash on the balance sheet, no debt. This is something that would meet our core criteria. It does meet our core criteria. And you can see on the following slide, the price chart that we start to buy into the position on the recovery, and we have added to that position. That position continues to perform very well for the company, and there's no reason to suggest that it shouldn't going forward. Turning now to the outlook. We've spoken a little bit about this in our newsletters, but clearly, central banks globally have been increasing the purchase of physical gold. Therefore, they purchased 228 tonnes in the first quarter of this year. That's 30% higher than the previous Q1 record of 2013. So these are record levels of Central Bank gold purchase. The Australian budget recorded a $4.2 billion surplus for the year just gone. This is aided by high commodity prices, particularly in iron ore and coal, and predictions now are for multiyear deficits of around $14 billion per annum. So we will move from our levels of debt. Obviously, when we're producing deficits, will increase year after year over the next, I think, forecast 4 to 5 years. Negotiations have also progressed for the U.S. debt ceiling to be extended from around 31-point-something billion to around -- trillion, I beg your pardon, to around $34 trillion. And as interest rates have gone up in America, we now turn to the idea of 5% interest on that $34 trillion, which is around $1.7 trillion of interest per annum to service that debt. Western economies continue to run high levels of debt with Australia having a net debt position of $517 billion. That should cost over $112 billion in interest over the next 5 years. Conversely, countries such as China and Russia have cash in the bank or net surpluses and they earn interest on the money they have in the bank. Interest rates have risen at the fastest rate in history, you would have read about that in the last 12 months. And this -- the effects of this are still yet to be fully absorbed. And actual fact, one of the biggest changes in trend that has occurred in the last few decades is the change in interest rates from a falling interest rate trend to a rising interest rate trends. And of course, this is taking up a lot of airtime and newspaper and journalist time and people speculating what might happen next, but quite clearly, that period of falling interest rates over 40 years ended a few years ago. This environment obviously favors fundamental stock-picking and companies that, in fact, do generate cash flow. And so it's an environment that should be conducive to the Cadence Opportunities Fund. I have had a few people ringing up asking about what happens to a trading fund in this environment. And what I've been at pains to say to people is, obviously, when trading opportunity presents, you trade and you make the returns that you can. But it's also very important to be disciplined -- and when trading opportunity does not present, it's important to be disciplined and, in our case, to hold high levels of cash until opportunity presents again, which, of course, it invariably does. Our stock is currently trading at around a 10% discount as we come into year-end tax loss selling. And this is a pretax discount to NTA whilst also holding 50% cash. The CDO's share price is implying that shares in the portfolio can be bought at a 20% discount to their underlying value. That's suggesting that, of course, the cash has not traded a discount to cash because it is cash, and so this is an unusual situation for CDO. CDO has been in a situation to be trading at a discount to NTA historically. And we're also holding very, very high levels of cash. Of course, the decision to be invested at a whole cash is a decision we constantly make so that our shareholders do not have to make that decision. And as I've always said to my shareholders in our 2 funds, CDM and CDO, I prefer to buy these shares at a discount to NTA rather than a premium. And so that is the situation at the moment. Ladies and gentlemen, thanks very much for your time. And I always at the end of this audio call, say, if you would like to keep up to date with us, please join our monthly newsletter to receive the newsletter and also to receive these webcasts and other periodic results and to be able to log into our website and see some of the interviews and articles that we have contributed in recent times. Thank you very much.