Cadence Capital Limited (CDM) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Cadence Capital Limited Half Year Webcast Ended December 2024. The fund was down 3.6% for the period. The top contributors to performance were Netflix, Evolution Mining, QBE Insurance, IPX, Queensland Pacific Metals and Meta Platforms. The largest detractors from performance during the first half year were Whitehaven Coal; Resolute Gold Mine; Capstone Copper; Stanmore Resources, again, coal; and BHP. This was largely due to the downturn in the commodities index, which was down for 6 months around 3.1%. A number of our investments were impacted by this downturn and have been reduced in size. We were also carrying higher-than-normal cash balances in the period. Investing in turnaround situations has continued to contribute positive returns for the fund, and price earnings expansion in some of our positions has also helped perform -- the fund perform well. We participated in IPX, QPM and AML3 equity raises, which all produced good returns for the funds. You can see from this table that a $0.03 interim dividend was paid franked at 50%. That brings our dividends to date of 189 cents, or $1.89 has been paid. The interim dividend equates to an 8.7% fully franked yield or 10.6% gross yield based on the share price at the time of the announcement of $0.69. After paying this dividend, the company will still have $0.095 per share of profit reserves to pay future dividends. The ex date for this dividend is the 10th of April 2025, with payment date for the dividend on the 30th of April 2025. The DRP will be operational for this interim dividend and will be priced at a weighted average price over the relevant DRP pricing period. At the time of writing this presentation, CDM shares are trading at a pretax NTA discount of around 18%, which is higher than we've experienced for some time. Participating in the DRP is an efficient mechanism to add to existing holdings in the fund without paying brokerage. If you are not registered for the DRP and would like to proceed, please contact BoardRoom. The company will buy back the shares it issues under the DRP. The buyback will not operate when the CDM share price is trading at a discount to the pretax NTA -- I beg your pardon, will operate when we're trading at a discount to pretax NTA. Here's a breakdown of the portfolio, which is really to illustrate that the portfolio overall is very liquid at the moment, with the majority of positions being in companies at least $250 million market capitalization and a lot actually at larger than $1 billion of market capitalization. We could liquidate 89% of the portfolio in 1 week at the moment and 94% of the portfolio within a month. We are carrying around 40 positions, with the largest position being 6% of the fund. And approximately 76% of the fund's gross exposure is in companies with $1 billion or greater market capitalization. You can see a delayed list of our holdings, the top 20 shareholdings of the fund on the right. This is an important slide that we have been articulating now for probably 1.5 years, and you can actually see how extreme this situation has become. What this slide is showing is that when EPS growth was mildly positive, i.e., around 2% or 3% growth, the PEs that we were experiencing were around 16, 15, 14, probably on average around 14 PE. But in the year that's just gone, we've seen PEs expand dramatically to in excess of 20 on this particular slide, and EPS growth has actually turned negative. This is not something that you would typically expect to find, and it's problematic if you're a fundamental investor and are trying to invest in companies with earnings per share growth on compelling PEs to create favorable PEG ratios. This situation has actually made PEG ratios more and more unfavorable in the year just gone. Similarly, we -- it is very difficult to short these stocks even though they don't meet fundamental criteria because the PEs keep going up, which in turn means that the share price keeps going up. We obviously continue to invest using our criteria. And importantly, since the 1st of January of this year, we're starting to see a reversal in this PE ratio situation. The 2 -- these companies, for example, Commonwealth Bank and Sigma Healthcare were the top 2 contributions to the All Ordinaries index performance over the last 6 months. These are examples of stocks with a high PE that are, in fact, becoming more expensive. CBA is on a PE of 25, growing at 3% to 4% per year. Sigma just merged with Chemist Warehouse and is on a PE of 60 in 2026. Chemist Warehouse grew sales at around 13% compared to last year. These are examples of stocks that are -- have a PEG ratio well above 1 and do not meet the Cadence fundamental criteria. PE expansion has benefited some of the holdings that have continued to go up in our portfolio, Suncorp and QBE, for example. These investments were made a number of years ago, and both of these companies were able to increase premiums in an inflationary environment. As part of the Cadence process, we will follow the trend. And while Suncorp and QBE may not now meet our fundamental criteria, they are currently therefore trades because their PEGs are higher than 1. And we will only sell them when the price trend changes. This is really just to give you an indication of many of the stocks that are out in the listed environment at the moment trading on very high PEs with little-to-no earnings growth. I like this slide. It gives a fairly good graphic representation of how high forward PEs can get, EV-to-EBITDA multiples, market caps to GDPs for countries, et cetera. This is an amalgam of many of those ratios. And really what we're saying here is you can see those periods when the multiples were very, very high in 1929, 1966, 1999 and, of course, now. And you can see with this particular chart that the ratios at the moment are as high as they've ever been. And of course, the valuations do move from being undervalued to overvalued. That's just the typical cyclical nature of how the equities market works. We are, as you can see from this chart, at quite highly extended valuations. Now we spoke about this in the previous webcast and just wish to readdress this. You can see that the gold price has been moving steadily for the last 18 months, but ASX-listed gold miners and many gold miners around the world have not performed as well as the gold price. I've often used this quote before by Ed Seykota in Masters of the Market, "Commodities are the purest form of trading in the world, and resources companies are just a leveraged version of that same trade." For this reason, gold miners should start to outperform gold. But to date, they have not. Although in the last month, we have seen some of the gold stocks starting to perform. But of course, a lot has been written about how much gold has performed, and we expect that the gold stocks will follow eventually. Here's an example of a gold mine in our portfolio, experiencing 100% earnings growth on a PE of 15 with a very compelling PEG, very good operating cash flow, very good free cash flow and net debt of $1.2 billion against a market cap of $12.8 billion. This is obviously an asset which is in the Tier 1 jurisdiction in Australia and Canada. The strong operating performance of the gold tailwind has resulted in them delivering record profits for the first half of '25. It's a low-cost producer with an all-in cost of AUD 1,638 per ounce, helping them to deliver $435 million of net mine cash flow and a reduction in its net debt position with gearing now at 23%. We, of course, expect this cash flow to continue and the debt to be eliminated. EVN is targeting further reduction obviously in that debt. The guidance suggests that production rates are incrementally going to be higher, and as such, cash flow should improve. The share chart is reflecting the change in cash flows and the change in earnings. And we, over time, have added to this position. Other gold positions that are worth mentioning are Calibre Mining, which trades on a very compelling valuation. Production has increased from 240,000 ounces per annum to 280,000 per -- to 380,000 ounces per annum in 2025, and we expect further improvements in 2026. There's currently a proposed merger with Equinox Gold, and this may add production growth again. Westgold has finally completed its merger with Karora Resources, taking its production to 225,000 ounces in '24 to 330 -- 350,000 ounces in '25 and more than 400,000 ounces in '26. This will make Westgold one of the largest producers in Australia with -- looking to deliver more than 400,000 ounces of run rate for the June '25 quarter. West African Gold is a producer in Burkina Faso with an excellent management team and a strong track record of delivery. Costs in Burkina Faso are significantly lower relative to Australia's operations, allowing for substantial cash generation per ounce of gold. They are also about to experience a doubling in production on a go-forward basis. This puts it on a very, very compelling valuation compared to many gold companies around the world. Turaco Gold is a gold explorer in Côte d'Ivoire. This company is led by a strong management team and continues to release exceptional drilling results. A maiden JORC resource of 2.5 million ounces lays a solid foundation for additional drilling to delineate a commercial project for development. Importantly, TCG has the funds required to complete all of these drilling projects. Catalyst is a gold producer in WA, led by a strong management team, also offers sizable organic growth profile for 2024, with production of 105,000 ounces per annum expected to double. This presents as one of the few gold producers with material organic growth options, a strong balance sheet and attractive valuation metrics. We spoke about Resolute Gold in our last webcast presentation after its CEO was detained in Mali last year. Led by a new CEO with a focus on returning capital to shareholders, we continue to foresee an improvement in investor sentiment towards the stock. Notwithstanding, we have reduced our exposure to RSG at the moment. Pantoro is another gold company in WA with organic growth opportunities from less than 100,000 ounces again towards 200,000 ounces, with the tailwind of the rising gold price and materially improved operating margins placing it in a net cash positive position of $100 million and well funded to pursue further growth. Turning now to energy and resource stocks. You can see, with all of these slides, a general tapering off to -- from left to right. The S&P/ASX 300 Metal & Mining total return was down 3.1% for the last 6 months, and most commodities were down. Gold was the outlier, which performed well. We have also reduced our energy and resource positions during this period. Turning now to some of the trading that the fund has done. The IPX placement, which develops technology to produce titanium at a significantly lower cost than industry methods, was a very good placement for the fund. We took this position through the placement and sold it for a profit after share price started to turn down from its highs. QPM was a placement in an emerging gas and energy company. Management acquired the Moranbah Gas Project for bargain prices and have the restarted project, delivering significant increase in production and reserve. This company is now poised to grow as a stand-alone gas business. If management continue to execute, QPM will become a position that meets our core criteria, and we still have that position. AML3D was a placement in metallurgical science company and has a number of contracts in the defense industry and allows for the printing of complex industrial parts for defense, as mentioned, oil and gas and the aerospace industries. We have exited that trading position as well. So of those 3, it is the QPM one that has the potential to become a core position for us. In summary, for the first half of 2025 from July to December '24, the All Ordinaries index was up 7%. The portfolio was not positioned to materially benefit from price earnings expansion as it only had a few trading positions and benefited from -- that benefited from PE expansion. Exposure to coal, gas, copper, aluminum, iron ore on the whole were down. Gold position were a mixed bag. Evolution Mining and Robex Resources made money, while Resolute Mining and West African Resources lost money. That situation has reversed now in the second half of the year. A few trading opportunities such as IPX, QPM and AML3D made money. The fund had lower-than-normal exposure, and this caused underperformance to the overall market. We are conservatively positioned, and we made a small loss. Now turning to the third quarter, which is now January to March '25, with the March month nearly over. The All Ordinaries since then has fallen 8% from its high. The gold index is up around 3% during this period, and we have been adding to gold positions, which have been performing well for the fund. We have been adding to our short exposure, and CDM has had a strong relative performance during this period as we've seen a distinct change in the market dynamics. Over the past 6 months, the yield on government's bond has increased in both the U.S. and Australia, with markets concerned that policies of the new U.S. government will put upward pressure on inflation. And we've spoken extensively about this before. After the Reserve Bank of Australia lifted interest rates 13 times since May 2022, they reduced interest rates by 25 basis points this month. This means that Australian interest rates are below U.S. rates, which is very rare. Over the past 6 months, the yield on government bonds has increased in both the U.S. and Australia, with markets concerned that policies of the new U.S. government will put upward pressure on inflation. The market continues to watch rates closely as they affect the valuation of all asset classes. The reporting season was largely shown earnings growth at significant valuation expansions over the past few years and, once again, highlights the growing gap between earnings growth and valuations. Within our own portfolio, we have seen PE expansion in companies such as QBE, SUN and ORG as well as overseas turnaround companies, including Netflix and Meta, which previously met our earnings per share growth to price per share multiples but now are becoming stretched and are, in fact, becoming trading positions. Resources and energy stocks, whilst relatively cheap, have not performed in line with the markets as underlying energy and commodity prices have been under pressure, except for gold, which continues to track higher. This has led to the fund continuing to hold higher-than-normal cash levels. We are going through a period of significant change with the new government in the U.S, and we expect volatility to remain high in the coming months. We continue to focus on implementing the Cadence process that has served us well through market cycles. And of course, at this stage, we do have high cash levels, and we have positions that are, during this quarter, finally outperforming the market. Ladies and gentlemen, thanks very much for your time again listening to the quarterly webcast. And just making sure that you are receiving the monthly newsletter and an e-mail version of the webcast and periodic results. If you are not, please register at -- on our website at the address mentioned, and we look forward to distributing this information to you. Thank you.