Cadence Opportunities Fund Limited (CDO) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Cadence Opportunities Fund Limited Half Yearly webcast for December 2024. The portfolio was down 1.1% for the half year with top contributors for the period being Echo IQ, Netflix, IPX, Queensland Pacific Metals, Base Resources and Evolution Mining. The largest detractors for the period were Whitehaven Coal, Resolute Gold Mining, Capstone Copper, Step One clothing, Alcoa and BHP. The downturn in commodity prices led to the metals and mining companies performing poorly over this period with the S&P/ASX 300 Metals & Mining Index being down 3.1% during that time. A number of our investments were impacted by this downturn and have been reduced in size. Trading opportunities have improved over the last 6 months, and CDO participated in Echo IQ, IPX, QPM and TTT equity raises, which have all produced excellent returns for the fund. An interim dividend of $0.065 as fully franked has been declared. This dividend equates to 7.6% annualized fully franked or 10.9% on gross yield, grossed up franking credits based on the share price, where of this announcement of $1.70. You can see that the fund to date has paid out $1 of grossed up dividends. The interim dividend now means that the company has $0.135 per share of profit reserves to pay future dividends. The ex-date for this dividend is the 10th of April and the payment date is the 30th of April 2025. The DRP is in operation for this interim period and the DRP will be priced at the weighted average share price over the relevant DRP pricing period. At the time of writing this presentation, CDO shares are trading at a pretax NTA discount of around 15%. Participating in the DRP is an efficient mechanism to add to existing holdings in the fund without paying brokerage or spread in the share price. If you are not registered for the DRP and would like to participate, please contact Boardroom. The company will buy back the shares and issues under the DRP. The buyback will operate when the CDO share price is trading at a discount to the pretax NTA. Here, you can see some sector analysis for the fund. We have a very liquid and diversified portfolio, and the company holds around 45 positions with the largest position being 7% of the fund. We have recently increased our cash holdings. You can see our top 20 holdings, both long and short, on the right-hand side of this presentation, and this portfolio is delayed since January. There have been a number of trading opportunities over the last 6 months. We participated in the Echo IQ placement, a medical technology company that uses artificial intelligence to detect heart failure. The company's technology received FDA approval in October and recently announced an integration agreement with Beth Israel Deaconess Medical Center, Boston U.S.A. The IPX placement was in a U.S.-based company that has developed technology to produce titanium at a significantly lower cost than current industry matters. This company is scaling up production for a facility and is winning contracts with the U.S. government and OEMs. We took this position through an equity placement and sold it for a profit after the share price started to turn down from its highs. The QPM placement is into an emerging gas and energy company. Management acquired the Moranbah Gas Project for a bargain price, have restarted the project and delivered significant increase in production and reserves. QPM is now poised to go as a stand-alone gas business. If management continued to execute, QPM will become a position that means our core criteria. Base Resources/Energy Fuels Scheme of Arrangement. CDO took advantage of the arbitrage opportunity between BSE and short Energy Fuels in the U.S. When the scheme of arrangement became effective in September, our position offset each other and the arbitrage profit was realized. The TTT placement has developed cold spray technology to be used in additive metal manufacturing and advanced coatings and metal repairs. This cold spray creates stronger and more durable parts for aerospace defense and industrial applications. TTT is expanding its U.S. manufacturing footprint. The De Grey's placement is a gold developer that is expected to go into production in the second half of calendar year '26. Company raised equity and refinanced its debt to fund the Hemi Gold Project. We sold the position after share price started to ran and then started to rollover. Spartan Resources Placement was a gold producer WA focused on growing high-grade gold ounces. They recently raised equity to develop their underground mine and announced the proposed merger with Ramelius. This is an important slide that we've been talking to now for, well, nearly 2 years. What you can see here is that earnings per share across the index was mildly positive, and since -- and more recently and especially in the last set of ASX announcement and results for listed companies, EPS has turned negative. This has occurred whilst PEs have simultaneously gone to higher and higher levels. So what we're saying is that the market overall has moved to higher PE ratios while simultaneously seeing EPS growth turn from positive to negative. And this, of course, means that many stocks are not meeting our fundamental criteria. We see PE expansion was limited to no earnings growth, and this creates an unfavorable PEG ratio and most often unfavorable cash flow multiples as well. It's been difficult to short these expensive stocks because in actual fact, the share prices have continued to rise so that it has not been a good idea to short the stocks even though they have been fundamentally expensive. We will continue to invest using our investment criteria, and I'm pleased to say that, that situation now seems to be reversing, especially at the top of recording this webcast, we're seeing a bit of reversal in the overall market. Some examples of this PE expansion relative to earnings growth are Commonwealth Bank and Sigma Healthcare. These are the top 2 contributors to the All Ordinaries Index performance over the last 6 months. Both are high PE stocks that are becoming more expensive. CBA is on a PE of 25, growing at 3% to 4% per year. Sigma announced the merger with the Chemist Warehouse is now on a PE of 60 for 2026. Chemist Warehouse sales grew 13% compared to last year. Both of these stocks are on a PEG ratio well above 1 and do not meet our fundamental criteria. PE expansion has benefited some of our existing positions, for example, Suncorp and QBE, which were made a number of years ago when Suncorp and QBE were able to increase premiums in an inflationary environment. A key part of the process for us is to follow the trend. And while Suncorp and QBE may not meet our fundamental criteria, they are currently there for trades because their PEG ratios are above 1, and we will look to sell them when the share price changes. This is a really good graphical representation of a combined index for trailing PEs, forward PEs, price to book, EV/EBITDA, key ratios, market cap to GDP. Really, what we're showing here is that valuations can move to very high levels. And whilst -- and they can also move to very low levels, and this tends to be cyclical in nature. You can see levels as high as we're currently experiencing in 1929, 1966 and 1999. Conversely, you can also see what happens after these periods of very high valuation when markets tend to change direction, change trend and move the other way. Really, what we're showing here at the moment is that valuations are as high, if not higher, than they've been in these extended periods historically. We've spoken about the gold -- share gold price trend as well as relative gold stock price trend in our previous webcast. This is just to say that the Australian dollar price has been rising steadily for the last 18 months, but ASX-listed gold miners and in fact, global gold miners have not performed as well during this period. As Ed Seykota famously said in his interview for Masters of the Market, "Commodities are the purest form of trading in the world and resource companies are a leveraged version of the same trade." For this reason, we ultimately see gold miners earnings growth and then their valuations catching out and outperforming gold. They have not done that today, but we're starting to see the first signs of that. Here's an example of a gold stock in our portfolio with 101% earnings per share growth in the year just gone, a PE of 15, a PEG of 0.2, good operating and free cash flow yield, net debt of $1.2 billion and a market cap of $13 billion. A large cap company, displaying very, very good core fundamental criteria. The company has just delivered a record underlying profit of $385 million for the first half of million its cost base is below AUD 1,638 per ounce, giving a net mine cash flow of $435 million. This will allow Evolution and has allowed Evolution in the period has gone to reduce their gearing and will allow it to reduce its gearing further in the time ahead. Full year guidance suggests that production rates are moving incrementally higher, and that's so should cash flows. You can see here with the share price we have been adding to this position. This is a core position in our portfolio that has been performing very well. Other gold positions in the portfolio. Calibre Mining is in Canada, a very cheap gold mine, which is increasing its production from 250,000 ounces per annum to ultimately 380,000 ounces planning in '25 and further improvements in '26. More recently, there's been a proposed merger with Equinox Gold and if executed, will lead to further production growth. Westgold has finally completed its merger with Karora, taking its gold production from 225,000 ounces to a move to the 350,000 ounces in '25 and to well over 400,000 ounces for '26. This will make Westgold one of the largest producers in Australia and should deliver in excess of 400,000 ounces run rate for the June Q '25 period as a near-term catalyst. West African Gold is a gold produced in Burkina Faso with an excellent management team that has a strong track record of delivery. Operating costs in Burkina Faso are extremely low compared to relative parts of the world and Australia in particular, allowing for substantial cash generation. The delivery of its current project is expected to more than double production on a go-forward basis at very, very high cash flow -- cash margins. Turaco Gold is a gold explorer in Cote d'Ivoire. This is a company with a very strong Australian management team and continues to release exceptional drilling results. And maiden JORC is also 2.5 million ounces lays a good foundation for additional drilling to delineate a commercial project for development. Catalyst mining is a gold producer in WA with production around 100,000 ounces looking to double production to around 200,000 ounces. This presents as one of the few gold producers with material organic growth options and a strong balance sheet and attractive valuations. Resolute Gold, which we spoke in our previous webcast, fell 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 this, we have reduced our exposure when the stock rolled over. Pantoro is another WA-based producer with organic growth, again, moving production from around 100,000 ounces to 200,000 ounces. With the tailwind of rising gold prices, this has materially improved their operating margins, placing them in a net cash position of $100 million, and they are well funded to pursue further growth. Here, you can see 4 slides showing the energy and resource stocks. The S&P/ASX 300 Metals & Mining Total Return Index was down 3.1% during the 6 months. Most commodities were down except for gold, which performed very well. We have reduced energy and resources exposure. So in summary on how CDO performed. Trading opportunities have picked up with trading opportunities such as Echo IQ, IPX, QPM, TTT, De Grey Mining, Spartan Resources and Tasmea making CEO money. The All Ordinaries Index was up 7%. The portfolio was not positioned to materially benefit from price earnings expansions as it only had a few trading positions that benefited from this expansion. Exposure to coal, gas, copper, aluminum and iron ore lost money. Gold positions were a mixed bag with Evolution Mining and Robex performing very well while Resolute Mining in West African Resources lost money. We're actually seeing a reversal of that in the current quarter. CDO was conservatively positioned and made a small loss. Now to the third quarter, January to March '25, the All Ordinaries Index is now down 8% from its highs. The Gold Index is up 3% during this period, and we have been adding to our gold positions, which have been performing well for the fund. Trading opportunities continue to present and we are adding to short exposure. CDO has had a strong relative performance during this period. Over the past 6 months, the yield on government bonds has increased in both the U.S. and Australia with markets concerned that the policies of the U.S. government will put upward pressure on inflation. After the Reserve Bank of Australia lifted interest rates 13x since May 2022, they reduced interest rates by 25 basis points this month. This means Australian interest rates are below U.S. interest 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 the policies of the new U.S. government will put upward pressure on inflation. The market continues to watch interest rates closely as they affect the valuation of all asset classes. And that combination of pressure on inflation, and the hope that we cut interest rates is obviously creating a complex story for the market. The reporting season has largely shown earnings growth significantly below valuation expansion over the past few years, once again highlighting the growth gap between earnings growth and valuations. Within our portfolio, we have had benefits with QBE, Suncorp and ORG with price earnings expansion as well as overseas turnaround companies such as Netflix and Meta, which previously met our earnings per share growth to price earnings multiples but have -- these have now become stretched, and they are, in actual fact, both trades. Resource and energy stocks, whilst relatively cheap, have not performed in line with the market as underlying hedging 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 and ultimately be quite conservatively positioned. We are going through a period of significant change with the new government in the U.S. and 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. Ladies and gentlemen, thanks very much for your time again listening to this webcast. And as always, if you are not receiving our monthly newsletter webcast and periodic results via e-mail, please register on our website, and we look forward to talking to you again in the near future. Thank you.