Cadence Capital Limited (CDM) Earnings Call Transcript

Ladies and gentlemen, welcome to the Cadence Capital Limited Year-end Webcast for 2023. The fund was down 4.2% this year against the backdrop of having been 9.9% per annum for the past 3 years. The top contributors to performance during this period were Whitehaven Coal, Newhope Coal, Patriot Battery Metals, Meta Platforms, BHP, Capstone Copper and Terracom, really a lot of energy and metal stocks in the things that performed well. The largest attractors for the period were Australian Pacific Coal, City Chic Collective, Domino's Pizza, Nvidia and Genworth Financial. Obviously, core investments across the energy and resources sector were again the major driver of returns for the fund over the past year, continuing the theme witnessed over previous years and, of course, continuing into this new financial year. Conversely, the fund was very conservatively positioned over this past year, holding very high levels of cash in the portfolio on average above 50%, which obviously dragged on returns, especially in the second half of the year. Other detractors to the company's performance, we're investing in potential early turnaround situations and making too many small losses on new positions that we entered. Actually, this is on both the long and the short side. So in particularly the second half of the year was a difficult trading period. Turning now to the dividends for the full year. We paid a $0.03 fully franked final dividend, bringing our 2023 total dividend to $0.07 per share fully franked. That equates to a 9% fully franked yield or a 12.8% gross up yield, grossed up for the franking or before tax, based on a share price of $0.78 per share on the date that the dividend was announced. In the table above, you'll see this familiar table, we have paid around $1.25 of dividends to date. When you include the franking on that, it's $1.76 of dividends per share. After paying this final dividend, the company still has nearly $0.19 per share of profit reserves to pay future dividends. The ex-date for this dividend will be the 16th of October, and the payment date will be the 31st of October 2023. Importantly, the dividend reinvestment program will be in operation for this final dividend, and the dividend will be priced at the weighted average share price over the relevant DRP period. The company intends to implement an on-market buyback to repurchase the shares and issues under the DRP so that there's no dilution. This buyback will operate when the CDM share price is trading at a discount to the Pre-Tax NTA. The purpose here is that we are looking to support the DRP registered shareholders to reinvest their dividends at a discounted NTA instead of leaving them to manage market orders for reinvesting their dividends or which can be very cumbersome when you're trying to reinvest a small amounts of dividends. If you are not registered for the DRP and would like to participate, please contact Boardroom at the number here. Turning now to the market capitalization of the portfolio. You can see that a large part of the portfolio sits in stocks greater than $1 billion of market cap. And when you go down the market capitalization table there, you can see that we do not have a lot of stock tied up in very small cap stocks at the moment, and we're obviously holding a lot of cash at -- during the period. So we have a very liquid and diversified portfolio. And to put it another way, 94% of the portfolio could be liquidated in 1 week and 97% of the portfolio in 1 month. So we're not suffering from any liquidity constraints at the moment, which is important in this environment. The company holds around 40 positions with the largest position being 6% of the fund. And approximately 83% of funds gross exposure is in companies with $1 billion market cap or greater. And approximately half of the portfolio, I've already mentioned, is sitting in cash or cash equivalents. You can see the top 20 shareholdings on the left of the page. I'm sure you would have -- you would -- a lot of these stocks would be familiar and you would have seen them in our presentations before. As already mentioned, the main energy stocks and the resources and metal stocks have been performing particularly well. Turning to this very important slide now for the longer term, where we show the CDM share price versus pre-tax NTA and periods when we trade at a premium or a discount to NTA. Unfortunately, this chart only goes back to 2007. But if you take it back to when we floated, we also floated and traded at a premium at that stage as well. So looking at that chart objectively, the company trades at a discount and it trades at a premium. The biggest discounts we've traded at have been in periods of extreme periods, the first one being the global financial crisis. And interestingly, the second one being COVID-19. Actually, the discount that we went to during COV19 was greater than the discount that we went to during the global financial crisis. And we're currently trading at a discount to NTA of around 8%, I think, as I make this webcast. And the -- you can see that if -- to put this another way, the shares in the portfolio fell by 10%, the pre-tax NTA would still be above the current share price, or to put it another way, the shares in the -- you could essentially buy shares in the portfolio at a 10% discount currently to their underlying value. Now we know and I hope that our shareholders know that our company trades at discounts and premiums and discounts and premiums. And as I always say, the best time to buy the shares is buy it at a discount to NTA and the best time to sell them, the corollary would be is when they're at a premium to NTA. As you know, we are the largest shareholders in these funds, and we do not sell our shares but we do buy at a discount to NTA. I'm going to turn now to Chris to take you through one of our investments and the thesis on why we entered the position. Thanks, Chris.

Thanks, Karl. The fundamentals of Meta are strong, with EPS growth of 26%, a PE ratio of 26x, and a PEG ratio of 1.0, strong operating cash flow yield of 8%, free cash flow yield of 3.2%, net cash of USD 13 billion and a market cap of USD 776 billion. Meta's main apps are Facebook, Instagram, Threads and WhatsApp. Meta is also heavily involved in AI with work progressing on their ChatGPT like large language model, which will soon be integrated into their apps. Meta's second quarter results were released in July. Net income was USD 7.8 billion, up 16% compared to the second quarter of 2022, which continue to run of quarterly results that beat expectations. Meta's cash flow is very strong with operating cash flow expected to be USD 60 billion for 2023. Meta's strong cash flow enables it to conduct regular share buybacks. The Reality Labs division, which is focused on virtual reality, currently makes a significant loss. The losses will continue in the short term but eventually, this division will make a profit. If we exclude the losses in Reality Labs, then Meta is on a PE of only 19 for 2023. Meta has been in our portfolio since April 2023. The chart on Slide 8 shows that Meta has been in a strong uptrend since the start of 2023. We entered the position once it became clear that the prior downtrend had ended. Last night, Meta announced details of their latest virtual reality headset, the Quest 3 as well as a chatbot called Meta AI, which can generate both text responses and photorealistic images. Meta AI will be available on WhatsApp, Messenger and Instagram. If the chatbot is anywhere near as popular as ChatGPT, this will be a very popular feature. I'll now hand back to Karl to talk about Whitehaven Coal and Westgold Resources.

Thanks, Chris. I was actually just reflecting, it's quite amazing. It's such a large global stock fell so much in Meta, our fundamental criteria and is now recovering. So of course, it does happen at very, very large international stocks bid both our fundamental and technical criteria. Turning now to Whitehaven Coal, which is a long core position for us. You can see on the left-hand slide here that the PE of Whitehaven Coal is 3.7x. It has a PEG of 1.3%, operating cash flow yield per annum of 37%, free cash flow yield per annum of 32%, net cash of $2.5 billion on its balance sheet and a market cap of $5.9 billion. After having just announced a record profit about the same size or slightly larger than quarter of this profit. The -- after selling our position in Whitehaven in last year and then towards last financial year the big department and finishing [ selling out our position ] at the beginning of this financial year, we have now reentered a long position and the stock is performing very well, and so we have added to that position. Looking at future earnings. We have not included any BH coal -- BHP Coal acquisition at this stage. And you can see that even excluding this acquisition, Whitehaven is trading on very conservative multiples, and is it very cheap on operating and free cash flow yield basis. Should energy prices remain high for the next 2 to 2.5 years, and the world is still using coal at that stage, investors are potentially picking up shares of this company for "free" because the cash flows over that period were just about have paid for the entire market capitalization of the company. Whitehaven is potentially the buyer of BHP assets, coal assets, which has been widely reported in the paper and provided that these -- that Whitehaven buys these coal assets at a valuation lower than Whitehaven's current valuation. These acquisitions would be value accretive but importantly given the structure of the muted deal, it will be highly EPS accretive. To put coal in perspective, at the moment, we've seen over the last 3 months reports out of Victoria and New South Wales that both state governments are currently negotiating to keep baseload coal-fired power stations running for at least another decade after 2025. These coal-fired power stations were to be closed but it appears that we, as a nation, are not in a position to close these coal-fired power stations at this stage. And that is a phenomenon that's being experienced around the world as well. Nations are simply not in a position to stop using energy at the moment. Turning now to Westgold Resources, which is a core long position. This is what I would term a turnaround situation. You can see that Westgold has experienced the year about to have a 900% plus EPS growth, will be on a PE of 8.3%, a PEG of 0.01, operating cash flow yield of 30%, free cash flow yield of 9%, net cash on the balance sheet and no debt, and a market capitalization of over $800 million. It's fair to say that Westgold management have successfully turned these gold operations around and 2024 looks set to be a much improved-earnings environment. In addition, Westgold recently announced that they have -- will undertake a CapEx program over the next 2 years to significantly increase the amount of volume being mined. Westgold has been "suffering" under a previous hedge book that has now rolled off. And so any gold mine from now on will receive the full margin between the gold price and the cost of mining the gold. That's a significant change in the business. Obviously, the company has net cash, which I just outlined. The gold price has been inching up over time and especially in Australian dollars against the U.S. dollar, and this should also help to improve earnings as the Australian dollar compresses against the U.S. dollar. Just by way of background, we did also participate in a red capital raising at $0.13, the gold mine, and we were bid $0.26 for those shares recently and we sold half of our position. So this tends to point to the fact that the gold sector has and will continue to experience merger and acquisition activity. We are in the middle of the largest gold merger in history between Newcrest and Newmont. And this looks like moving closer to completion as well. So gold is definitely a bright spot on the horizon in terms of operating cash flow yield and performance of some of these assets in Australia. The following slide shows the price of Westgold. You can see that it performed very poorly and with the new management now is turning around and really has been a very, very good success story for turnarounds. Turning now to other investment themes. We've spoken extensively about the fact that prior to 2020, we've had 4 decades of falling interest rates. That downtrend ended around 2020 and interest rates have been going up ever since. This will be one of the most important trends to monitor in determining the direction of future asset prices. Commentators continue to talk about peak interest rates or terminal interest rates, whilst interest rates are truly reflecting the cost of money. The cost of money goes up and down over time, and this is -- and has been as high as around 17% and as low as 2% over the last 50 years. In periods of rising interest rates and inflation, sectors and stocks with pricing power tend to perform well. In periods of inflation, energy and resources stocks can perform well. The relentless demand for more energy globally will need to be met by supply, otherwise, energy prices will rise significantly and remain high. U.S. interest rates are currently higher than Australian interest rates, and this is unusual from a historical perspective and should lead to a generally weaker Australian dollar against the U.S. dollar. The Australian dollar has fallen significantly from parity against the U.S. dollar to around USD 0.64. A weak Australian dollar also leads to inflation in Australia. Turning now to the outlook. The post cover recovery in markets ended in around mid-2021. And for the past 2 years, markets have continued to be volatile, with no clear trend emerging. Asset prices have been very resilient in the face of dramatic increases in interest rates since 2020. The interest rate trend tends to go in 40-year cycles. So the asset price trends should also go in much longer cycles. Asset price compression remains a potential risk across all asset classes in this interest rate environment. We continue to focus on implementing the cadence process that has served us well through many market cycles. Fewer stocks are meeting both fundamental and technical criteria but importantly, they do exist, and we have solved to see some of the cash in our portfolio deployed. We have started to see trading opportunities in which shares are trading at a discount to underlying assets and subject to detailed due diligence. These tend to be good risk-adjusted long-term investments. Nonetheless, cash and liquidity levels remain high. Both factors reduced the level of risk in our portfolio, whilst we are looking for new investment opportunities. Ladies and gentlemen, thank you very much for your time. And as always, please join our newsletter distribution. And if you would like to get in contact with us, please do so. Thank you.