L1 Long Short Fund Limited (LSF) Earnings Call Transcript & Summary

Hello. My name is Rafi Lamm. I'm the Co-Managing Director and CIO of L1 Capital. In today's webinar, myself and L1's Head of Research, Amar Naik, will give you an update on the Long Short Fund, covering reflections on 10 years of managing the Long Short Fund, observations on the market, a portfolio performance review and some discussion on key themes that we are seeing today. The Long Short Strategy has been the best-performing Australian long short fund over the past decade since we launched in September 2014. Let me tell you a little bit about the evolution that led us to here. In 2007, we launched a benchmark-aware long only Australian Equities Fund based on Mark and my backgrounds in our previous roles. We believed that we could generate significant alpha from 3 main areas: Strict valuation and qualitative focus; building and leveraging a very extensive network of contacts throughout corporate Australia and overseas; and finally, embracing independent thinking. This investment process has been consistent and successful over many years and has been able to generate significant alpha for our clients in many different market environments. We founded L1 on the principle of alignment of interest with our clients. We would call it extreme alignment. The vast majority of our personal investable wealth is invested alongside our clients in L1 funds. We do not permit personal share trading. We pay half of all staff bonuses in the form of investments in L1 funds, they are escrowed for a minimum of 3 years. We also close our funds to new investors at levels where we believe we can keep delivering strong returns. All L1 funds were launched with the end client being the primary focus. We ask ourselves the question, is this a fund that we would be prepared to put a large portion of our personal wealth into? And also, does it offer something differentiated and have a compelling risk-reward compared to other funds already in the market? This brings me to 2014 and the launch of the Long Short Fund. While the Australian Equities Fund was one of Australia's best-performing long only funds, and likely the top-performing value fund over its life, we both thought that there was a better way to generate returns for our clients, aligned with how we would invest our own money. This led to the launch of the L1 Capital Long Short Fund in 2014. We leveraged our existing research process while also being able to add value in 3 additional ways: Through shorting, adjusting market exposures according to conditions and finally, through international investing, all with an absolute return focus in mind. LSF has quickly become our flagship equity product. Over the last 10 years since inception, it has returned 19% per annum for investors compared to 8.3% per annum for the ASX 200 Accumulation Index. Despite the success of the Long Short Fund, this has been achieved with value stocks facing enormous headwinds during this period. Since 2014, low valuation stocks have underperformed high valuation stocks by 116%. But the relative multiple of low P/E stocks when compared to high P/E stocks has almost halved. Ironically, in retrospect, 2014 was pretty much the worst time in history for launching a value-focused strategy. Despite this enormous style headwinds, we have been able to deliver attractive returns first and foremost, due to the high caliber of our investment team, through our independent thinking and through the flexibility of our fund structure. We are extremely excited about where the portfolio is positioned today. Very rarely have there been as many portfolio stocks trading at such large discounts to the market despite having excellent medium-term prospects. We sincerely appreciate the faith and trust that you have placed in us, and we will be working hard to repay that trust over the years to come. And now I'll hand over to Amar to take you through our market observations.

Thank you, Rafi. In terms of economic trends, starting on the U.S., the data continues to remain relatively resilient. Unemployment levels have risen to 4.1% from 3.7% at the start of the year, however, remain well below the long-term average of around 5.5%. U.S. GDP growth accelerated to 3% in the second quarter, and consensus estimates continue to point to around 2.5% growth for the full year. Consumer spending has held up relatively well despite elevated cost of living pressures. One area we remain watchful on is the U.S. 10-year yield. That's up nearly 50 bps this month to 4.25%. We think this is more a reflection of debt and fiscal sustainability issues in the U.S. rather than enduring inflation concerns. Overall, the current data supports a flat-to-moderate economic growth outlook for the U.S., which is reflected in current market estimates for around 2% GDP growth in 2025. From a U.K., Europe perspective, we remain more positive on the U.K. relative to the rest of Europe. We've seen a recovery in key economic indicators in the U.K. PMI has inflected above 50, as shown by the light blue line. Consumer confidence is now at the highest level it's been in 5 years, and housing activity is poised to rebound strongly. The European outlook is, however, more cloudy. Manufacturing PMI is below 50, consumer confidence has plateaued, and there are risks in 2 of the largest countries, Germany and France. In Germany, economic growth has largely stagnated, and business activity continues to contract. France is facing a significant jump in corporate tax rates from 25% to 33.5% to repair its current deficit. So overall, we remain optimistic on the U.K., but more watchful on Europe. On to China, which has been very topical over the past quarter, we've seen a significant step up in fiscal and monetary stimulus announcements from government officials. This has driven the Shenzhen 300 Index to rally strongly over the September quarter. The measures have been targeted at removing the inventory overhang in the housing market, improving consumer sentiment and achieving a moderate rebound in economic activity. We think there's a strong commitment from the government, particularly to drive near-term GDP growth. Current market projections indicate around a CNY 3 trillion per annum estimate in additional spending or an increase to around 10% of GDP growth from the stimulus measures. However, with not all the specifics announced, it remains very difficult to be both definitive on timing or impact of these measures. And this could vary significantly from that base estimate. On balance, we expect some success from these measures, which will be positive for global growth, Chinese equities and materials demand. And lastly, on to Australia, where we think economic growth will be supported for 2 main factors: First is the surge in migration levels. This has driven population growth close to 2.5%, which is the highest level since the 1950s. And secondly, commodity prices continue to remain at relatively attractive levels, which will support the budget. Unemployment levels remain steady at around the 4% mark over the last few months and inflation, which we continue to monitor, is trending just above the high end of the RBA's 2% to 3% target. Overall, we think the data remains supportive here of a moderate growth outlook with 2% GDP growth forecast for 2025. From an index and valuation standpoint, if we look at most developed market indices, they are trading 15% to 20% above their long-term average. Earnings growth continues to look relatively robust, supporting these index valuations. The MSCI World and S&P 500 are expected to grow EPS over 10% per annum over the next 2 years, and the Nasdaq over 20% per annum on market estimates. Australia is somewhat of an outlier with only 5% per annum earnings growth expected over the next 2 years despite the ASX 200 trading at a 15% premium to its 10-year average. If you break down the ASX return at a sector level, you can see a very wide divergence in performance. The tech and financial sectors, which mainly comprise the domestic banks within the financials, are trading well above their long-term averages and have driven a large amount of the ASX 200's performance year-to-date. Conversely, resources and energy are trading well below their long-term averages. So overall, while we see some risks to market valuations at an index level, particularly the ASX 200, we are finding compelling opportunities in sectors that have lagged domestically such as resources and energy. We are also cognizant of several other risks that may impact the market, some of these are: The upcoming U.S. elections. Many companies we speak to have called out a pause or a reduction in spend until there is greater clarity on the election outcome and implications, we expect this will cause some short-term volatility. Geopolitical risk continues to remain elevated. Government policy, particularly regarding industrial relations and energy has been unhelpful, and many consumers today continue to face cost of living pressures in a higher rate environment. Another area we have been asked a number of questions on are the domestic banks. And we wanted to highlight an example of why we believe valuation discipline is critical. If we go back to when L1 Capital was started in 2007, Woolworths was the market dialing and most popular growth stock at the time. It had a stellar performance since IPO, growing at 18% per annum. It was and still remains a very high-quality company. However, the valuation at that point had risen to very full levels with a 65% increase in the earnings multiple from 15x to 25x earnings. If we then look at performance since 2007, the stock has risen by less than 1% per annum over the next 17 years. And this is all despite the tailwinds of population growth, increased spending, a growing store network and a relatively favorable industry structure. If we look at CBA now, we see a number of parallels with Woolworths from 2007. It is Australia's largest and highest quality bank. However, its earnings multiple has increased by over 50% over the last 12 months from 16x to almost 25x. Typically, this is driven by earnings upgrades or a strong growth outlook. We have seen neither of these at CBA. Earnings outlook has remained relatively unchanged over the past 12 months, as you can see from the EPS revisions, and the market has less than 2% EPS growth per annum forecast over the next few years. The dividend yield has fallen to just 3.3% now, which is well below the current cash rate. And when we look at asset quality, we are coming out of a very benign period from the pandemic, and we expect pressure to increase here. With interest rates at higher levels, we expect overdue loans to revert back towards pre-COVID levels, especially with the risks of sharper cost of living pressures. Overall, we see the banks as vulnerable to a pullback either from any economic weakness or from improved sentiment to other sectors or geographies, which could drive our rotation away from the banks. On to portfolio performance and key themes. Just highlighting some of our key contributors and detractors over the calendar year-to-date to the end of September. Starting with Qantas. Qantas has seen strong operational trends while also addressing a number of pain points in its business and a new CEO, Vanessa Hudson, around customer experience and loyalty. The improved operational backdrop underpinned improved shareholder returns through increased share buybacks and dividends. On Hudbay, Hudbay has been a key beneficiary of rising copper and gold prices as well as strong execution by management, which has driven production results above market estimates. Flutter continues to execute well in the U.S. market and cement its leadership position. There is some tax rate uncertainty in the U.K. and the U.S. that the company will need to navigate but being the #1 player in both of those markets, we think they are best placed to mitigate this on a medium-term basis. CRH delivered a very strong Q2 update and upgraded full year earnings guidance. This is despite poor weather in the U.S. that led to many of its peers downgrading guidance as volumes fell. We think this highlights the quality of the management team and the strength of its vertically integrated business model. Downer continues to execute well on its cost out program and the path to greater than 4.5% EBITDA margins. Chorus stepped up dividends by over 20% heading into FY '25 as the business transitions from being a capital-intensive network builder to a more capital-light network operator. Tesco delivered market share gains, which has contributed to increasing operating leverage and margin expansion. We continue to expect strong shareholder returns from both share buybacks and dividends going forward. NatWest delivered Q2 earnings well above market expectations. A few days ago, the company reported their Q3 results and again delivered earnings above expectations. We continue to see a good runway for further earnings growth here. On Fraport, and starting our detractors, Fraport has been impacted by lower passenger growth trends due to delays in aircraft deliveries and ongoing grounding for engine issues impacting its key partner, Lufthansa, as well as strike action earlier in the year. Mineral Resources has been impacted by falling commodity prices, namely iron ore and spodumene. This has triggered some concerns on its balance sheet capacity and ability to fund its current growth projects. In addition, Min has been weighed down by an investigation into tax matters and related party transactions by senior management. And lastly, Arcadium Lithium has been impacted by a fall in spodumene prices. In early October, the company received a takeover offer from Rio Tinto at a 90% premium to its undisturbed share price. We used the rally in the share price post this offer to exit our position. I'll now hand you back to Rafi to take you through some key changes in sector positioning as well as some of the current themes we like in the fund. Thank you.

Thanks, Amar. Let me now touch on a few significant changes in the portfolio positioning over the last 6 months. Firstly, we have increased our weight in the infrastructure space, adding several attractive opportunities. We have also increased our net long to the gold sector. In materials, we've added to some oversold positions, which remain high conviction within the portfolio. We reduced our overweight in Aussie industrials, selling down several positions that had rallied strongly. And finally, we reduced our large net long copper position after several of the shares rallied strongly. And in particular, we exited Capstone Copper after a particularly strong run. In terms of geographical exposures, we added several new positions and increased our overweight in the U.K., while we sold down some positions and reduced our net long in the U.S. Asia remains a very small part of our overall portfolio. We have retained a similar exposure to Australia and New Zealand, rotating into oversold names and out of strong performers. We're invested in 5 key themes that we believe offer compelling asymmetric risk-reward. The first theme is infrastructure, predominantly regulated assets with significant barriers to entry, strong cash generation and long-term demand growth in their end markets. Two stocks I'll focus on here of Fraport and Aurizon. The next theme is global leaders, #1 players in structurally growing industries, high-quality management teams with attractive options to invest, acquire and return capital to shareholders. Two of our picks here are CRH and Flutter. The next theme is U.K. quality value. Dominant high-quality companies with significant barriers to entry, strong earnings growth and pristine balance sheets, very low P/E multiples versus global peers. Two of our picks here are Rightmove and Tesco. The next theme is gold. We have seen ongoing strong demand from global central banks as well as Asian consumers. Recent interest rate cuts and U.S. federal debt, deficit concerns should continue to support pricing. Two of our picks here are OceanaGold and Eldorado Gold. The final theme is uranium. Uranium demand resurgence driven by the need for zero-emission reliable base-load energy is here. Major new mine supply is required given the demand outlook and the reliance on supply from Russia and Africa. Our favorite exposure here is NexGen. I'll now cover each of these in a bit more detail, together with some key stock ideas in each one. Fraport is the owner of Frankfurt Airport as well as a number of international airport concessions in Greece, Turkey and Peru. The company is approaching an inflection point in its cash flows as it nears completion of a EUR 4 billion third terminal in Frankfurt that will increase airport capacity by over 30%. We conducted a Frankfurt site visit of the new terminal in September. Construction has well progressed and on track for completion in October 2025, with operations due to commence in around Q2 of 2026. As spend on T3 winds down, Fraport will also complete major projects at their Peru and Turkish airports, after which all key concessions will be ex major CapEx on a long-term view. This dynamic will facilitate steady deleveraging, a return to dividends from 2026 and high levels of free cash flow generation over the subsequent decade or decades. Aurizon is the largest hauler of bulk commodities in Australia as well as the owner of over 5,000 kilometers of railway network assets. The majority of the company's valuation is derived from the below-rail network assets which are regulated infrastructure assets providing high levels of predictable cash flows. For the last couple of years, earnings and cash flow have been weighed down by the major investment in One Rail as well as new growth projects. This has also impacted shareholder returns since FY '22. However, we see an inflection point with gearing levels materially reduced and growth CapEx demands reducing. Following the announcement of a higher dividend payout ratio for FY '25 and $150 million share buyback, we see a continued step-up in shareholder returns in the coming years. Moving over into global leaders. CRH is the largest building products company in North America with a market cap of around USD 60 billion. It completed a shift in its primary listing from the U.K. to the U.S. in September last year. The company has an outstanding track record of delivering growth with EBITDA growth of around 15% per annum and EPS growth of 19% per annum over the past decade. It is well placed to benefit from the golden age of infrastructure investment in the U.S., which will underpin many years of robust demand. The IIJA, IRA and the Chips and Science Act together add roughly $2 trillion to aging U.S. infrastructure. CRH is trading at only 15x FY '25 earnings, with a double-digit per annum earnings growth outlook over the medium term. This is nearly half the multiple of pure-play aggregates peers in the U.S., such as Martin Marietta and Vulcan Materials. We believe the company is a highly attractive investment with further upside as it starts to get included in key U.S. indices, such as the S&P 500. Flutter is the #1 player in the North American sports betting and iGaming markets. It has greater than 50% market share in U.S. sports betting and 25% share of U.S. iGaming. We recently attended the company's Investor Day in New York a few weeks ago where the company upgraded their view of total addressable market size in North America from $40 billion to $70 billion. This amounts to nearly 4x increase in the market value versus 2023 and an over 70% increase relative to the company's view of just 2 years ago. The majority of this increase is driven by a 45% increase in player values. Flutter outlines ambitious targets at their Investor Day to double group EBITDA over the next 3 years. From $2.5 billion today to over $5 billion in 2027. This will underpin a step change in cash flow generation and support a $5 billion share buyback program. During our trip, we also had the opportunity to meet with 6 of the 7 top players in the U.S. market. We came away with increased conviction on Flutter's ability to maintain the U.S. market leadership position. The company has around 7,500 technologists globally and 1,500 employees working on risk and pricing alone. This unrivaled scale and focus gives them a structural advantage that is hard for peers to replicate. Now to U.K. quality value. The U.K. stock market is a standout globally with numerous high-quality companies trading at compelling valuations. The U.K. market has underperformed for over a decade due predominantly to Brexit, COVID and weak economic growth. We are seeing clear signs of the macro environment improving, including consumer confidence, PMI numbers and housing activity. Recent investor trips to the U.K., we have noticed a significant improvement in both corporate and consumer confidence levels. We have identified multiple opportunities in high-quality leading U.K. companies trading at large discounts to global peers. Tesco is the clear leader in the U.K. supermarket sector with a market share of approximately 28%. It has little debt and owns 60% of its property footprint. Tesco's management team are executing extremely well with its strong product offer and competitive price positioning, driving consistent market share gains and volume-driven operating leverage. This is also resulting in strong cash flow generation, which, combined with the sale of its banking operations, is funding a substantial buyback and dividend program. Despite this, Tesco is trading at a discount to its long-term valuation multiple and well below global peers, including Woolworths. Moving on to Rightmove. Rightmove is the dominant real estate portal in the U.K., generating in excess of 80% of all real estate search traffic in the country. Given the positive network effects of this market position, we see the business being able to grow both its core listing offering as well as key adjacencies to deliver double-digit earnings growth over the long term. In September, REA Group made a number of takeover proposals for Rightmove before ultimately withdrawing its interest as it was unable to secure support from the Rightmove Board for its approach. While we were disappointed that a formal proposal to shareholders could not be reached. The approach highlights the value in the platform in the eyes of a global leader. The business remains well positioned, currently trading on 22x time FY '25 P/E multiple compared to the peer marketplace businesses trading at a significant premium to that, and REA group itself trading at around 54x P/E. Turning to gold. The 2024 rally in the gold price, we believe, has been driven largely by an acceleration in buying by central banks as well as Asian consumers. However, over the long term, we view the challenges around U.S. fiscal sustainability as being a major ongoing driver of positive moves for the gold price. In fact, the U.S. federal government debt is rising by around $1 trillion every 100 days as we speak. We remain positive on gold due to elevated geopolitical tensions, lower real interest rates and structural demand growth from central banks and consumers. We recently traveled to the Denver Gold Conference in Colorado and had meetings with over 30 of the world's largest gold miners. Those we met included Eldorado Gold and OceanaGold, which we see as standout names within the sector. Both have long-life assets, sector-leading growth profiles, a diversified multi-asset, multi-region production base, yet trade at a substantial discount to larger names within the sector. We believe, over time, this value delta should close as they deliver on growth aspirations ultimately via consolidation, which is already very active in the sector. OceanaGold has 2 core assets, both 10-year plus mine life assets located in the Philippines and the U.S. as well as some shorter life assets in New Zealand. The company is approaching a major inflection point this half as the ramp-up of underground mining rates dramatically increases gold grades. We see a 2.5x grade uplift in U.S. asset hail from underground versus open pit tonnes, while we see a 5x grade uplift in the Philippines asset, Didipio, from underground versus stockpile tonnes going into the mill. Currently, Oceana is trading on a very low multiple with a net cash balance sheet, providing significant scope for shareholder returns and buybacks. The company has some substantial long-term growth options including the WKP project in New Zealand, which is set to benefit from proposed fast track permitting in New Zealand. Eldorado has a diversified portfolio of gold assets in Greece, Turkey and Canada. The key growth driver for the company is completing the development of its flagship Skouries gold, copper project in Greece, which is expected to commence production by the end of calendar year '25. Skouries at current commodity prices should add around USD 500 million per annum of incremental cash flow for Eldorado. Delivery of this large project would be a material derisking event for the company that we would expect should result in a valuation re-rating for the company. Longer term, we see scope for Eldorado to be a regional consolidator, having established itself as an industry leader in Turkey, in particular. Moving to uranium. The outlook for uranium is bright, given the world's desire for reliable, affordable and green energy. Many large western nations are looking to dramatically increase nuclear energy capacity by 2050. China is expected to grow at an even faster rate. Significant new mine supply is required to meet current market demand and growth and also reduce sovereign supply risk that we see from Russia, Kazakhstan, Niger and other locations. Microsoft, Amazon and Google have recently announced major investments in nuclear power for new data centers. This is an exciting new area of demand. We believe NexGen is the most attractive way to play this thematic. NexGen owns the largest uranium asset under development globally called Rook I. This is an exceptional project of large scale and long life. NexGen is in the final stages of approvals and financing and is expected to commence major works within the next 6 to 12 months, with many of the key items already on site ready to commence the build. NexGen has over CAD 1 billion in cash and uranium assets on its balance sheet, which places NexGen in a very strong position to fund the first couple of years of the project build. NexGen is very attractively valued. And indeed, at $100 uranium price, NexGen could produce around CAD 3.4 billion of EBITDA compared to the current enterprise value of around CAD 5 billion. This brings our webinar today to a conclusion. Thank you once again for your strong support of L1 Capital and the Long Short Fund over the past decade. As I mentioned, we are particularly excited about the opportunities ahead of us over the coming year, and we look forward to sharing our next LSF update with you soon.