Good morning, everyone, and thank you so much for joining us for the L1 Long Short Fund Investor Webinar. My name is Mark Landau, I'm the Joint Managing Director and Co-Chief Investment Officer of L1 Capital. Today, we'll be giving you a quick snapshot on performance, a summary of contributors and detractors, how we're seeing the market overall, where we're positioned with that environment and lastly, a number of stocks that we have very high conviction in.
Today, I'll be joined by Amar Naik, who is my colleague, Senior Investment Analyst in the L1 Capital Long Short Fund team. and we'll start to run through the presentation now.
So turning to performance. As you can see on this slide, performance has been very strong, both in absolute and relative terms. Over the past year, the portfolio has returned 21.9% compared to 13.5% for the ASX 200 Accumulation Index. Over the past 3 years, the portfolio has returned 26% per annum compared to 11% for the ASX 200 and 8.1% for the MSCI World and 1.8% for the Global Hedge Fund Index.
Over the past 5 years, the portfolio has returned 16% compared to roughly 7% for both local and global indices. And since inception of both LSF listed vehicle and also the strategy since 2014, the portfolio has returned strong double-digit returns.
I'm very pleased to say that the portfolio has been the best-performing Australian long short strategy since inception in 2014 and returning close to 20% per annum compared to 6.9% per annum for the ASX 200 Accumulation Index, 7.4% for the MSCI World Index and lastly, 1.2% per annum for the Global Hedge Fund Index.
Pleasing way, we've been able to deliver these returns without any tailwind from our investment style. It's important to remind our investors that we are a value and contrarian investor, and by far, the strongest investment style over the past decade has been growth and momentum stocks. It's a real credit to the Long Short Fund broader investment team that have been able to do such a high-quality company and industry research and deliver such strong outcomes for our investors.
The L1 long-short strategy has essentially 2 objectives: the first one is to deliver strong absolute returns to our investors and secondly, to protect capital into our markets. On this slide, you can see the capital protection of the portfolio in falling markets. You can see that in the months when the ASX 200 has been down, and there's been 43 occasions when this has happened, the portfolio has been able to protect 87% of investors' capital, providing very strong and consistent capital protection. Portfolio has also outperformed the market in roughly 80% of months when the market has been down.
On the right-hand side, you can see how the portfolio has performed in upmarkets where it has essentially kept pace with the market despite the fact that we average of 70% net long. So both in rising and falling markets, the portfolio has been able to strongly outperform and it's a real testament to the strategy and the process that we adopt, very focused on valuations, balance sheets, industry structure, operating trends and management quality. And we believe those are the things that are really critical in protecting the portfolio in a down market.
So turning to the stock contributors and detractors. On this slide, we list a number of the key contributors and detractors to performance over the calendar year-to-date. Cenovus, which has performed very strongly benefited from a rally in oil prices to $90 a barrel for Brent as well as tailwinds from higher refinery margins.
Flutter, which has been a long-standing position for us has been a real beneficiary of the strong momentum we've had in our U.S. business, with the division moving to profitability much faster than market expectations.
In my recent months, the stock has sold off, which has given us a very attractive entry point to increase our position. James Hardie delivered first quarter earnings well above market expectations and has delivered strong second quarter earnings guidance.
NexGen Energy in the uranium space has been a beneficiary of higher uranium prices, and they're continuing to progress well on developing their flagship Rook I project.
Seven Group delivered excellent FY '23 results and gave a very positive outlook statement, particularly in terms of Westrac and Coates, which are continuing to exceed market expectations.
On the negative side, there are 3 stocks that attracted from performance. In the case of Imdex, the company delivered results were modestly below consensus expectations, which we believe shouldn't have been a big surprise to anyone given how subdued exploration activity has been in recent times.
Mineral Resources suffered from a 70% fall in the lithium price this calendar year-to-date as the market has corrected from a significant supply deficit to a much more balanced market.
And lastly, Nufarm has been negatively impacted by a poor weather season in the U.S., which led to a 5% downgrade to EBITDA guidance, which was actually much better than many of their global peers.
So turning to the market outlook. We think the outlook for equities is relatively unexciting over the next year or so. On the positive side, we believe the market will benefit from inflation pressures moderating from very elevated levels. We believe interest rates globally are close to a peak. China is starting to announce fiscal and monetary stimulus, which will be particularly helpful for the Australian stock market and there will be a surge in migration with close to 1 million new migrants coming into Australia over the next 3 years.
Unfortunately, on the negative side, valuations today are relatively full. Geopolitical tensions are rising. We believe there's going to be an economic slowdown, both in Australia and the U.S. in 2024. The tail risk from the U.S. regional banking crisis hasn't gone away despite less news flow in recent times. And lastly, most government policy at a federal level has been relatively unhelpful for corporates in industrial relations and also in energy policy.
So on balance, we believe that global equity indices are fully priced and will only offer a modest positive return going forward. So when we look at the market overall, what we can see is that the ASX 200 today is trading almost exactly in line with its 20-year average. The market today is on a P/E of 14.2x which compares to an average P/E of around 14.5x.
So at face value, this suggests the market is relatively fair value and unexciting. But what it doesn't show you is that there are some major distortions and mis-pricings beneath the surface.
As we look at a further breakdown in the market to industrials and resources, what we can see is that the industrial sector is trading well above its long-term average at a P/E of 21.1x, almost 20% above its 20-year average. At the same time, the industrial sector, we believe is likely to slow in terms of its earnings growth as revenue trends moderate with higher interest rates and cost of living pressures. And at the same time, costs are continuing to increase quite strongly with higher wages, insurance, electricity, utilities and other input costs continuing to run at above average levels.
On the flip side, the resources sector is trading very cheap versus history. It's around a 20% discount towards 20-year average. The way you can see here is the resources sector is not only undervalued from a multiple point of view. It's also been through a very difficult period from an earnings point of view, given that most of the resource sector is very leveraged to China and Chinese activity has been incredibly subdued given their COVID lockdowns have gone much longer than the Western world. And also, they have not engaged in the same degree of fiscal and monetary stimulus as we saw in the West, but this is now starting to happen.
So we believe we're hitting an inflection point in terms of earnings trends for resources and combined with a very undervalued sector, we think that it's much more attractive to pay resources versus industrials at the moment. When we look at the market in a P/E sense, what we say is that low pay stocks are trading incredibly cheap versus their 30-year average. In fact, low P/E stocks have only have traded this cheap twice before in the last 30 years. Once was during the dot com boom when no one had interest in low P/E stocks and then we saw a huge period of outperformance for low P/E stocks. And again, during the GFC when investors were crowding into defensive and very highly priced defensive stocks, whereas today, those low P/E stocks are trading on the same multiples as
those 2 periods, both of which proved to be extreme buying opportunities.
In the case of high P/E stocks, we see that, that part of the market is trading at the highest metrics it's traded in the last 30 years with the only comparable period, the dot com boom, which was obviously a period of insanity where investors simply forgot about valuations, which was followed subsequently by a major crash in dot com stocks.
The surge in high P/E stocks has occurred today because of a combination of COVID, where Tech and Healthcare was viewed as a defensive part of the market that was less impacted by COVID, 0 interest rates, which dramatically increased the valuation of long-duration stocks and lastly, flows into growth funds, which obviously were a beneficiary of strong performance during that period of high P/E performance.
What you can see today is that high P/E stocks are trading at a 73% premium to the market which is around 30% above its 20-year average. There's simply been no other period in the last 30 years outside of the dot com bubble where we've reached those levels, which I think is a very ominous sign for high P/E stocks going forward.
When we break the market down into a more granular level, what we can see is that there are a number of parts of the market that are trading way above their long-term averages. On this chart, you can see the P/E of many different parts of the market compared to how it's traded over the past decade.
And what you can see here is that defensives, staples and offshore earners look very stretched versus history in terms of their multiples today versus their decade average. On top of that, the comparable period over the last 10 years is a period where these types of stocks were already trading very expensive because they were positively exposed to lower interest rates and in many cases, 0 rates and negative bond yields.
For offshore earners, not only do they have elevated multiples, but they're also benefiting from a very strong U.S. dollar, which inflated their Aussie dollar earnings. Today, the Aussie dollar is trading in the low 60s, and there's only been 2 comparable periods in the last 20 years when the Aussie dollar has traded so weak, once in the GFC and once in the March 2020 crash due to COVID. In both cases, the Aussie dollar bounced off those levels, which will obviously be an earnings headwind for those offshore earners.
On the flip side, you can see the undervalued part of the market low P/E stocks, energy and metals, which we see are trading 20% to 30% below their normal multiples. So as you can see on this slide, despite the fact the market overall looks relatively fairly valued, there are pockets of the market that are very risky and expensive and there are other parts of the market that look incredibly undervalued and exciting.
So turning to LSF portfolio positioning. Given the background we've given on where we see the distortions in the market, it will come as no surprise to anyone that we are skewing our portfolio towards low P/E stocks. On the long side, the average P/E across our portfolio is around 10x earnings, the companies we own are typically growing at around 10% per annum. They are generating around a 6% free cash flow yield. And they also have very low net debt levels, which mean, we'll suffer less pain from higher interest rates.
On the flip side, our shorts typically are trading on close to 20x earnings. Their earnings are going backwards, and they're generating 40% less cash than our loans. So we're very excited about the metrics that we see across our portfolio and believe it bodes well for performance over the next few years. The LSF portfolio is built very much bottom-up with detailed company and industry-specific research that aggregates to a portfolio of around 80 stock [ ideas ]. Typically, around 55 of those will be long positions and around 25 will be short.
So when we try to summarize our portfolio, it's quite difficult given how many different stocks and how many different themes we're exposed to. But if you were to step back and look at our portfolio today, you would notice 5 key clusters or themes of ideas that we believe offer incredibly compelling asymmetric risk reward.
Firstly, the energy sector. The outlook for oil and LNG is much better than market expectations. Demand for energy continues to grow, and there's a clear underinvestment in new supply. Given that, we think the prices will stay much more resilient than the market expects. And on top of that, we're seeing a surge in sector M&A activity where we've seen some of the oil majors in the U.S. have been key players in M&A activity in recent weeks.
In terms of global leaders, we're exposed to the #1 players in structurally growing industries. These companies are run by high-quality management teams that have both organic and inorganic options to reinvest and accelerate growth. And 2 of those examples are CRH, which is the world's largest construction materials company and Flutter, which is the clear leader in U.S. sports betting.
In terms of gold, it provides an incredibly valuable diversification benefit to our portfolio. It's able to hedge against geopolitical risk, inflation and potential U.S. dollar weakness. On top of that, the companies we're invested in are providing strong growth in production and leverage to higher gold prices. And 2 of our favorite names are Newmont and Westgold.
Hidden Tech is an area of the market that we find really attractive. These are companies that are trading on low multiples and are believed to be particularly exciting. But when you dig beneath the surface, you can find incredible, valuable IP which is able to drive very long-term structural growth in earnings. Two examples of this are Nufarm with the intellectual property they've developed with the CSIRO over 15 years in their C technology. And in the case of Imdex, they've spent a decade building the best suite of technology for the exploration drilling market, which we believe is being underappreciated by the market.
And lastly, in infrastructure, we like monopoly regulated assets with huge barriers to entry that are able to deliver dividend yields of 6% to 7% and then grow those dividends over time with the benefit of rising volumes and prices and 2 of those stocks are Chorus and Aurizon. One sector that we're very positive on is energy. We believe energy is likely to benefit from ongoing demand growth, difficulties in increasing supply and investor positioning is outright bearish.
On the demand side, what we can see is a very rapid recovery in Chinese aviation activity, which is now bouncing back after the COVID lockdowns in China. We're also seeing continued rise of Asian demand, which will continue to provide a support to reductions in demand in some parts of the Western world. At the same time, the strategic petroleum reserve has been drained and is now being replenished. We can see that inventories are now at the lowest levels that we've seen since the mid-1980s.
So on that basis, we believe the energy market will prove more resilient than investors expect. On the supply side, we think we'll continue to see ongoing constraints. For oil majors such as Exxon, BP and Shell and others have seen a multiyear underinvestment in CapEx, which we believe will result in no production growth going forward.
At the same time, the Saudis in OPEC+, a constraining supply and have extended their 1 million-barrel a day supply cut until the end of this calendar year. And lastly, Shale, which has traditionally been the most responsive to higher oil prices, is no longer seeing an increase in the rig count. We've seen well productivity declining for the first time in history. And as you can see in the chart, the rig count is simply not responding to higher oil prices, which is very unusual for this sector.
The other thing we find fascinating about today's market is that sentiment to the energy sector could not be more bearish. If you look at this chart, what you can see is in the red is the positioning of U.S. hedge funds to the energy sector and in the blue is the WTI oil price. And what we find incredible about this chart is that investors today are just as bearish as they were in the early to mid part of 2020. If you think back to that period, COVID fees were extreme, virtually no one in the world was driving or flying, oil storage globally was full and the oil price was actually negative. We find it very hard to understand how investors can be just as bearish today as they were back then.
If you look at hedge fund positioning, it's at such extreme levels, we're at the 98th percentile versus its 5-year history. And that obviously includes a period of very depressed oil prices and a very bleak outlook, particularly in the early part of COVID.
We find such extreme negative positioning surprising, considering the oil price today is over $80 a barrel. We've got tensions and war in the Middle East, a favorable supply/demand outlook and oil inventories are at multi-decade lows. The combination of all of this extreme negative positioning suggests to us that the market is predicting a very large fall in the oil price, which we simply don't think is realistic given the demand that's likely to come from the strategic petroleum reserve and the potential cuts from OPEC+.
It's now my pleasure to introduce Amar Naik, who will take you through a number of the high conviction stocks in our portfolio.
Thanks, Mark. If we start on the energy theme with Santos, which we think is the best energy investment opportunity in Australia. Despite strong operational execution and a portfolio of high-quality, long-life assets, Santos' share price has lagged global peers meaningfully over the past 3 years. If we look at valuation today, the company trades at around a 35% discount to U.S. peers despite having a much stronger EBITDA growth profile.
According to consensus estimates, Santos should grow earnings 22% over the next 3 years versus peers, which are all expected to go backwards. We think a large part of this discount is driven by the company's underappreciated LNG assets. Together with our [ Catalyst Fund ], we recently published a detailed piece proposing a structural separation of these LNG assets, which we think has the potential to deliver a 40% valuation uplift.
Furthermore, we think the separated companies will be highly attractive to a wide range of investors and this could catalyze M&A interest in the sector.
Moving on to Cenovus, which is an integrated energy company with its main operations located in Canada. The company has an exceptional portfolio of assets with long life and a low cost of production, where it's breakeven oil price is around $40 a barrel. At current oil prices above $80, it is generating exceptional free cash flow. Cenovus has seen some impacts from refinery outages, but operational performance has improved significantly in recent periods, which will support much better downstream performance.
We believe the company is on track to hit its $4 billion net debt target early next year, which will enable a major step-up in shareholder returns. The company has been very clear that as soon as it hits this target, it will return 100% of free cash flow to shareholders. It is currently able to return about 12% of its market cap per annum in free cash flow.
If we move on to the next theme, which is Global Champions, starting with CRH. CRH is the largest construction materials business in North America. It has a market cap of roughly $38 billion. Despite its size, we think it's flown somewhat under the radar for U.S. investors. It's an Irish domiciled European-listed business, even though 75% of its EBITDA is generated from North America, and it has #1 positions in several construction materials categories.
In late September this year, the company moved its primary listing to the NYSE, and we think this will be a catalyst to increase its profile with investors and driver re-rating. CRH's outlook is exceptional. It's exposed to huge growth in U.S. infra spend, which has already been committed from Acts such as the IIJA and the IRA. If we take 1 example, CRH is the largest road builder and paver in the U.S. And this is at a time when we see spend committed to road building going up 50% over the next few years.
Furthermore, with the U.S. focus on onshoring, there's been over $200 billion in projects already committed across water and tech and a few other categories. The company has a strong track record of driving EBITDA growth and operating cash flows well above peers. At its recent Investor Day, CRH outlined a pathway to double-digit earnings growth per annum over the medium term, as well as the potential to deliver nearly its entire market cap over the next 5 years, primarily from operating cash flows.
Despite this exceptional growth outlook, the company trades on only 11x FY '24 earnings, a huge discount to U.S. peers. Martin Marietta, for example, trades on 20x and Vulcan at 25x earnings. We're not saying CRH will trade at those levels, given it is a much more diverse business, but the 11x multiple is far too cheap for the strong growth outlook the company has and its privileged positions.
Moving on to Flutter, which is the stock we've spoken about previously. I've recently come back from the G2E conference in Las Vegas, which is the largest of its kind in the world and attracts more than 25,000 people from across the gambling industry. At the conference, we had the opportunity to meet Amy Howe, the CEO of Flutter's U.S. Division, FanDuel as well as several other industry participants.
The trip reinforced our conviction on Flutter's key advantages. The company has the best tech, the best risk management and the best pricing capabilities and so far has delivered the best execution in the market. And we believe this is set to continue. You can see some of this advantage in the chart where Flutter has a 400 basis point margin benefit to peers.
We think the company continues to execute well and the business has a number of inflection points coming up. The U.S. business is set to be profitable for the first time this year, and we see an exponential growth path ahead for that business.
In addition, Flutter is planning to secondary list in the U.S. in the coming months which we think will be a huge catalyst for the profile of the company and open it up to a much wider investor base. Flutter is currently trading on 23x FY '24 earnings and we see the potential for a 20% to 25% per annum EPS growth profile over the next few years.
Moving on to the gold sector. And if we started the large-cap space with Newmont, we initially built a position in Newcrest about a year ago. Newcrest has subsequently been acquired by Newmont, and we've rolled our position into Newmont with the closing of this transaction. Newmont is now the largest gold producer in the world by a huge margin. It has nearly doubled the annual production of the second place company, Barrick. It has a portfolio of Tier 1 long-life mining assets with several development-ready growth assets.
We believe the NewCrest acquisition will drive strong upside with $500 million in synergies identified and over $2 billion in portfolio optimization benefits over the next 2 years. The company also has strong copper exposure with GBP 16 billion of copper reserves. We believe the recent share price performance is transitory and mainly due to indigestion around the takeover offer.
In the smaller cap space, we like Westgold Resources. Westgold is a WA-based producer with 4 key mines across 3 processing hubs. If you couple this production growth with a very attractive Aussie dollar gold price, which is at all-time highs, above $3,000 an ounce, we see the potential for very strong free cash flow growth in the coming years. The new management team continues to execute well and has delivered an outstanding turnaround over the past year.
Moving on to hidden tech and starting with Nufarm. Nufarm is an agriculture company with 2 main divisions. Firstly, the crop protection business, which sells insecticides, herbicides and fungicides to farmers. That's about 80% of group earnings. And secondly is the seed technologies division, which sells sorghum, sunflower and canola seeds and also has some exciting proprietary products in canola and Omega-3. That's about 20% of the earnings.
Now the crop protection segment has been impacted by destocking and dryer conditions, which has weighed on the share price. A lot of this is due to inventories built up during COVID to protect against long lead times. And now we're seeing that correction. But we expect that will largely transitory and the Crop Protection business is well placed over the medium term with a solid pipeline of new products coming to market. The part we're really excited about and the part we think is ignored by the market is the seeds technology segment. Now this segment has grown at close to 40% per annum over the past 3 years. And that increased its earnings from 10% of the group to 20%.
At its Investor Day, Nufarm's aspiration is to take that EBITDA to close to $150 million in FY '26 and over $400 million in FY '30. A large part of this growth is from its proprietary Omega-3 technology, which has been working on for over a decade. And basically, the Omega-3 tech works as a hybrid form of canola, which when it's crushed delivers an Omega-3-rich oil. Now this can be used in salmon farming, for health products and for a number of other users.
And the dynamics of the industry is that most of that Omega-3 or fish oil has come from wild fish and that's [ Antares ] and sardines mainly. And that supply growth has been capped out, as you can see on the chart. And this is due to overfishing, strict quotes and sustainability concerns.
We see this omega-3 technology as providing a sustainable and scalable solution to support the demand growth.
And then on to index. Imdex is the global leader in mining exploration drilling technology. It has a track record of strong earnings growth. EBITDA has grown 24% per annum over the last 5 years relative to the industry that has only grown low single digits. The share price has recently been impacted by the downturn in mining equity raisings, as you can see on the chart. This a large part of this is junior miners not having access to equity markets given the volatile market backdrop.
What we've seen recently is raisings have started to stabilize and potentially starting to recover. And if we think about the cycle on a medium-term basis, Commodity prices remain very favorable, and we expect further investment in exploration, which will support Imdex. Imdex was the clear #1 player and earlier this year, completed the acquisition of the #2 player Devco. We believe the combination of these companies massively extends their leadership position and positions Imdex with the best portfolio of products in the market and the ability to drive earnings growth for many years to come.
Moving on to the infrastructure theme and Chorus. This has been a long-term shareholding for L1. We first bought the shares in 2014 at around $1.60 a share. Chorus owns and operates the majority of New Zealand's high-speed broadband infrastructure. To give you an idea of the speeds here, in New Zealand, around 70% of the population have access to a plan of around 300 megabits per second. If you compare this to Australia and the nbn, most of the population has under 100 megabits per second speed. A Chorus currently trades on a dividend yield of around 6.5%, and -- and what excites us the most about the stock is we see strong potential for this dividend to accelerate in the coming years. A large part of this is due to Chorus with it having just completed the decade-long investment in its fiber network.
And on to our final stock Horizon. Horizon is a leading rail operator in Australia with over 5,000 kilometers of network rail assets. It has the largest haulage operations domestically across coal, bulk commodities and containerized freight. We see 3 key drivers underpinning the earnings outlook for the company. First is the step-up in its regulatory network earnings as it cycles into a new regulatory period. Second is the growth in volumes from contract wins and less weather-related impacts. -- and finally, an ongoing focus on operational efficiencies.
And we also expect CapEx to peak this year and return to through-the-cycle levels over the next few years. Now this combination of increasing earnings drivers and declining CapEx, we think will drive a steady increase in returns to shareholders with further support from management returning the payout ratio to the top of their range.
I'll now hand over to Mark for the summary.
Thanks very much, Amar. So in summary, we're really pleased with how the portfolio has been performing over the last year, where we've returned 21.9% and -- and over the past 3 years, we've returned 26% per annum. We believe equity indices are currently fully priced and are only offering a modest positive return. The positive, though, is that we're seeing a huge amount of disparity in the market, which is really conducive to fighting with price stocks.
At the moment, we see 5 key themes that we believe offer a compelling asymmetric risk reward, energy global leaders, gold, hidden tech and infrastructure, and there are heaps of opportunities outside of that as well. We're really excited about the outlook for the portfolio and believe that we're very well placed to navigate the evolving macro backdrop.
Thank you, everyone, so much for your time today. We really appreciate your support. And as always, feel free to reach out to us if you have any follow-up questions. Thank you.
