L1 Long Short Fund : Quarterly Report - June 2022

L1 Long Short Fund Limited

Quarterly Report | JUNE 2022

		 The L1 Long Short Fund (LSF) portfolio returned -10.4% (net) for the June quarter (ASX200AI -11.9%).
		 Global markets fell sharply during the quarter (S&P 500 -16.1%, MSCI World -16.2%, Nasdaq -22.3%) on increasing concerns
				over central bank policy tightening and the possibility of a U.S. recession.
		 The portfolio has returned -0.2% over the past 6 months (ASX200AI -9.9%) and 10.0% over the past year (ASX200AI -6.5%),
only	supported by favourable stock-specific company updates together with long exposure to Energy, and short exposure to
unprofitable technology stocks and 'COVID winners' that fell significantly.
		Global markets fell sharply during the quarter as a		Returns (Net)1 (%)	L1 Long Short	S&P ASX200	Out-
				Portfolio	AI	performance
		higher than expected U.S. May inflation reading
		exacerbated investor concerns over the		3 months			(10.4)	(11.9)	+1.5
		po	ibility of further Fed tightening, which raised
usefears about a potential U.S. recession. The S&P			6 months		(0.2)	(9.9)	+9.7
		500 and the Dow Jones fell 16.1% and 10.8%,			1 year			10.0	(6.5)	+16.4
		respectively, their worst quarterly performance
		2 years p.a.		37.9	9.3	+28.5
		since the first quarter of 2020 when COVID-19
		ockdowns drove a significant market correction.		3 years p.a.			22.7	3.3	+19.4
		The tech-heavy Nasdaq fell 22.3% in the second
		LSF Since Inception p.a.		11.0	6.5	+4.6
		qu rter, its worst quarterly performance since
		2008, with negative returns in five of the first six			Strategy Since Inception2 p.a.		21.0	6.2	+14.8
		mo	ths this year.

personalThe ASX200AI fell 11.9% over the quarter with nearly all sectors coming under pressure. The strongest sectors were Utilities (+1.7%) and Energy (+1.5%), while Information Technology (-27.2%), Property (-17.7%) and Materials (-16.1%) lagged.

L sses across the S&P 500 accelerated in the most recent period. All sectors declined by 5% or more (Figure 1) as investors became increasingly concerned about surging inflation, central bank tightening, the Russia/Ukraine war, COVID-19 lockdowns in China and global supply chain disruptions. This contributed to a sharp contraction in valuation multiples, with the S&P 500 de-rating abruptly (Figure 2).

Figure 1: Q2 2022 Total Return - S&P 500 (%)	Figure 2: S&P 500 - 12m forward P/E
Consumer Discretionary -26%			P/E	23x
Communication Services	-21%
	Forward
For	Information Tech	-20%		20x
Financials	-18%
Materials	-16%			17x
Industrial Services	-15%			15.8x
Real Estate	-15%
		14x
Healthcare		-6%
Energy		-5%		11x
Utilities		-5%
Consumer Staples		-5%		8x
-30%	-20%	-10%	0%
1986 1990 1994 1998 2002 2006 2010 2014 2018 2022
Source: Bloomberg and L1 Capital as ta 30 June 2022.		Source: Bloomberg and L1 Capital as at 30 June 2022.

The downturn in performance was even more extreme in the bond market where inflation concerns and an acceleration in central bank tightening have meant government bond returns are on course for their worst year of performance in real terms since 1865 (Figure 3).

1. All performance numbers are quoted net of fees. Net returns are calculated based on the movement of the underlying investment portfolio. Figures may not sum exactly due to rounding. Indices are shown on total return basis in AUD. 2. Strategy performance and exposure history is for the L1 Long Short Limited (LSF:ASX) since inception on 24 Apr 2018. Prior to this date, data is that of the L1 Capital Long Short Fund - Monthly Class since inception (1 Sep 2014). Past performance should not be taken as an indicator of future performance. NOTE: Fund returns and Australian indices are shown in A$. Returns of global and U.S. indices are shown in US$.

Quarterly Report | JUNE 2022 | L1 Long Short Fund Limited

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L1 Long Short Fund Limited

Quarterly Report | JUNE 2022

onlyFigure 3: World government bonds - Annual returns

useSo rce: BofA Global Investment Strategy, Global Financial Data. * 2022 YTD annualised.

On an overall basis, portfolio performance was solid in April and May. However, the U.S. CPI reading in June triggered a broad-basedpersonalse -off in equities which extended to almost all sectors. This weighed on portfolio performance, largely due to the sharp correction in Energy and Materials stocks. These stocks had contributed strongly to portfolio performance over the preceding 12 months however, in June, the share prices fell much further than the underlying changes in commodity prices. For example, Copper and

Energy stocks declined around 30% in June, despite physical markets remaining tight.

We believe this sell-off in share prices has been excessive due to non-fundamental factors such as quantitative flows, hedge fund de-grossing, redemptions, ETF flows and margin calls. We have used the opportunity to add to several of our highest conviction p sitions as further outlined below.

In the context of elevated volatility and extreme weakness in global and domestic stock markets, portfolio performance has been relatively pleasing, with the portfolio remaining largely flat (-0.2%) over the last six months (ASX200AI -9.9%) and returning 10.0% over the past year (ASX200AI -6.5%).

Po tfolio positioning

We have used the extreme sell-off towards the end of the quarter to add to several of our highest conviction positions at exceptional prices. Some examples of this, include:

 BlueScope Steel: With the 13% fall in June, the company currently trades on just 4x consensus FY23 EV/EBIT and 5.6x consensus FY23 P/E (relative to a pre-COVID5-year average of ~12x P/E), which we believe significantly undervalues BlueScope's strategic asset base and enormous cash flow generation potential.

For Capstone Copper: Copper equities have fallen ~50% from their highs as copper prices have come under pressure with increased possibility of a recession. We believe the sell-off is not consistent with the prevailing market tightness and the strong demand growth we expect as the energy transition gains momentum. Capstone currently trades on only ~4x consensus FY24 P/E when their projects currently under construction will be in full production.

 MEG Energy and Cenovus Energy: We continue to remain positive on the outlook for Energy. While a potential U.S. recession would result in softer oil demand, we believe this would be more than outweighed by China re-opening over the coming year (which would see a major lift in car and air traffic). Oil supply continues to remain constrained with sustained declines in global inventories and OPEC+ remains unable to grow production significantly. With the sell-off in energy stocks, MEG and Cenovus are currently generating more than 20% of their market cap in cash flow with large dividends and share buybacks to come.

 Qantas: Recession fears drove a sharp correction in travel stocks in June. We believe significant pent-up travel demand will more than offset increased economic pressures. If Qantas management can achieve their FY24 targets there is potential to deliver close to $1 in EPS, with Qantas currently trading on only ~4x that run-rate EPS level. We believe there is more than 100% share price upside potential through earnings growth and for a valuation re-rating as the company's earnings mix shifts towards the higher quality domestic and loyalty businesses.

Quarterly Report | JUNE 2022 | L1 Long Short Fund Limited

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L1 Long Short Fund Limited

Quarterly Report | JUNE 2022

onlyIn addition, we have used the correction to selectively add new positions in high quality businesses that we believe have reached

oversold levels. One example of this is James Hardie which has fallen more than 40% over the past six months on concerns that the

U.S. housing cycle is about to crash due to the sharp rise in interest rates. James Hardie is currently trading on ~13x consensus FY23

P/E relative to its pre-COVID5-year average of ~22x. While we expect house prices to soften and housing activity to moderate, we

believe the current environment is very different to that experienced during the GFC. Household balance sheets are much stronger,

credit availability is much tighter and there is a structural under-build of housing (not a significant overbuild as was the case in the

GFC). James Hardie is well placed to manage the near-term macroeconomic headwinds given its strong balance sheet, variable cost- base and a decade of structural growth ahead of it as the market environment improves.

Over the past year, we have flagged increasing risks in speculative areas of the market where unprecedented fiscal and monetary

stimulus, together with ultra-low interest rates, had driven valuation levels to extremes. The end of quantitative easing and the usechange in central bank policy led to the market making a much needed shift towards focusing on sustainable profitability and cash

g n ration. This has driven a correction in long-duration growth assets which continued into the second quarter of this year. This, in turn, led to our short position across a basket of offshore unprofitable technology stocks being a significant positive contributor to portfolio returns over the quarter. Non-profitable tech stocks have now declined more than 70% from their 2021 peak (Figure 4).

Figure 4: Non-Profitable Technology Index (indexed to 100)

personal	600
																																Peak: 480,
	500																																	(12 Feb 2021)
	400
	300
																																															FY22: 142,
																									Pre-COVID: 151,
	200																																										(30 Jun 2022)
																								(19 Feb 2022)
	100
	0

Source: Goldman Sachs as at 30 June2022.

From an Australian perspective, while long-duration growth assets have de-rated, they continue to remain relatively expensive compared to the current level of interest rates. Figure 5 on the next page illustrates that ASX 200 'High Growth' stocks trade at an average 12 month forward P/E of 33x which, is still well above the ~25x multiple, that 'Growth Stocks' have typically traded on when Forlong-term interest rates have been at similar levels to today. Conversely, ASX 200 low P/E stocks remain more than 20% below their 20-year average P/E multiple (Figure 6), supporting our continued belief that 'Value' stocks (particularly those with no structural

headwind) remain far more compelling investments than 'Growth' stocks.

Quarterly Report | JUNE 2022 | L1 Long Short Fund Limited

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We expect market returns to be more modest going forward.

			L1 Long Short Fund Limited
			Quarterly Report | JUNE 2022
Figure 5: ASX 200 high P/E firms relative to 20-yr average	Figure 6: ASX 200 low P/E firms relative to 20-yr average
50x			12x
40x			9x
30x		37%
only		premium	6x	25%
		to 20-yr
20x		discount
	avg
			to 20-yr
10x			3x	avg
	ASX 200 - High P/E Firms; Avg fwd P/E	20-yr Avg	Low P/E Firms; Avg fwd P/E	20-yr Avg
So rce: Goldman Sachs as at 30 June 2022.		Source: Goldman Sachs as at 30 June 2022.
use

We remain cautious on 'buying the dip' in 'High Growth' stocks given the above valuation considerations, as well as the fundamental shift we have seen in the tailwinds that propelled the valuations of many of these stocks.

personal
	The past decade of declining interest rates has now come to an end. This has structurally lifted the risk free rate and discount
	applied to longer-dated/more uncertain cash flow profiles.
	There is a renewed focus on cash generation and profitability as investors have reassessed the merits of new valuation
	methodologies such as EV/revenue.

 The devaluation of historic share-based compensation to employees and the prospect of reduced growth going forward is making many of these companies less attractive places to work.

 The days of 'free money' via equity markets and convertibles are over. To fund their growth, companies will increasingly need to generate cash flow rather than raise equity at hugely inflated share prices.

Outlook

We believe the outlook for equities has become more challenging given the tightening of central bank policy, cost pressures facing corporates and falling consumer confidence. These factors are further compounded by

Forthe Russia/Ukraine war, COVID-19 l ckdowns in China and global supply chain disruptions. The Fed has been well behind the curve and is rapidly increasing interest rate rises (along with quantitative tightening) in order to subdue inflation pressures that have been evident for over a year.

U.S. 10-year bonds have fallen dramatically in recent weeks (see Figure 7 on the next page), signalling that the market has shifted its concerns from inflation to growth. The 10-year - 2-year spread has been narrowing for the past eight months (see Figure 8 on the next page) and has inverted once again in July. Yield curve inversion has historically been a strong leading indicator of recessions.

Quarterly Report | JUNE 2022 | L1 Long Short Fund Limited

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Source: Bloomberg as at 30 June 2022.

L1 Long Short Fund Limited

Quarterly Report | JUNE 2022

Figure 7: U.S. 10-year government bond yield	Figure 8: U.S. 10-year - 2-year spread
3.5%	~50bps fall	140bps
3.3%	in 2 weeks	100bps
3.1%		60bps
only		20bps
2.9%
2.7%		-20bps
use

So rce: Bloomberg as at 30 June 2022.

While we are cautious on the macro environment and have accordingly reduced our net long exposure over the quarter, we

believe the recent market sell-off has been quite erratic and is providing us with a better than usual set of investment
opportunities.
personaldividends, which gives us greater confidence on the potential for a 100% return of free cash flow generation via dividends and
	In a similar vein to March 2020, we are adding to numerous stocks that are dramatically oversold. We believe that looking

through the short-term hysteria and non-fundamental selling will prove to be the best decision for our investors.

 Based on our analysis, we believe U.S. inflation is now peaking and that central banks will end up pausing their rate hikes earlier than what economists and bond yields currently suggest.

 A pause by the Fed would trigger both a relief rally and a major rotation in the market out of expensive defensives and into oversold cyclicals, which we are well positioned for.

 While these periods of short-term volatility and weak portfolio performance are frustrating (both for us and for our investors), we are excited by the medium-term upside we see in the portfolio and have significantly increased our investment in the Long Short Strategy.

K y stock contributors for the quarter

Cenovus Energy (Long +14%) shares rallied driven by continued strong free cash flow generation, as well as being positioned to benefit from strong refining margins and downstream operations. The company recently announced a significant increase in

buybacks from early CY23. Given the long-life nature of its oil sand assets and its low cost of production, we estimate the company Foris f ee cash flow break-even at an oil price of ~US$40/bbl. At present, oil prices are more than double this break-even point, implying considerable upside to consensus cash flow estimates (if prices remain near current levels). There are also additional value realisation catalysts with the company continuing to progress the de-gearing of its balance sheet via organic cash generation and

asset sales.

Shopify (Short -54%)shares collapsed further during the quarter on broader weakness in the ecommerce market as well as Amazon's launch of 'Buy with Prime', which allows merchants to sell through Amazon on their own websites. Shopify enables small and medium size businesses to easily manage an online shopfront. We started shorting the company at ~US$136 per share in December 2021, closing it out at the end of April around US$42-43per share (prices quoted are post a 10-for-1stock split that was effective 29 June). Shopify was a significant 'COVID winner' as numerous businesses were forced to open online stores (driving up subscriptions) and consumers shopped more online (driving up payment volumes). Our view was that despite some demonstrable strengths, the company had become significantly overvalued with the market underestimating the risks around slowing growth as economies re-opened,as well as increased competition from ecommerce players and well-fundedcopycat platforms. In addition, Shopify, like many ultra-highP/E stocks, has also de-ratedas a result of higher bond yields which essentially reduce the present value of 'long duration' cash flows (that are many years or decades in the future).

As mentioned in the opening section of this report, the portfolio also benefitted from shorts in a basket of unprofitable technology stocks.

Quarterly Report | JUNE 2022 | L1 Long Short Fund Limited

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