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Livewire | How this portfolio manager delivered a 33% return YTD

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David SteinthalChief Investment Officer | L1 Capital International
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9 mins
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This article was first published by Ally Selby in Livewire Markets on 11 December, 2023.

I don’t know about you, but my portfolio has not performed well in 2023. It’s probably because I have a penchant for small-caps – which, as has been well-documented, have severely lagged behind their large-cap counterparts over the last few years.

One man who has managed to outperform this year, though, is L1 Capital International’s David Steinthal. The fund, which recently listed on the ASX as an exchange-traded managed fund (or ETMF), has managed to deliver investors a return of 33% in the calendar year to date, outperforming the MSCI World Index by 12%.

Given I am obviously in need of guidance right now, I listened keenly to David to learn about what he believes it takes for a business to make a great investment. He also discusses some of the stocks that have contributed to this outperformance in 2023.

Plus, he also gets out his crystal ball and shares his highest conviction stock pick for the year ahead.

I hope this interview helps you as much as it did me.

Livewire Markets | This interview was recorded on Thursday 23 November 2023.

Edited Transcript

Ally Selby: Hey, I am Ally Selby, and welcome to Livewire’s newest series, The Pitch. In this series, we’ll be interviewing some of the country’s top fund managers for their best ideas and insights. Today we’re very lucky to be joined by L1 Capital International’s David Steinthal. His fund has outperformed the MSCI World Index by 12% since the beginning of the year. Some really impressive stuff. And today we’re going to be learning about how he did it. Thank you so much for joining me today, David. I’m really excited to learn about some of your favourite stocks right now.

David Steinthal: Great to be here, Ally.

Ally Selby: L1 Capital International uses a quality rating system. Can you take us through the five criteria that you use?

David Steinthal: We’ve developed a process that really helps us identify quality and risk. We break it down into five areas. We focus on businesses and industries with:

  1. Really strong business drivers: For example, increased spending on cloud computing, electronic payments, ageing population, increased healthcare and infrastructure spend, or corporate management.
  2. A consolidated industry structure:We really like industries where there are just a couple of companies that dominate – we call it “Noah’s Ark”. So, say two companies that lead and very fragmented competition. That really limits the degree of competition and enables these companies to continue to grow over time.
  3. Strong management teams:This is absolutely critical. We’ll spend just as much time looking at the past as trying to predict the future. We’ll analyse how the companies have been operated, how management’s allocated capital, and how they’ve been incentivised over the past 10 years – because that’s a really good indicator of how they’re going to perform in the future.
  4. Strong financials: We’re really disciplined around our valuation analysis. We look for companies that have strong free cash flow, not too much debt, improving margins, and really high returns on their capital.
  5. And are at the forefront of addressing ESG issues: These companies are trying to position their business for the long run, and they attract and retain the best people by taking a leadership position on ESG considerations.

Ally Selby: You spoke to valuation a little bit there, but I want to dive a little bit deeper into that. How important is valuation to your process?

David Steinthal: Valuation’s really important. You can overpay for a really high-quality business, but for us, you’ve got to get quality first and then we consider valuation. So it’s quality and valuation, but it’s got to meet our quality thresholds first.

Ally Selby: But you pay for what you get in life, right?

David Steinthal: To a degree, but you can also overpay for some things as well.

Ally Selby:Which stocks do you feel significantly contributed to that outperformance over the past 11 months now?

David Steinthal: Sure, so the fund is up over 30% this year, and what’s really pleasing is it’s been really broad-based contributors. We invest in a whole range of industries, small-cap companies, $1-2 billion companies, all the way up to the biggest companies in the world.

So some of the large-cap tech companies like Microsoft (NASDAQ: MSFT) have certainly contributed. But Booking Holdings (NASDAQ: BKNG), the world’s largest online travel agent, which owns Booking.com – its share price almost doubled this year. Last year, its share price was trading at a crazy low price. If you go back to where its share price was last year, it was lower than what it was after COVID hit – before we had vaccines. In those days, we were all scared to leave our house and go to the supermarket. Last year, the market was just saying, there’s going to be a deep recession. No one’s going to go on a holiday again. So that company has almost doubled over the past 12 months.

Even some of our cyclical businesses that are exposed to infrastructure and housing spending, particularly in the US, have done really well in this environment. So it’s been really broad-based.

Ally Selby: What hasn’t worked over the last 11 months or since the beginning of the year

David Steinthal: We really think about downside protection and pleasingly over the past 12 months there have been really no significant detractors. The one area that’s been a bit soft is healthcare equipment and services. A lot of those companies did really well during COVID-19, and there was a lot of spending on the healthcare industry.

What we’ve found is some of that equipment’s been repurposed. It was used for COVID analysis and the like, and their customers have found ways to repurpose it. So demand has been a bit softer. And coming out of COVID, China was really a strong growing market for those companies, and it’s been really soft, which is really interesting. So those companies have disappointed us a bit. Not disasters by any means, they’re still really good businesses. They’ve just underperformed a bit.

Ally Selby: Okay. I am very excited about this. What’s your highest conviction pick for the next 12 months and why?

David Steinthal: So firstly, we have conviction in our entire portfolio, we only own about 25 companies. Our top 10 is about 60% [of the portfolio]. So we have pretty large positions in all our companies. One of our companies, which is actually just outside of our top 10, but is the one that we’ve been adding to the most recently is HCA Healthcare Inc (NYSE: HCA).

It used to be called Hospitals Corporation of America, but it’s the largest for-profit hospital company in the US. It owns about 180 hospitals, mainly in Florida and Texas, and the states where people are either moving to for jobs or a lot of retired people are moving there for the weather. So it’s benefiting from population growth and also an ageing population, as older people go to hospitals more.

It’s just a “steady eddy” compounding type of business. You just need to believe what’s happened over the last couple of decades will continue to happen. A couple of percent more people every year go to their hospitals. They’re building new hospitals to support that demand. The price per hospital visit goes up about 3%. It’s kind of like inflation because people are going to hospital for more complicated things.

They’re growing, so they’re getting a little bit of margin expansion. They produce huge amounts of cash flows, they’re building new facilities, not just hospitals, but outpatient centres and those kinds of things. So it can compound its earnings at 10%, we think, for a very long period of time.

It’s trading on a P/E of 12 times or a 6% free cash flow yield, which is half the multiple of an Australian company like Ramsay Health Care (ASX: RHC). So we think that’s a really safe compounding opportunity in this market. Not very macro-sensitive at all.

Ally Selby: Okay. Well, thank you so much for your time today, David. I really enjoyed this chat. If you enjoyed that too, don’t forget to subscribe to Livewire’s YouTube channel. We’re adding so much great content just like this every single week.

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