Veteran investor Nick Train has criticised the strategy of his long time holding FTSE 100 drinks company Diageo, after a series of changes at the company.
Mr Train runs the £1.2bn Finsbury Growth and Inome Trust, which has returned 127 per cent over the past five years, compared with 74 per cent for the average trust in the AIC UK Equity Income sector in the same time period.
Diageo is the second largest investment in the trust, accounting for 10 per cent of the capital.
Mr. Train said he has bought “a lot” of shares in Diageo in 2017, and continues to view them as undervalued. He has owned the stock for at least the last ten years.
Diageo shares have risen from £21.78 to £25.71 over the past year, an increase Mr Train said he views as merited by the progress of the company in that time.
But despite his positive outlook for the shares, Mr Train said he has serious reservations about the strategy of the company.
Mr Train’s investment style is to buy the shares of businesses that have what he feels are predictable and long-lasting cashflows.
His rationale is that if a company is generating more cash over the next 20 years than the yield available on a UK or US government bond, then it is an attractive investment relative to the bond, paying a higher income but with a similar level of risk.
In his latest note to shareholders in the trust, Mr. Train said that for Diageo to qualify as a good investment by those criteria, it must not only be generating the cash, but also allocating that cash in a “disciplined and value creating way”.
Mr Train is unhappy that Diageo recently purchased Casamigos, a tequila company co-founded by George Clooney.
He said: “Diageo had bought another tequila, Don Julio, in 2015 and it’ll be interesting to see how the company develops and differentiates the pair.
"What’s more, part of the consideration to pay for Don Julio was the sale/swap of Diageo’s then Irish Whiskey brand, Bushmills – the world’s oldest distillery.
"We were sorry to see Bushmills go and then somewhat surprised to see Diageo announce this year it is investing in the creation of a brand new Irish whiskey brand. It’ll take some doing to match the 409 year heritage of Bushmills.
"We are watching very closely the capital allocation decisions taken by the boards of the companies we hold – knowing that cumulatively and over time it is the calibre of those decisions that will determine the long term success of our own investment decision.”
Mr Train noted that when Diageo previously invested heavily in buying companies with a strong presence in emerging markets, Diageo shares proceeded to underperform for three years.
He contrasted that with Diageo’s recent results, which sent the shares to an all-time high.
Terry Smith, who runs the £12bn Fundsmith Equity fund, has a very similar investment process to Mr. Train, tending to invest in very large companies with predictable cashflows.
But he said he is not keen to invest in beer companies, and doesn’t own Diageo.
In his view much of the expected growth reflected in the share prices of companies such as Diageo is based on an expectation that emerging market consumers will, as they get wealthier, begin to drink beer brands popular in developed markets.
Mr Smith said beer drinkers predominantly stick with local products, while beer tends to be difficult to transport and so has to be brewed near to the place where it is to be consumed.
On that basis, he is not invested in Diageo shares.
The Fundsmith Equity fund has returned 169 per cent over the past five years, compared with 85 per cent for the average fund in the IA Global sector in the same time period.
Laith Khalaf, senior analyst at Hargreaves Lansdown, commented that both Mr Train and Mr Smith have done “fantastically well” in recent years.
David.Thorpe@Ft.com
