Citywire AAA-rated Train has purchased a significant amount of drinks giant Diageo's shares this year through the CF Lindsell Train UK Equity fund. This is because he viewed the company as undervalued.
Diageo represents the biggest holding in the £4 billion fund, equating to 10.4% of the portfolio. It is an attractive income stock, in Train's opinion, because it generates around 30% of its operating margins on a regular basis and turns nearly all of its operating income into cash.
The history of large payouts means that shareholder expectations are high.
'In particular they [shareholders] expect the board of the company in question to allocate its ample cash flows in a disciplined and value-creating way,' Train added.
In the fund manager's opinion, there's no point generating above-average cash returns on capital if the excess cash is then misallocated,’ he said.
‘We do not say this is the case with Diageo, but even the company admits that some of its investments of the last few years could have been better timed,’ Train explained.
The most recent deal is the purchase of Casamigos tequila, set up by actor George Clooney and Rande Gerber, the husband of model Cindy Crawford. The $700 million price tag equates to 20x sales.
Although Train supports the sale, he questioned how the purchase would sit alongside tequila brand Don Julio, which Diageo purchased in 2015.
‘It will be interesting to see how the company develops and differentiates the pair,’ he said.
Part of the Don Julio purchase included the sale/swap of Diageo’s 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,’ said Train.
‘It’ll take some doing to match the 409-year heritage of Bushmills. And ostensibly, it does not appear consistent.’
Spotlight on deals
For Train, it is not just Diageo's collection of brands that he is starting to feel cautious about, but also the deals it completed between 2011 and 2013 in emerging economies. his was a time when optimism and asset prices were riding high in the region.
Businesses that were purchased in Brazil, China, India and Turkey have struggled since then. Nevertheless, Train is happy Diageo owns these assets. In particular, he describes India as a wonderful prospect.
‘But Lindsell Train investors wouldn’t thank us if we developed a habit of paying top dollar,’ he said.
Following these acquisitions, Diageo’s earnings went through a rough patch and the share price moved down or sideways for three years. During this time, Diageo did not buy back any shares. Through this period, the company looked undervalued, Train (pictured) said.
Back in July of this year, the drinks company has announced a £1.5 billion share buyback, which sent the shares up 7% to an all-time high. The shares have risen by close to 40% since they reached a low in 2015.
‘It’s not that we disagree with this buyback - we expect it to enhance our clients’ per share ownership of Diageo’s terrific brands - it’s just we’d like it even better if the timing appeared smarter,’ said Train.
While alarm bells are not yet ringing for Train when he looks at Diageo, he will continue to monitor the capital allocation decisions taken by its board. In the same way, he does with the other companies held in the portfolio.
'Knowing that cumulatively and over time it is the calibre of those decisions that will determine the long term success, or
otherwise, of our own investment decisions,' he added.
The CF Lindsell Train UK Equity fund is ranked in eighth position out of 216 funds in the UK All Companies sector for its five-year performance. During this period, Train has generated a 125.7% return versus 71% by the sector average.