An 11% freefall in Diageo’s share price last month was a “major factor drag” on the performance of Nick Train’s Finsbury Growth & Income trust for November, according to its factsheet published today (13 December), despite the vehicle’s NAV managing to return 3.4% in total return terms over the month.
Train, who has been at the helm of the investment company since 2000, said there were two main contributing factors to Diageo’s poor performance – one expected, the other less so. As at the end of November, the stock accounted for 10.7% of the trust’s underlying portfolio.
“First, Diageo indicated that in 2023 interest rates “higher for longer” and the unwinding of the post-Covid binge had resulted in consumers retrenching their discretionary spending and in some markets trading down from premium to mass-market brands,” Train explained in his monthly investment commentary. “Almost every consumer company we follow has acknowledged similar conditions, as indeed had Diageo in its guidance from earlier in the year.”
However, a company-specific headwind the alcoholic beverage company encountered was that it overstocked products in Latin America which, combined with a fall in consumer demand, meant its revenue in this region was down 20% year on year.
“This matters, because it constitutes 11% of group revenues,” Train said. “This is not the first time that Diageo has discovered it has, doubtless inadvertently, over-supplied the region – effectively booking revenues and profits early – and suffered a painful hiatus, while supply and demand come back into balance.
“ It was galling to investors and, we are sure, the very new CEO, that the warning came not only as a surprise, but resulted from a mistake that previous CEO Ivan Menezes had endeavoured to eradicate.”
While Train said these struggles are “frustrating”, he argued they do not invalidate the investment case for the firm, which Train has held in the portfolio for more than 16 years.
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“There are two, apparently unavoidable, characteristics of doing business in that region,” he said. “First, its economies are volatile and unpredictable. But, second, its people love Diageo’s products, particularly whisky.”
The fund manager said that, despite running into recent difficulties, Diageo’s operating margins in Latin America for the 2022/23 financial year were “attractive” at 36%, while overall group revenues are up 50% over the last decade. Train added that, as investors, they must still be “happier to benefit” from the company’s £1.8bn revenues “rather than not”, regardless of recent volatility.
According to data from FE Fundinfo, Diageo’s overall share price is up 92.2% over ten years.
“Diageo confirmed that trading for the other 89% of its business was progressing as expected and continues to forecast steady growth at least through to the end of this decade,” the manager continued. “It is worth reflecting on that forecast for steady growth, because it transpires that is exactly what Diageo has delivered over the 21st century to date.”
For the 2022/23 financial year, the company’s earnings were £1.64 per share, compared to 99p in 2013 and 49p in 2003. Meanwhile, return on capital both in 2023 and 2013 has been 16%.
“Diageo reveals itself to be a globally diverse business, with attractive and resilient profitability ratios and a credible growth opportunity,” Train said. “Stockmarket history suggests that businesses offering these qualities deserve to be highly valued, for the melancholy but never to be forgotten reason that most companies do not succeed in delivering such reliable, growing profits.”
The manager admitted that some companies across other sectors – such as software and digital platforms – could offer more resilience and growth than Diageo, and has therefore recently added online property platform Rightmove to the portfolio recently.
“Nonetheless, Johnnie Walker, Guinness and Diageo’s tequila brands really are of the highest calibre and are set to drive growth for the foreseeable future,” he argued. “At the current share price, these prospects are valued at little more than 17x earnings, or an earnings yield of nearly 6%. On those terms we have been adding again to Diageo shares.”
According to FE Fundinfo, Finsbury Growth & Income has returned 111.8% over the last decade in total return terms, compared to its average peer in the IT UK Equity Income sector’s gain of 52.5%. It is in the bottom quartile over three years, however, returning 3.9% compared to the average return of 16.9%. It is currently trading on a 6.9% discount to NAV, according to AIC data.
