Nick Train: Diageo’s prospects and the firm I hope will quintuple in value

The Finsbury Growth & Income investment trust manager discusses the highly concentrated portfolio’s companies, including London Stock Exchange Group and RELX, reveals the quality he views as a winning investment trait, and shares his outlook for the UK market.

Timestamps
00.28: What next for names like Diageo? 
04.58: What would a successful turnaround look like? 
07.42: How much scrutiny do you apply to CEOs? 
10.45: The outlook for the UK market 
14.03: The impact of US investors 
16.10: Rising stars of the fund 
19.22: Skin in the game

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Dave Baxter, senior fund content specialist at interactive investor: Hello, and a very warm welcome back to our Insider Interview series. I’m Dave Baxter here at ii. Today I’m joined by Nick Train, portfolio manager on the Finsbury Growth & Income Ord (LSE:FGT) investment trust. Nick, many thanks for joining us today. 

Nick Train, portfolio manager on the Finsbury Growth and Income investment trust: Dave, it’s good to be here and let’s hope that we can talk about some interesting stuff. 

Dave Baxter: In thefirst video, we discussed data software and platform companies and how they might be affected by the rise of AI. In this segment, I want to focus a bit more on some of the other parts of the portfolio.

You’ve long had a lot of exposure to consumer stocks, so staples names like Diageo (LSE:DGE) and Unilever (LSE:ULVR), and then luxury goods companies as well. What do you now think are the key battlegrounds for names like Diageo, and Unilever? What would influence their fortunes in the coming years?

Nick Train: Well, for Diageo, I think it’s so, so important to reassert the fact that per capita consumption of alcohol in, certainly developed markets, has been in decline for 100 years. I mean, there is a very, very clear long-term trend as people get wealthier, as their lives get less awful, they drink less alcohol. I’m sorry to be blunt about that, but that’s the truth. And you might think, well, surely that’s bad news if you’re in the alcoholic beverage business? 

But, actually, that’s not the case because the countervailing phenomenon to people drinking less ethanol or raw alcohol is that they drink higher-quality premium products, heritage products. People still want to treat themselves, people still want to go out. 

And a business like Diageo, only a handful of global alcoholic beverage companies have been perfectly satisfactory investments over a number of decades as they’ve sold more of their premium products. 

When I look at Diageo’s product portfolio, strategically, by which I mean 20 years, will people be drinking more Guinness? Will people be drinking more single-malt whiskies? Will people be drinking more Johnnie Walker Black rather than Johnnie Walker Red? Will the high-quality tequila boom in the United States translate worldwide? Diageo has the number-one tequila brand in the world. 

I can see plenty of drivers for that company, given that it probably needs to be run more effectively than it has [been] for a period of time. I can see plenty of grounds for that company to deliver not 20% per annum growth, but 5% to 7% per annum growth. And if that growth comes from them selling more premium products at higher margins, that’s a very, very nice predictable business model. 

So much, I think, of the investment challenge hangs on building portfolios around assets that can endure. I mean, most companies are ephemeral. Most of the companies...currently driving the AI boom probably won’t be around in five years’ time. Some of them are going to create extraordinary wealth from here, but a lot of them won’t. And how do you invest in response to that? 

Finding assets that have semi-eternal, truly enduring characteristics with preferably some sort of secular growth win behind them, that seems like an important framing for a portfolio construction. And, yeah, absolutely, Diageo seems like a business to us that has those characteristics of durability and predictability. 

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Dave Baxter: With the changes going on at Diageo, I mentioned the turnaround efforts and Dave Lewis making various changes, what would you be monitoring to gauge whether that is working out well? 

Nick Train: I guess in the final analysis, the share price, that is the ultimate validator of a turnaround, and maybe it’s too soon to say, but Diageo is trading about 30% above the absolute lows that it got to earlier this year. So, definitely there has been a change in sentiment towards the business. 

The two things that most fuss us, or the most important things from our perspective, were, one, truly understanding what, if anything, was necessary to improve the business performance of the company.

I must say we’ve been really taken aback by the clarity, as well as the criticism, that Dave Lewis has brought to bear on the way that the company was being run. He has, no question, unearthed inefficiencies that, frankly, shouldn’t have been there but that create the opportunity for the company to first of all improve its efficiency and profitability, and then hopefully move back into another phase of growth. 

The other thing that was so important for us was to be reassured that the company wasn’t going to dispose of unique, hugely valuable brands at the bottom in an attempt to pay down debt more quickly. 

And to have Lewis explicitly say, they are not selling any of these wonderful brands that they own, and then to talk about the strategic potential in their position with Scotch. One out of every three bottles of Scotch consumed around the world every day is a Diageo. It’s an incredible position they have in Scotch, and to hear them saying: we’re not going to sell our stake in Moet Hennessy. One out every three bottle of Hennessy cognac drunk around the world [is] a Diageo, [it] has partial ownership of that. Seeing the company talking about the value of its unique assets was very, very reassuring for us. 

Dave Baxter: So, you’ve referenced chief executives like Dave Lewis, and it’s interesting that in your fund commentaries, you often quote CEOs of companies that you hold. With that in mind, how do you balance taking them at their words with scrutinising what they’re saying?

Nick Train: I think that is a fair observation. I am personally a believer in business life and, indeed, in just our ordinary course of life, to take people at face value until you have reason to doubt their integrity, not to doubt their integrity. 

I think it’s also important to recognise that we’ve been invested in many of the companies that we’ve already discussed this morning for a decade, two decades. We know the incumbent managements well. We know previous managements well and, yeah, it helps increase confidence in what CEOs are saying if what they say is consistent with what they’ve said in the past, but maybe what their predecessors have said as well, and also it’s consistent with our understanding of where the value is created in a given company. 

We are super-alert to companies misallocating capital or behaving in a way that seems to us to undermine the reason that we invested. I think that people who run businesses, this is true for me as well, it’s a difficult thing to become a chief executive of a FTSE 100 company. I mean, it’s not a trivial thing, and most of the people who get there are highly effective, they’ve had to be highly effective. 

Because I think that this is central to business life, they also tend to be optimists. I think optimism, that’s a winning trait in business, in investment. And maybe sometimes these CEOs are too bullish about their businesses. And maybe you do have to take things with a pinch of salt, but I’d sooner have a smart optimist running a business than a pessimist. 

I think there isn’t enough optimism maybe across UK companies. You want people to be taking risks to grow because opportunities are out there, but you’ve got to be an optimist to take advantage of those opportunities. So, it’s a good question and maybe that’s a rambling answer, but does that make sense about the way we would think about it? 

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Dave Baxter: Let’s talk more about the glass half-full or empty premise, but this time with the UK market. Clearly there’s been quite a lot of hand-wringing about the state of the UK market in recent years. When I spoke to you a few years ago, we were talking about companies’ preoccupation with paying dividends over potentially growth, and things like the frenetic M&A activity we’ve seen in the markets. How do you feel now about the outlook for the UK? 

Nick Train: Well, listen, as you say, the frenetic M&A definitely, you have to acknowledge that the M&A is a signal that the UK stock market had become undervalued and opportunities were being presented, still are being presented, to private equity or to competing companies, but in and of itself that’s probably not enough. 

I think for me to get bullish about the market as a whole - I hope I’ve conveyed it, tell me if I haven’t - I am very optimistic about some of the businesses that just happen to be listed in London that we own in our portfolio. 

I’d really, really like to see RELX (LSE:REL) quintuple from here. Here’s a company that genuinely has an opportunity to deliver AI tools to the world’s scientific research community, as well as the world’s legal community. And if RELX can fulfil its potential as a business in that way, I think it could be totally transformative of that company’s valuation, its profit level, and its share price. 

But I’d love to see a London-listed company demonstrate that it is able, at a global scale, to be a tech winner. We need more of those in the UK stock market. So, listen, we’re invested in RELX because we think we can make a lot of money out of it for our investors. 

And in a sense, don’t get me wrong, I don’t really care about what happens to the UK stock market. I mean, I sort of do, but I don’t really care. But I think that what would make the UK stock market a more interesting place is if investors could see a cohort of British companies taking advantage of a technology wave at a global scale to create truly enduring and rapidly growing businesses. I think that’s what we need. 

Dave Baxter: I guess the problem is they would get bought again, as has happened in the past. 

Nick Train: Or that they change their domicile. I agree, I agree. 

Dave Baxter: I think about three years ago you were making the interesting point that perhaps one boost to the growth of UK-listed companies was the increased presence of US investors on the shareholder registers of some of these companies, and maybe focusing less on things like dividends and more on organic growth, and so on. Do you think that trend has continued since then? 

Nick Train: Well, again, maybe I just have to go back to the companies that we’ve selected rightly or wrongly to make the heart of Finsbury’s portfolio. So, the companies that we see have a significant opportunity to take advantage of AI to accelerate their growth rate. 

These companies from RELX and Rightmove (LSE:RMV) to London Stock Exchange Group (LSE:LSEG) have all significantly increased their rate of investment in new product development. And that is absolutely the right thing for them to be doing. And we can see the benefits of it in an uptick in their revenue growth, which we believe and hope will continue. 

So, I’m encouraged, and I think, to a degree, it’s part of our job that when we meet with Sage Group (The) (LSE:SGE), some investors look at its operating margins in the low 20s and say: this could be a 30% operating margin company. 

We look at Sage and we say: you’re growing at 10% at the moment, which is great, but you could be growing at 15% or 17%, invest in order to capture that accelerating growth rate because that’s what really will deliver value to your owners over time. 

So, not managing companies to maximise short-term profitability, running the companies to capture the big growth opportunities, that’s what we’ll do. That’s what we’ll continue to encourage the companies to do. 

Dave Baxter: Are there any stocks in the fund that are on relatively low weightings but you would expect to become much more prominent in, say, a year or two? You’ve got some relatively new additions, things like TP ICAP GROUP (LSE:TCAP) and Spirax Group (LSE:SPX), and a bit less recently, Games Workshop Group (LSE:GAW). 

Nick Train: Well, I have to say, I do think that the investment that we’ve made in TP ICAP, that is a fascinating opportunity that this company has presented with. 

I mentioned Clarkson (LSE:CKN) earlier, the world’s biggest shipbroker with this extraordinary data asset that it has developed. Finding Clarkson and thinking through the implications of that led us to have a very close look at TP ICAP. 

TP ICAP is the world’s number one over-the-counter (OTC) broker. It sits at the heart of a market that’s 20 times the size of the global equity markets and sees an extraordinary volume of trade in these complex financial instruments that banks trade with each other. It’s a very, very important part of the global financial plumbing as it were, but it’s also a position that, just like Clarkson, is generating a lot of data and that data is increasingly valuable as the company can apply new analytics to that data.

The company has split out a data division, which has been growing rapidly. Put it this way, one reason that London Stock Exchange Group’s shares bounced in October was that LSEG announced the acquisition of a business called Optus, which is a fixed-interest data business. London Stock Exchange Group paid 10 times revenues to acquire that unique data asset in Optus. 

If we even begin to think about TP ICAP’s data as being as valuable as the asset that LSEG has just bought, just take it from me, if that were correct to make that analogy, that comparison, TP ICAP’s share price is way, way too low relative to that strategic data asset. It’s developing and growing every single moment within its business. 

You’re right, it’s a relatively recent holding. It just seems so pertinent in an AI world, the value of proprietary data is going up. Let’s try and find companies with growing amounts of proprietary date, because they’re likely to become more valuable. 

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Dave Baxter: And, finally, our usual question, do you have skin in the game? 

Nick Train: I have very, very significant skin in game. My investment in Finsbury is far and away the biggest asset that I own. I guess I’m ashamed to say that I am a living proof that having a significant amount of skin in the game doesn’t necessarily generate satisfactory returns at least over the last three or four years, as my wife does not hold back in reminding me. 

But, listen, I feel that it’s absolutely appropriate in a strategy that’s taking risk, anybody can buy a risk-less, in a way, index fund. In an active fund, you’ve got to take risk. I absolutely feel it’s appropriate that I personally should take more risk, I’m sure, than any other shareholder in Finsbury. 

I also think to myself, well, say I wasn’t running Finsbury and I had this capital, what would I want to invest in? I would want to invest in the core holdings in Finsbury Growth & Income Trust today.

So, I’m not unhappy with what we own and I’m not unhappy owning a big position in Finsbury. Finsbury’s share price, the absolute low was 27 March this year, it’s etched in my soul. £7.13 was the low for the share price, we’re at 8.30 or something. Today, the net asset value (NAV) is over £9. There’s been some recovery. Let’s hope there’s a lot more to come.

Dave Baxter: Let’s hope so. Nick. Many thanks for your time. 

Nick Train: Indeed, Dave. Thanks very much.  

Dave Baxter: And thank you for watching. As ever, do let us know what you think in the comments and if you’ve enjoyed this series, hit the like button and hit the subscribe button. Thanks and take care.