Holly Black: Welcome to the Morningstar Series "Three Stock Picks". I'm Holly Black with me is David Smith. He's manager of the Henderson High Income Trust. Hello.
David Smith: Hi, Holly.
Black: So, we're talking about three stocks in the portfolio, where would you like to start?
Smith: So, to talk about Diageo first. It's one of my biggest holdings in the portfolio. It's actually one that's been in the portfolio for many years. So, we've just celebrated our 30th anniversary and Diageo is actually was first bought for the Trust back in 1997, so it's a very long-term hold.
Black: Oh, wow. Has it been in there the whole time? Or have you been in …
Smith: Yeah, for the whole 22 years. So, it's been you know, it just shows you when you find a good quality company, you know, you can hold on to it for that for the long-term. And it's because it consistently delivers good returns. And you look forward and you look at the quality of the business. It owns good quality alcohol brands in good growing categories. What I like about the business, the management team that came in a few years ago now, they're really investing in the company continue to drive that growth. And that's what we like about our businesses. We want them to invest to grow into the future. I mean, some people you know, misconstrue the income investors that we just want the cash flow paid as income. No, we want the company to invest first, and any excess cash flow beyond that investment comes back to shareholders in income and we think that growth can continue, as it has done in the near future.
Black: That is a real case of running your winners, though. Do you ever trim some profits back?
Smith: You do. You obviously got to keep a mindful of where the valuation gets to and, you know, when the valuation comes back, you always add to it and when the valuation gets a bit choppy, you may be trim a bit of your holding. But again, I think it just gives you an example of a good company that continues to invest. You know, I'm happy to own those for the longer term as long as they keep doing the sensible things in terms of their investment.
Black: Super. What is stock number two?
Smith: So, Bodycote. So as more – much more recent purchase, we bought it in October. And you look at the business, it provides heat treatment to metals to improve their – some of their properties such as strength and durability. And I think what we like about the business is, you know, it's moving the business more in towards specialty technologies. So, having the expertise in terms of what they do to certain – to work closely with certain customers. And it's a much more higher margin and much more valuable business. And I think as that business grows, it means the overall margins of the company can further increase from here over the longer term. Now, it is cyclical. It has come under some short-term pressure from the downturn in manufacturing. But I think if we are more towards the bottom of that downturn, people will look through that and look through towards the recovery as we go through in the next two years.
Black: Superb. What's our final stock?
Smith: The final stock is National Express. So it's quite an interesting one, where you talk about National Express everyone thinks about the coaches in the UK. Actually, that's only about 10% of the business. It's a very well diverse geographical business. It operates buses, both in the UK, in Spain, Morocco, and also, the US as well. And what again, it's sort of similar to the idea, what do we like about the business, it's investing. And it's investing in in a few areas really.
Firstly, to make sure they deliver very good service quality. They're also investing to improve operational efficiencies. They're also investing to supplement organic growth through bolt-on acquisitions, in core competency in what they already do. I think the combination of that means that the management team have been able to grow the earnings certainly over the last six years by 10% per annum. But despite that growth, it's only trading on 12 times earnings, which I think is too cheap, given the consistency of the growth the management team have delivered. So, once the market accepts that that growth is here to stay than I think you should see a good re-rating in the shares going forward.
Black: Is Brexit a concern for any of these stocks? Obviously, domestically focused businesses are unloved and under pressure at the moment.
Smith: Yeah. Well, I think there are three things about all those businesses, that they have the majority of their businesses overseas. So, I think the outlook for them is less to do about, less to do about the UK political situation and Brexit and more to do about how they run the business for the longer term. And I think that's always the way I think about companies is, what's the company do? How does the management change, drive profitability, and what the valuation is telling us? Valuations will move up and down depending on sentiment around political situation. But I always use that as an opportunity to buy or sell companies, because I'm looking at more longer term, dynamics in there.
Black: Well, thank you so much for your time.
Smith: Pleasure. Thank you very much.
Black: Thanks for joining us.
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