MS Global Franchise Buys Stake in Reynolds American in 4th Quarter

Fund exits holdings of business in deteriorating environments

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Mar 27, 2016
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The Morgan Stanley Global Franchise Fund invests in high-quality franchise businesses around the globe. During the fourth quarter, the fund returned 5.4%, slightly underperforming the MSCI World Index, which returned 5.5%.

MS Global added two new holdings during the quarter, and in maintaining its concentrated portfolio strategy, exited two other stakes in consumer products companies. In its fourth quarter commentary, the fund offered a brief reasons for its portfolio activity.

“Sales in the fourth quarter can be summarized as retreats from areas where we are worried about the business or the deteriorating environment for the business. We initiated two new positions in what we consider high quality companies at the upper end of reasonable valuations,” the fund wrote.

Reynolds American Inc. (RAI, Financial)

MS Global’s largest purchase during the quarter was 611,059 shares in tobacco company Reynolds American, for an average $46.29 per share.

The stock rose 44% over the past year and currently trades at 18x earnings. It is overvalued according to the Peter Lynch earnings line.

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Reynolds American had EPS of 19 cents in the fourth quarter of 2015, up from 14 cents in the year-ago quarter. Annual EPS for the whole year 2015 was $2.57, a vast improvement from $1.37 the year before. The company also more than doubled its profits last year, with net income of more than $3.2 billion.

Reynolds’ trailing dividend yield of 2.97% is close to the 10-year low in the dividend history. The payout ratio is 54%.

L’Oreal SA (XPAR:OR, Financial)

The fund’s second purchase was 96,567 shares of cosmetics and beauty products company L’Oreal, which traded for an average €163.59 during the quarter.

L’Oreal owns a multitude of brands including Maybelline, Urban Decay, Lancome and Shu Uemura.

L’Oreal traded down by 7% over the past year and trades at 26x earnings. Annual diluted EPS declined sharply from $8.39 in 2014 to $5.84 last year due to a French tax on dividends and deconsolidation of the Venezuelan subsidiary.

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The company’s trailing dividend yield is 1.72%, while the payout ratio is 46%. The MS Global Franchise Fund (Trades, Portfolio) is currently the only guru shareholder of L’Oreal.

Sold out

The fund exited its position in Procter & Gamble Co. (PG, Financial), selling 155,600 shares for an average $76.46 per share. The stock held steady in the past year, increasing just 1%. The consumer products company trades at 28x earnings.

Diluted EPS for FY 2015 was $2.44, down from $4.01 the year before. However, in the second quarter 2016, P&G posted EPS of $1.12, an improvement from 82 cents in the year-ago quarter.

In addition, the fund also sold its stake in Mead Johnson Nutrition Co. (MJN, Financial), selling 28,767 shares for an average price of $78.83 per share. Over the past year, the stock had declined 17%. Mead Johnson produces infant formula and children’s nutrition brands. The company pays a dividend yield of 2% and has a payout ratio of 50%.

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