Officially, Bill Ackman’s funds at Pershing Square ended the third quarter with a -16.2% return, much like many other hedge and mutual fund managers who posted losses after the particularly difficult quarter. Fortunately, his losses faded over the next month after he deftly made several new investments, some at deep lows made possible by market volatility. He informed clients that from the end of the quarter to November 22 his funds had recovered by approximately 11%.
Ackman typically purchases undervalued stocks and then works with the companies to increase value, taking profits as a result. He expects with this approach his fund will outperform regardless of the macro environment. Since his holdings have improved widely on business measures, he believes their stock price will follow in due time, but has reduced risk and increased potential profits for his firm in the meantime. Thus, he has increased his exposure to be 98% invested.
Four of his third-quarter top buys and additions, of his portfolio of 11 stocks, have jumped since the end of the third quarter: Family Dollar Stores Inc. (FDO), Lowes Cos. (LOW), Canadian Pacific Railway Ltd. (CP) and Kraft Foods Inc. Cl A (KFT).
Ackman owned 22,230,989 shares of Kraft going into the third quarter, and added 2,952,344 at about $35 per share. Kraft’s stock price was not as relatively cheap as some of his other third-quarter buys. It had already advanced nearly 9% year to date, and has gone up another 2%, the least of the four stocks, since the end of the quarter.
Kraft Foods, Inc. is the largest branded food and beverage company headquartered in the U.S. Kraft Foods Inc. Cl A has a market cap of $61.04 billion; its shares were traded at around $34.55 with a P/E ratio of 15.8 and P/S ratio of 1.2. The dividend yield of Kraft Foods Inc. Cl A stocks is 3.4%. Kraft Foods Inc. Cl A had an annual average earnings growth of 2.3% over the past five years.
Ackman did not comment on his Kraft investment in his most recent shareholder letter, but said in his letter from the third quarter of last year:
After acquiring Cadbury earlier this year, Kraft is now the largest global snacks company with roughly 50% of its sales coming from highly branded confectionary, cookies and crackers. We continue to like the “new Kraft” for its underappreciated international growth opportunities, as Kraft leverages Cadbury’s well-established distribution network particularly in emerging markets. We also believe the company will significantly improve its profit margins, which are among the lowest of its peers.
Thus far, our thesis appears to be on track. Year to date, base Kraft EBIT margins (excluding corporate expense) are up from 14.8% to 15.4%. We believe margins will continue to increase in the coming quarters, particularly as the company delivers its expected $750 million of cost savings from the combined Kraft/Cadbury operations.
From a valuation perspective, based on the attractiveness of the categories in which Kraft participates, and its strong and growing emerging market presence, we think the stock is inexpensive at roughly 11x 2012 earnings.”
Family Dollar Stores (FDO)
Family Dollar was also a preexisting stock in Ackman’s portfolio and was the third-highest growing since the end of the third quarter, at a 10% increase. Ackman bought 5,764,187 shares at about $47.50 in the first quarter 2011, added 5,330,306 shares at about $53 in the second quarter 2011, and added 293,836 in the third quarter of 2011 at about $52 per share.
Family Dollar Stores Inc. is one of the fastest growing discount store chains in the U.S. Family Dollar Stores Inc. has a market cap of $6.74 billion; its shares were traded at around $57.4 with a P/E ratio of 18.3 and P/S ratio of 0.8. The dividend yield of Family Dollar Stores Inc. stocks is 1.3%. Family Dollar Stores Inc. had an annual average earnings growth of 10% over the past 10 years. GuruFocus rated Family Dollar Stores Inc. the business predictability rank of 3.5-star.
In his third-quarter letter, Ackman said of Family Dollar:
In August, Family Dollar completed its fiscal year 2011, ending a year of strong samestore sales growth and modest margin expansion. Despite some business progress, FDO continues to trail its primary competitor, Dollar General (DG), by a wide margin. This is reflected in the valuation the market assigns to the two companies. Despite similar unit size, business models, and historical profitability, DG's enterprise value per unit today is $1.70 million compared to $1.04 million at FDO, a 63% premium.
On September 29th, Family Dollar announced that Edward Garden, the Chief Investment Officer of Trian, is joining FDO's board of directors. Contemporaneous with this announcement, Trian withdrew its $55 to $60 offer to acquire the company, an offer we and the company deemed inadequate. We hold Ed and the Trian team in high regard and are confident that Ed will serve the interests of shareholders well. Ed's appointment gives us the benefit of an effective activist shareholder on the board, while freeing our time for other commitments.
Lowe’s Companies has declined 10.4% year to date, and fell to 52-week lows in the third quarter, when Ackman bought it. Since the end of the third quarter it has gone up 16%, the second highest of his top-increasing new adds. He bought Lowe’s stock for the first time in the third quarter of 2011, at about $21 per share.
Lowe's Companies Inc. is a retailer of home improvement products in the world, with specific emphasis on retail do-it-yourself and commercial business customers. Lowes Cos. has a market cap of $28.75 billion; its shares were traded at around $22.81 with a P/E ratio of 14.4 and P/S ratio of 0.6. The dividend yield of Lowes Cos. stocks is 2.4%. Lowes Cos. had an annual average earnings growth of 7.8% over the past 10 years.
Lowe’s recently began implementing major changes to boost competitiveness, including closing 20 underperforming stores this year. In the third quarter, Lowe’s net income fell 44% due in large part to costs associated with store closings and other restructuring activities.
“When you look at the significant amount of change that we have put the organization through, any time you have that level of change, there's got to be some amount of disruption associated with that. That was part of the reason that we tried to consolidate all these changes and pull them together and execute them as quickly as we could,” CEO Robert Niblock said on the company’s quarterly conference call.
Lowe’s has grown its revenue at a rate of 10.4% over the last 10 years, and its EBITDA at 7.8%. Free cash flow reached its highest level of the decade at $2.6 billion last year. The company also has about $900 million in cash on its balance sheet and about $8.6 billion in long-term liabilities and debt.
Ackman delivered a detailed presentation on Lowe’s, called “Waiting for a Bounce from the Lowe’s,” in Nocember.
Canadian Pacific Railway Limited (CP)
This new buy of Ackman’s increased the most since the end of the third quarter, at 16.5%. He bought 4,040,235 shares of Canadian Pacific Railway Limited, or 12.2% of the company, at about $57 per share in the third quarter. The stock had also fallen to new 52-week lows in the third quarter.
Canadian Pacific Railway is North America's first transcontinental railway and is the only transcontinental carrier with direct service to the U. Canadian Pacific Railway Ltd. has a market cap of $9.73 billion; its shares were traded at around $57.41 with a P/E ratio of 18.1 and P/S ratio of 2. The dividend yield of Canadian Pacific Railway Ltd. stocks is 2.1%. Canadian Pacific Railway Ltd. had an annual average earnings growth of 5.9% over the past 10 years.
Ackman believes that Canadian Pacific Railway pales in comparison to its closest competitor and other North American railroads on nearly every operating measure. Fortunately, he thinks most of the problems can be solved, likely by him and his team.
Canadian Pacific has the highest P/E of its competitors at 18.56, and higher than the industry average of 16.22. Its trailing-12 month earnings per share of $3.02 are lower than its nearest competitors, but higher than $1.62 for the industry. Its gross margin underperformed both its competitors and the industry average, as did its operating margin.
The railway’s third-quarter earnings decreased 5% as it experienced a 47% increase in the average cost of fuel, while total revenues increased $55.4 million. For the long term, though, CP’s revenue reached a peak of $4.9 billion in 2010, and net income has remained relatively steady. Free cash flow has also been positive for the last decade, with the exception of 2003 and 2010.