Bill Ackman (Trades, Portfolio) of Pershing Square Capital just held his first quarter call discussing the fund’s holdings.
Due to the fund’s concentrated position in Valeant Pharmaceuticals (VRX, Financial), it had a disastrous 2015 and an even more disastrous first quarter of 2016. As of April 5 the NAV per share sat at $15.60 and the year-to-date return for the holding was -24.6%. Ackman called it a difficult quarter on a mark-to-market basis, implying intrinsic value of Pershing’s positions is much higher.
Pershing has board seats at a number of portfolio companies, which somewhat limits its ability to discuss holdings, but nonetheless the call was highly educational (as it is every quarter). Pershing currently holds quite a bit of cash after selling Mondelez (MDLZ, Financial) stock and Air Products (APD, Financial) stock (replacing the exposure with options). The call is available at Pershing’s website until April 20 but to save you time I’ve taken the following notes:
Valeant
According to Ackman, Valeant now fits the classic Pershing Square investment strategy much better. It started out as a passive investment where Pershing Square took the backseat and was along for the ride with Mike Pearson, but now it’s back in the driver's seat.
Pershing got two directors on the board and two other directors have been replaced as well. Pearson is doing his best to help with a smooth transition while the board is looking for a new CEO. There is a lot of interest in the position and because of all the M&A in the industry there are lots of qualified candidates. We can expect a new CEO within weeks.
Investors have lost confidence in the financial statement, in the management and in the governance. These issues need to be addressed and when that happens the stock price will reflect the intrinsic value of the company instead of being uninvestable, as it has been called.
Ackman thinks the company will deliver a 10-K on or before April 29.
According to Ackman the stock effectively trades at below 3x earnings. The game plan is to restore investor confidence after which the stock can recover rapidly.
Notably in the Q&A part of the call Ackman answered a question, saying he doesn’t think Valeant’s accounting is that aggressive but mostly in line with the industry, and he also noted that the Walgreen (WBA, Financial) distribution channel has a lot of potential.
To his credit Ackman also admits one mistake made with regard to Valeant was placing too little value on predictable free cash flows, a core component of other Pershing Square portfolio companies.
Air Products and Chemicals
Pershing Square has been invested here for 2½ years. Air Products is an extremely high-quality, simple, predictable free cash flow, generative-dominant business. Pershing owns a 10% stake in the company.
Previously the company was managed below its potential. Pershing installed a new CEO. The only negative about the company is its capital structure. It is too conservative. To remedy this, Pershing sold two-thirds of the stock and replaced it with in-the-money options. Pershing is now earning more yield on a smaller base of capital. Essentially it levered the position. (Author’s note: Pershing gets hammered when the stock falls a lot but otherwise profits from this transaction.)
The company is down to two turns of leverage. It will now have some room for buybacks, M&A or whatever offers the best returns for shareholders.
Canadian Pacific (CP, Financial)
The railroad business suffered from some of the macro weakness. It's a diversified business, and it holds up well as a whole. Volumes were down only 2% for the year. It makes great progress on improving operating margins, and it repurchased 8% of shares over the last year. EPS growth of 19% for the year despite muted top line growth.
Improvements are overshadowed by weakness in rail weakness. It remains an attractive investment. It guided for 10% EPS growth over the next year and, given the disclosures from the company, the guidance is achievable. It has a superb management team. The merger with Norfolk Southern (NSC) would create enormous additional value for shareholders, but it is uncertain whether it will happen. More news will come out in the next month or so.
Fannie and Freddie
Earnings are at a very healthy level. Underlying results are favorable but reported results continue to be very volatile. Pressure is increasing for Fannie (FNMA, Financial) and Freddie (FMCC, Financial) to retain capital. There have been several proposals for the company to retain capital. Pershing is observing a change in sentiment regarding the company’s continued existence.
Howard Hughes (HHC, Financial)
The stock price isn’t doing well. Ackman thinks this is due to the Woodlands project in Houston even though the Houston area isn’t actually that weak. In the fourth quarter and next year it will start to generate cash. This will become a much more cash generative company. Ackman encourages us to read the CEO’s letter to shareholders although I warn you, it is Tolstoy’s "War and Peace" –Â kind of long. Howard Hughes is going to do more about investor relations and get more Wall Street coverage. It’s time to start telling the story.
Short Herbalife
In the company’s 10-K Feb. 25, it changed disclosure regarding the FCC investigation. It says it is working on a resolution now. Pershing thinks it is not getting away with a slap on the wrist but instead resetting investors' expectations. Previously Herbalife (HLF, Financial) took the stance there was nothing to worry about. It is getting close to the end of the process.
Herbalife is a pyramid scheme and is hurting people. It should be shut down. The company filed an 8-K where it admitted a lot of errors. It is employing a new metric: active new members. Herbalife didn’t define it well. It overstated some numbers.
This illustrates how fake Herbalife’s numbers are. Churn rate is suspiciously not disclosed. Stock trades at 15x midpoint management guidance. From a valuation perspective there is very little upside and lots of downside. Risk/reward is compelling.
Mondelez
The company should perform better. There is a lot of room for improvement. It has some of the worst margins in the business.
Management is aware and has set ambitious targets. Pershing had communications about its perspective. Pershing believes it can do even better than management’s targets. If only management’s targets can be achieved, the stock should go up. After the recent sale the position is still a 5% position..
Recent weakness was due to legacy execution issues under the previous management. Nomad is spending too much on product development instead of focusing on its core product portfolio. It remains a consolidator in the fragmented food sector. Looking for tuck in M&A in the European frozen food sector.
Platform
New CEO started in January. FX was a massive headwind. EBITDA will go up only very modestly.
Restaurant Brands
Restaurant Brands (QSR, Financial) continues to show very strong results. Same-store sales growth is very good. 3G has the ability to make businesses more efficient while at the same time growing the top line. Competition is doing better; McDonald’s (MCD) gets a shout out. Overhead at Tim Hortons (THI) was reduced by 30%.
Zoetis
This is the only large independently traded animal health company with a $22 billion market cap. Half of the revenues come from the U.S. and the rest from International. Zoetis (ZTS, Financial) had a strong 2015. Management committed to grow net income faster than revenue long term. Three acquisitions were completed, an important one being Pharmaq, a leader in aquaculture vaccines. This is the fastest-growing sector in animal health.
Zoetis has all the benefits of pharma companies but with little of the downside: no problems with medicare, no politics, high quality growth company, significant opportunity for cost take out, sell directly to farmers and sell directly to vets, no third parties, not as attractive for generic companies.
