Chris Hohn's hedge fund, TCI Fund Management, is one of the best-performing hedge funds of all time. In recent years, the fund returned 41% in 2019 and 14% in 2020, and it added 17% in the first nine months of 2021. Since its inception, the $40 billion hedge fund has returned around 18% per annum net of fees.
Considering this performance, I like to keep a close eye on the fund manager's portfolio, as I am always looking out for investment ideas to add to my portfolio. TCI's track record suggests to me that the fund knows how to look for high-quality ideas.
According to its third-quarter 13F filing, TCI signfincalty increased its holdings in Visa (V, Financial) last quarter. The fund boosted its position by 42% to just under 20 million shares, making the holding the fourth-largest position in the portfolio.
It also pared back a position in Microsoft (MSFT, Financial) by around 19%, implying that the fund has been willing to sell Microsoft to invest in other opportunities. It also boosted a holding in Canadian National Railway (CNI, Financial) by 22% during the period.
I won't go into the reasons why I think TCI has been selling Microsoft and buying Visa, since that's all speculation. However, I do want to take a closer look at Visa as it is interesting to see that TCI has been buying the stock even though it was trading close (or within a 10% range) to its all-time high last quarter.
Visa's competitive advantages are well-known. The company is one of the two most prominent payment processing networks globally, alongside Mastercard (MA, Financial). These two networks manage trillions of transactions every year and, more importantly, have the infrastructure in place to settle these transactions.
Visa's advantages are two-fold. The company has a global reach, and it has the technology. Even if a competitor could afford to roll out the global network Visa operates, it would take decades for the new firm to build consumer trust in the way Visa and Mastercard have done.
That is not to say that the business does not have competitors. American Express (AXP, Financial) is probably the firm's main competitor in the U.S., although it's not as well recognized overseas. PayPal (PYPL, Financial) is another competitor, but this enterprise focuses mainly on processing online payments. "Buy now, pay later" and app-based payment services are also gaining popularity as credit card alternatives.
Visa has competitors, but I think it is essential to take a consumer-focused look at the market. Most consumers have more than one payment card with different issuers and processors. Personally, I have five cards, most of which are Visa, but there is also a Mastercard and Amex. There is room in the market for more than one processor (I also use PayPal and Stripe). Therefore, I think the company can deal with the competition.
As the number of cashless transactions grows, Visa's competitive advantage will only continue to expand. As the firm processes more transactions, its profit will grow, providing more capital to reinforce the durability and sustainability of its international network.
And despite the company's competition, its returns are only increasing. Return on capital employed has risen from 21% in 2017 to 24% for 2021. That does not signify a company with a shrinking competitive advantage.
As such, the company's forward price-earnings ratio for 2023 looks too cheap at a mere 23.5. According to the GuruFocus DCF calculator, using a 5% discount rate and assuming free cash flow continues to expand at 18.8% per annum for the next decade (replicating the growth reported over the past 10 years), the intrinsic value of the stock today would come out to $348. That is a 43% increase from current levels.
I think these numbers show why TCI continues to like the stock. Now only does it have a strong economic moat and margin of safety, it is also undervalued.