Bill Ackman (Trades, Portfolio) of Pershing Square has been extremely successful with his concentrated activist strategy but as of late has hit something of a speedbump. First Hillary Clinton tweeted about drug pricing getting out of hand which hurt his healthcore holdings. Subsequently, Citron Research published an unfavorable research report on Pershing’s largest holding Valeant Pharmaceuticals (VRX, Financial). As Citron is considered a rather sharp short seller with a good track record the market took note and Valeant sold off sharply. Valeant continues to be under intense scrutiny and has severed all ties with the Philidor specialty pharmacy.
To say the least, the Pershing Square quarterly conference call was highly anticipated. I have taken notes on the companies that are discussed on the call and the key takeaways for each company discussed. Ackman and his analysts talked about each holding in order of size of the position, but I will start with Valeant:
Valeant
Valeant makes up about 12% of total assets at Pershing Square. Ackman values businesses that generate cash over time which Valeant will. Because of the commotion in the media and the strong selloff Pershing examined all the products of the company in greater depth. It examined the impact of the Philidor discontinuation on cash flows and also the reputational implications of the Valeant story.
- The only Valeant-branded business is the dermatology segment.
- Pershing interviewed 10 dermatologists and surveyed 40 dermatologists.
- Dermatologists will continue to prescribe Valeant products if Philidor is replaced by another specialty pharmacy.
- If doctors can get the right drug for patients at low cost, they will prescribe Valeant products.
- There are clear reasons why doctors prescribe branded products over generics.
- The Bausch & Lomb brand has not been damaged.
- Free cash flow from Bausch & Lomb will not suffer from the Valeant turmoil.
- Salix products treat specific diseases, and they will continue to be prescribed.
- Valeant's generic business will continue to generate cash flow as it always has.
- Specialty pharmacies are not unique to Valeant.
- Drug pricing is not a problem that is unique to Valeant.
- Valeant does not need to be aggressive on price to be a very attractive investment.
- Lots of confidence-inspiring events are coming up.
- Panic caused the marginal investor to sell.
- Valeant has been the victim of fear and panic.
- Disclosure and more information will calm investors.
- No acquisitions are expected in the next 18 months.
- Compared to when it was at $250 it is a very attractive and lower risk investment.
Mondelez
Mondelez (MDLZ, Financial) is a well-known company and a classic Pershing Square holding; simple, predictable with attractive long-term growth potential. There are multiple avenues to create value. The team has been having highly constructive meetings with CEO Irene Rosenfeld. Key takeaways from these meetings include: product improvement opportunities, margin improvement opportunities. This year margins went from 12% to 14%. They can go much higher. Other notes:
- Organic growth is being realized through pricing actions.
- Volume growth was actually negative.
- Base productivity programs are being implemented.
- Massive investment in supply chain should boost margins in 2016 and beyond significantly.
Air Products and Chemicals
Platform companies like industrial Air Products and Chemicals (APD, Financial) were very much in vogue until recently but are getting hammered now.
- First 12 months under a new CEO who Pershing Square likes a lot
- EPS growth came out at 10% despite FX headwinds or it would have been 19%.
- Over the fiscal year EPS growth would have been 21% if there had been no FX headwinds.
- Next year: Guidance EPS growing 10% to 14%; Pershing Square thinks it can do better.
- Spinning off its materials technology business which makes great strategic and financial sense
- Underlevered segment within Air Products and ChemicalsÂ
- Will be spun off with debt of about 4.5x EBITDA
- $200 million EBIT improvement next year solely through cost savings
- Growth CapEx should deliver more growth although it will be lumpy
- Stock is down 6% for the quarter alongside many industrial companies.
- Company is not sensitive to industrial GDP growth.
Canadian Pacific Railway
Canadian Pacific Railway (CP, Financial) is a longtime holding of Pershing Square which has performed very well for them. The company transports goods over rail with a network of about 13,700 miles from Montreal to Vancouver, British Columbia, and the United States Northeast and Midwest regions.
- Global macro softness plagues the rail industry.
- Supply chain destocking continues.
- Conditions are challenging for the railroad businesses.
- Railroads have operating leverage, and this works against them now.
- Margins improved a full 3% nonetheless.
- The company did 4% more volume with 9% fewer people.
- Labor productivity will continue to increase.
- Reduction in number of railcars by 15%
- 400 high-powered locomotives have been put in storage.
- Unless volume increases considerably there is no need for new locomotives until 2018.
- Meaningful CapEx savings at $2 million per locomotive.
- Reduced CapEx guidance for 2016 from $1.5 billion to $1.1 billion.
- Repurchased 5% of shares outstanding at attractive prices.
- Even if volume does not recover the company can improve margins 2% or 3% in 2016
Zoetis
Zoetis (ZTS, Financial) is an animal health company that traded down in sync with human pharmaceutical companies. It shares nothing in common with the human healthcare pharmaceuticals. It provides ranchers and vets with medicine. There is a business-to-business segment, and it supplies pet owners through vets, but there is no government reimbursement taking place whatsoever.
- Zoetis is part of the same healtchare ETFs as the pharmaceuticals.
- Highly productive research and development engine
- Strong FX headwinds
- $1.2 billion revenue
- EPS increased 15%.
- Adjusted net income 15 cents 22% increase year over year
- Focused on growing revenue faster than expenses
- Zoetis acquired Pharmaq which leads in fish farm medicine –Â a natural strategic fit.
Restaurant Brands
Restaurant Brands (QSR, Financial) is a conglomerate managed by 3G. The company had a really good quarter. 3G is pretty much done turning Burger King around, but there is plenty of room to run in terms of increasing the number of restaurants.
- Overhead has been cut at Tim Hortons (THI, Financial).
- 3G is increasing efficiency at Tim Hortons but not at the cost of growth.
- Growth may actually be accelerating.
- 3G management can grow top line and cut costs.
- EBITDA up 6% despite negative FX (or EBITDA would have increased 20%).
Howard Hughes
Howard Hughes (HHC) is a real estate company. According to Ackman the company’s 20% drawdown of the quarter has nothing to do with performance. He suspects the company is selling off because the market is anticipating Pershing Square will have to liquidate stock due to the Valeant turmoil, including its less liquid holdings. Ackman is instead planning to hold on to these for a long time.
Pershing Square benefits from these selloffs even when it does not have liquidity itself because its companies are buying back shares. For example Canadian Pacific Railway is buying back shares.
Nomad Foods
Nomad Foods (NHL, Financial) is a European frozen foods company. It had a strong start as a newly formed company even though the European economy is weak. Its most famous brand is Iglo, which leads in frozen food.
- Trade spent is examined carefully (time the company spends with grocers) as this expense line is unusually high.
- Acquired non-UK assets of Findus Group which are highly complementary to Nomad’s assets
- 3x the size of next competitor in European frozen food
- Moderately levered; still room for value-enhancing acquisitions
Fanny and Freddie
Government-controlled mortgage companies Fannie Mae (FNMA, Financial) and Freddie Mac (FHLMC, Financial) need no introduction. Reported earnings declined due to losses on derivative portfolios. The emerging consensus is that the companies should be released from conservatorship
Herbalife
Its total members churn was higher for the first time since the short was put on. In this quarter alone 600,000 to 700,000 members quit, and the company only recruited 500,000 new members. It has only something like 4 million members total. Half of Herbalife’s (HLF, Financial) customers leave every year. Ackman talks about the video where the Herbalife CEO said Herbalife is built on recruiting which is the definition of a pyramid scheme. Herbalife is feeling the pressure on all fronts.
