Bill Ackman's Pershing Square: 3rd-Quarter Update

Activist investor Bill Ackman (Trades, Portfolio)’s Pershing Square Capital Management recently released its portfolio update for the third quarter. During the quarter, the hedge fund sold out of its position in Automatic Data Processing Inc. (ADP, Financial). It also added more shares of Berkshire Hathaway Inc. (BRK.B, Financial) and slightly trimmed its holdings in Chipotle Mexican Grill Inc. (CMG, Financial), Hilton Worldwide Holdings Inc. (HLT, Financial), Restaurant Brands International Inc. (QSR, Financial) and Lowe's Companies Inc. (LOW, Financial).

The fund holds shares in seven companies, comprising an equity portfolio valued at $6.27 billion as of the quarter’s end. Founded by Bill Ackman (Trades, Portfolio) in 2004, Pershing Square focuses on taking large stakes in a small number of well-researched companies that it deems to be fundamentally strong but underperforming in the short term. After obtaining a large enough position of influence as a major shareholder, preferably enough to get board representation, the hedge fund then aims to catalyze improvements in the target company’s strategy in order to further increase its expected profitability.

Automatic Data Processing

Pershing Square’s largest transaction for the quarter was the sale of all 4,029,526 remaining shares of Automatic Data Processing, which impacted the equity portfolio by -9.93%. Shares were trading at an average price of $165.20 during the quarter.

Automatic Data Processing is a provider of business outsourcing solutions based in Roseland, New Jersey. Its services include human resources, payroll, tax and benefits. As of Dec. 5, it has a market cap of $72.88 billion.

“During the last several weeks, we sold our stake in ADP,” Ackman wrote in Pershing Square’s 2019 semiannual letter to shareholders. “Although we expect ADP to continue to do well over time as the company executes on its business transformation, we view the prospective returns from today as more modest because the market is now more accurately pricing in ADP’s prospects for success.”

According to GuruFocus’s calculations, Pershing’s stake in Automatic Data Processing resulted in a total estimated gain of 26.47% from the increase in share price alone. Pershing estimates that the total shareholder return generated from the investment was 64% after factoring in dividends and leverage in the form of call options.

GuruFocus has assigned Automatic Data Processing a financial strength score of 5 out of 10 and a profitability score of 9 out of 10. The company has a price-earnings ratio of 30.99, an operating margin of 21.47% and a cash-debt ratio of 0.84. The Peter Lynch chart confirms Ackman’s assessment that the company’s prospects for success are already being factored into the stock price, making it overvalued. Thus, although the company itself and Wall Street analysts have high expectations for its future, Pershing has decided to bow out before the stock has a chance to collapse.

Berkshire Hathaway

The sole addition to Pershing’s portfolio during the quarter was 502,597 class B shares of Berkshire Hathaway, which impacted the portfolio by 1.67%. Shares were trading at an average of $206.13 apiece during the period.

Berkshire Hathaway is the famous Omaha, Nebraska-based insurance conglomerate headed by Warren Buffett (Trades, Portfolio), one of the most famous and successful investors in U.S. history. The company was originally a group of textile producers, but after Buffett became controlling shareholder in the mid-1960s, it diverted its cash flows into acquisitions (which eventually became its main source of income). Nowadays, Berkshire has transformed from a manufacturer into something more akin to an investment fund.

Pershing first acquired a stake in Berkshire during the second quarter of 2019. Ackman explained the reasoning behind the investment in his 2019 semiannual shareholder letter:

“The catalyst for our current investment in Berkshire is our view that the company is currently trading at one of the widest discounts to its intrinsic value in many years, at a time when we expect the operating performance of its subsidiaries to improve as a result of certain managerial and organizational changes at the company. While Mr. Buffett has long been one of most high-profile and closely followed investors in the world, we believe that Berkshire Hathaway’s undervaluation is partially explained by the fact that it is one of the least followed and misunderstood mega-cap companies.”

In recent years, the price of Berkshire stock has been ranging as revenue and net income fluctuated in the wake of changes to the generally accepted accounting principles, as shown in the chart below. After the changes were announced, Buffett said that, when combined with the unconventional structure of the company, they would cause difficulties in reporting realized gains and losses.

“Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance,” he wrote in his 2018 annual letter to Berkshire shareholders. “For analytical purposes, Berkshire’s ‘bottom-line’ will be useless.”

Berkshire Hathaway has a GuruFocus financial strength score of 5 out of 10 and a profitability score of 6 out of 10. It has a price-earnings ratio of 19.95 and a cash-debt ratio of 0.73. According to GuruFocus’ calculations, the investment has earned Pershing a total estimated gain of 6.01% as of Dec. 5 due to increases in the share price.

Chipotle Mexican Grill

As of the quarter’s end, Chipotle Mexican Grill is Pershing’s largest holding, making up 23.13% of the equity portfolio. Pershing sold 58,400 shares, reducing its holding in the company by 3.28% and impacting the equity portfolio by -0.64%. Shares were trading at an average price of $819.73 apiece during the quarter.

According to GuruFocus’ calculations, the hedge fund has achieved a total estimated gain of 75.03% from its investment in Chipotle based on increases in the stock price.

Although Pershing has been reducing its stake in Chipotle in recent quarters, it remains optimistic about the company’s growth prospects. “Management’s extensive pipeline of growth initiatives combined with Chipotle’s highly attractive customer value proposition gives us confidence that the company should continue to generate superior levels of sales and profit growth,” Ackman wrote in a letter to shareholders.

Chipotle has a GuruFocus financial strength score of 5 out of 10 and a profitability score of 8 out of 10. Its price-earnings ratio of 74.16 is higher than 90.38% of industry competitors, and according to the Peter Lynch chart, the stock is currently overvalued.

Restaurant Brands International

Pershing’s second-largest holding is Restaurant Brands International, the owner of Popeye’s, Tim Hortons and Burger King, which makes up 17.13% of the equity portfolio. The hedge fund sold 556,761 shares of the restaurant franchise company during the quarter, reducing its position by 3.56% and impacting the equity portfolio by -0.58%. During the period, shares were trading at an average price of $73.76 each.

GuruFocus calculates Pershing’s total estimated gain from the company’s stock price appreciation at 67.65%.

According to Ackman, “QSR’s shares have appreciated 45% this year, but currently trade at less than 24 times next year’s free cash flow, which represents a discount to both intrinsic value and slower-growth franchised peers.” Thus, Pershing still has high hopes for Restaurant Brands’ profitable royalty-based franchise model, especially in light of its plans to open 1,500 new Popeye’s restaurants in China over the next decade.

Restaurant Brands has a GuruFocus financial strength score of 3.6 out of 10 and a profitability score of 5.3 out of 10. Its price-earnings ratio of 26.42 is higher than 57.21% of competitors in the restaurants industry. The stock has been correcting to closer to its intrinsic value, so future earnings growth is more likely to create value for shareholders.

Disclosure: Author owns no shares in any of the stocks mentioned.

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