Billionaire Bill Ackman may be down on his luck recently, but he's not out. His hedge fund management company, Pershing Square Capital Management, runs a concentrated portfolio of stocks that it generally holds for the long haul. For this reason, its 13F regulatory filings are watched by many who want to get an inside look at which stocks Ackman believes will generate market-beating returns for years to come.
Recent regulatory filings and presentations show that Pershing Square bought shares of Mondelez International (NASDAQ:MDLZ) and Nike (NYSE:NKE), and sold Howard Hughes Corp. (NYSE:HHC). Here's the backstory on all three stocks.
Mondelez International is a packaged food business best known as the maker of the famous Oreo cookie. Like many of its peers in the packaged food industry, Mondelez is growing its earnings by shrinking its expense base, sending more of its revenue to pre-tax profit. It's been an up-and-down holding for Pershing Square, which purchased roughly 9.4 million shares of the company in the fourth quarter, about as many as it had sold over the first nine months of the year.
The thesis for Mondelez International is that it can continue to grow organic sales at a low-single-digit pace, and grow earnings at a faster clip than sales by slashing expenses. In the most recent quarter, it reported that organic revenue grew 2.4% year over year, driven by a 0.3% increase in volume and a 2.1% increase in pricing, with emerging markets leading the pack in sales growth.
In a business where efficiency and scale are everything, pricing increases and cost cuts can drive meaningful profit growth. Notably, Mondelez International's adjusted operating income margin expanded to 15.9% in the most recent quarter, up about 1.8 percentage points from the year-ago period. But Mondelez sees even more room for margin expansion, guiding for an adjusted operating income margin of 17% for the full year in 2018, driving double-digit increases in its earnings on a per-share basis, excluding the impact of currency fluctuations.
While many companies say they can drive margin expansion, Mondelez has proven capable of delivering. Since 2013, full-year operating income margin has expanded from 10.3% to 16.3% in 2017. There are many ways to grow profits, but Mondelez is almost singularly focused on pushing more of every dollar into income, and it's working.
Howard Hughes Corp is a long time Pershing Square holding, dating back to 2010, when it was spun out of General Growth Properties. In January, Bill Ackman's Pershing Square noted in a 13D/A filing that it slashed its stake by more than half, selling about 2.5 million shares.
One might believe Ackman has turned on Howard Hughes prospects, but this doesn't appear to be the case. In a presentation to investors in one of Pershing Square's funds, Ackman said the fund manager was slashing its common stock holdings in Howard Hughes and replacing them with total return swaps. That move allows Pershing Square to gain from the company's performance without triggering tax issues related to foreign real estate ownership.
Howard Hughes is best known for creating master planned communities, developments designed to be a mostly self-sustaining ecosystem within a larger community. One of its premier assets is a community in Houston, Texas, known as The Woodlands, which spans more than 28,000 acres and has more than 115,000 residents.
The business model is conceptually simple but difficult to execute. Starting with thousands of acres of undeveloped land, Howard Hughes draws up plans to create a whole community, chock-full of amenities like parks, golf courses, and walking or biking trails -- the kind of stuff people will pay dearly to live near. From there, it sells off lots of land to developers at premium prices, piece by piece.
Because land often makes up a small part of the cost of a new home, the difference between a $50,000 lot and a $100,000 lot isn't all that meaningful to a buyer who has already eyed a $500,000 new construction. But for Howard Hughes, turning cheap, undeveloped land into thousands of high-priced lots is a killer business model.
Pershing Square purchased more than 5.8 million shares of Nike in the fourth quarter, noting in a presentation that Nike is a "high-quality business that should compound long-term earnings at a high rate due to strong revenue growth and margin expansion." It went on to say that Nike has a "dominant market position" in footwear, protected by competition due to patented innovations, manufacturing skill, and unmatched marketing spend.
Nike generates roughly two-thirds of its revenue from footwear, with the remainder coming from apparel and other products. Ackman views its exposure to fast-growing emerging markets as a plus, given that these lucrative markets make up about 30% of its sales.
Shares of the footwear and apparel brand have surged since Pershing Square bought in, and they now trade for about 30% more than the $52 price it paid. The hedge fund manager told investors in one of its funds that it was "unable to acquire a full-sized position in our other new ideas as their prices increased significantly amid a rapidly rising stock market," listing Nike as one such stock. That suggests to me that Pershing Square isn't eager to add to its Nike stake today.
Nike has struggled as of late in its core North American market, where retailers are working through a glut of excess inventory, weighing on Nike's revenue and profit. Late last year at its Investor Day, the company laid out bold expectations for the next five years, suggesting that it expects gross margins to expand by as much as 0.5 percentage points per year, on average. That would be a substantial improvement for the world's most famous footwear company.
The company is pulling on every lever to get there, laying out plans to sell more product direct-to-consumer (eliminating the middlemen in the process), increasing prices, optimizing expenses, and increasing its sell-through at retail, where excess inventory can quickly turn into a liability that cheapens a brand's position in the marketplace. In a business where brands are often one-hit wonders, it's tough to bet against the 47-year-old swoosh logo and its ability to sell.