Let's be clear: You can make a lot of money following the moves of great investors. They have teams of analysts, endless resources, long experience, and great track records. Luckily, if they manage over $100 million, they must report their holdings every 3 months! Thus, we can see the ebbs and flows of their portfolio throughout the year -- buys, sells, and holds. Why ignore a potential gold mine of stock ideas?
Today's review
Today we'll focus on Bill Ackman. Mr. Ackman runs Pershing Square Capital Management, based in New York City, with estimated assets under management (the ol' AUM) of $6 billion at the end of the third quarter. Ackman's approach is somewhat unusual: he takes large stakes in (often) well-known companies while pushing management to improve performance. Unlike many activists, Ackman isn't a corporate raider interested in slashing and burning, but rather a constructive voice for smart financial management and shareholder friendly policies. He takes big risks and they pay off enough for him to reward his fund partners.
Ackman's unusual approach has led him into sizable holdings of J.C. Penney (NYSE: JCP), Kraft (NYSE: KFT), Beam (NYSE: BEAM), and Family Dollar (NYSE: FDO), among others. In the case of JCPenney, Mr. Ackman is the company's largest shareholder and a member of the Board of Directors, not to mention a major contributor to the recruitment of new CEO (and former Apple store retail guru) Ron Johnson. And he owns Beam via his prior ownership in Fortune Brands, which spun off Beam and Fortune Brands Home & Security (Nasdaq: FBHS).
With that in mind, let's take a look at what Bill Ackman was up to last quarter.
Top 10 Holdings (italics signal material share changes from June to September.)
| As of June 30, 2011 | Shares Held (in millions) | Value* (in millions) |
|---|---|---|
| J.C. Penney | 38.7 | $1,337 |
| General Growth Properties | 72.2 | $1,206 |
| Fortune Brands | 17.2 | $1,095 |
| Citigroup | 23.5 | $979 |
| Kraft | 22.2 | $783 |
| Family Dollar Stores | 11.1 | $583 |
| Howard Hughes | 3.6 | $232 |
| Alexander & Baldwin | 3.6 | $172 |
| Greenlight Capital Re | 0.25 | $7 |
| As of Sept. 30, 2011 | Shares Held (in millions) | Value* (in millions) |
|---|---|---|
| Fortune Brands | 20.8 | $1,126 |
| J.C. Penney | 38.7 | $1,037 |
| General Growth Properties | 72.2 | $874 |
| Kraft | 25.2 | $846 |
| Citigroup | 26.1 | $669 |
| Family Dollar Stores | 11.4 | $579 |
| Lowe's | 21.2 | $411 |
| Canadian Pacific Railways | 4.0 | $194 |
| Howard Hughes | 3.6 | $150 |
| Alexander & Baldwin | 3.6 | $130 |
Source: 13F-HR Filings for Pershing Square Capital Management, L.P. *Based on stock price at filing date.
Note: Curiously, Greenlight Capital Re is the publicly traded investment holding company run by David Einhorn, another superinvestor. One investing in another? High praise indeed!
Taking a closer look: Lowe's
One of Ackman's new holdings is Lowe's (NYSE: LOW), a formerly dazzling growth stock that's been stuck in neutral for the last 10 years (kind of like some cars I had in college). Lowe's operates in a sort-of duopoly in home improvement retailing, competing with Home Depot (NYSE: HD) for dominance of the market. Think to the last time you replaced your sinks, countertops, or flooring -- what stores came to mind when you went to make a purchase? Lowe's and Home Depot were among the first. (Although, given today's economy, no apologies needed if you can't remember the last time you could afford to remodel!)
In most cases we can only speculate why anybody buys anything, but Ackman has generously laid out his case in a presentation released to the public. He loves to talk his book -- that's hedge fund speak for "make an investment and then tell everyone else so they'll buy, he makes money and proves how smart he is." It boils down to a few simple variables, as any good investment should.
The main points
The stock's low price is an easy place to start: Lowe's trades for roughly 14 times its forward earnings estimates. And those estimates reflect the moribund market for new home construction and the poor economy overall.
But even beyond the rough economy, Lowe's has underperformed its main competitor in recent years. Same-store sales growth -- important in retail, where many costs are fixed and incremental revenue can boost profit margins rapidly -- has been higher at Home Depot than at Lowe's for eight of the past 10 quarters. This is a huge departure from the previous 10 years, in which Lowe's had consistently beaten up on its big brother in the same-store sales department (you know, the next section over from lumber).
The poor sales performance, partly Lowe's fault and partly the economy's, means depressed profit margins, net earnings, and free cash flow. The stock has dropped almost 40% from its all-time highs in 2007.
Catalysts?
Which leads us to the catalyst for a better stock price: Lowes' sales may be about to gain steam rapidly as the housing market recovers and Lowe's closes the competitive gap with Home Depot. As sales pick up, margins should move back closer to their peak levels in 2006-2007, cushioning the bottom line and investors' spirits. In the meantime, Lowe's has been buying back its own stock in record amounts (7% in the first half of the year) and has much more planned.
Yes, Lowe's does have debt, but if you believe shares are great buy and will return than your cost of capital -- that a dollar will earn more in effect buying your cheap stock than the interest saved on debt -- it's the right capital allocation. Management must be, uh, smart and value-oriented.
This combination of higher sales, higher margins, fewer shares outstanding, and possibly a higher P/E multiple make Lowe's a very interesting proposition. (Where P/E tracks operating and free cash flow, it's a relevant measure. Otherwise, I don't use it.)
Lowe's is high
Keep in mind that size is the enemy of returns. Successful investing brings the money manager more assets, and before you know it, the billions limit the universe of investable stocks -- if you've got Ackman's $6 billion-plus under management, buying the kind of $100 million market cap stock that I and the Motley Fool Special Ops team prefer doesn't move the needle on your returns.
But while smaller stocks are more likely to be mispriced, any size company can offer value and catalysts, particularly if, as Ackman, the investor pushes management to unlock shareholder value. Lowe's is a perfect example of just that. And given Ackman's track record, Lowe's low valuation, and its leverage to the eventual housing market turn, investors should think hard about some home -- I mean, portfolio -- improvement via Lowe's.
Fool on!
