Hedge funds make a comeback in 2019
Some hedge funds are making a strong comeback in 2019 after a dismal 2018. We highlighted in Einhorn’s Greenlight Capital Had Impressive Gains in H1 how David Einhorn’s Greenlight Capital (GLRE) had a promising performance in the first half of 2019. Greenlight Capital gained 1.3% in June, which took the gains for the first half of 2019 to 18%. Greenlight Capital is focusing on fewer names and its highest conviction bets.
Back to the basics of investing
Bill Ackman’s Pershing Square is having an even better year with year-to-date gains of 45.3%, as per the fund’s performance report, which is a significant outperformance as compared to the S&P 500 (SPY), which has gained 6.4% in the first half of the year. The fund’s remarkable performance came after a series of disappointing years, with losses of 20.5%, 13.5%, 4%, and 0.7%, respectively, in 2015, 2016, 2017, and 2018, respectively.
In April 2019, Bill Ackman had attributed his fund’s comeback in 2019 to legendary investor Warren Buffett. As reported by Yahoo Finance, during a money manager conference in New York on April 16, Ackman said, “one of the most instructive things” in his career has been reading Berkshire Hathaway (BRK.A) (BRK.B) founder Warren Buffett’s legendary investor letters.
Contributors to the fund’s performance
A large contribution to Pershing Square’s outperformance year-to-date has come from Chipotle Mexican Grill (CMG). The stock has gained ~70% in the first half of the year. CMG accounted for 19.7% of Pershing’s total portfolio at the end of Q1.
Chipotle Mexican Grill
The impressive performance in the fourth quarter of 2018 and the first quarter of this year, and investors’ optimism surrounding Chipotle’s initiatives appear to have contributed to the rise in its stock price. Strong results and improving fundamentals have helped Chipotle outperform the broader markets YTD. Since Chipotle reported its first-quarter earnings on April 24, Piper Jaffray, BTIG, Wedbush, J.P. Morgan, Cowen and Company, and UBS have all raised their target prices.
Pershing Square has a strong conviction in CMG and the fund mentioned in its letter that it believes “Chipotle is in the early innings of its transformation, and that its robust pipeline of initiatives in the stage gate process, accelerated footprint expansion, and a world-class management team should drive superlative growth in sales and profits for years to come.”
Restaurants Brands International
Restaurant Brands International (QSR) was the fund’s second-largest position at the end of Q1, accounting for 17.8% of the portfolio’s value. Restaurant Brands is the parent company of Burger King, Popeyes Louisiana Kitchen, and Tim Hortons. QSR’s stock has increased by 33% in the first half, adding to the fund’s gains.
During its first-quarter earnings call, Pershing Square Holdings said it believes that while QSR’s stock price has appreciated significantly in 2019, “it’s very inexpensive relative to the business quality and its long-term prospect.” To put this into context, the fund further elaborated that QSR is trading at just 24x this year’s free cash flow per share, while its peers McDonald’s (MCD) and Yum! Brands (YUM) are trading in the high 20s despite growth rates that are lower than QSR’s. The fund believes that QSR’s opportunity to grow its unit costs around the world combined with its strong operational skills should allow it to see a high rate of growth over time.
Lowe’s (LOW), accounting for 15.2% of the fund’s portfolio, has returned 9.3% in the first half. While Lowe’s stock has underperformed the broader markets in the first half, Pershing Square is confident that Lowe’s is making progress toward closing its performance gap with its direct competitor, Home Depot (HD). Lowe’s is currently trading at a PE ratio of 17x, while Home Depot’s PE is close to 19x. The fund believes that Lowe’s valuation doesn’t reflect the company’s significant profit improvement potential.
Pershing Square’s other stock picks have also contributed significantly to the fund’s outperformance in the first half. Hilton Worldwide’s (HLT) stock has returned a market-beating 36.1% in the first half. Pershing is of the view that the company’s strong value proposition and business model should allow it to compound its EPS at a mid- to high-teen growth rate for many years to come. Also, HLT is trading at a PE ratio of 24x, which is a discount to its historical multiple, according to the fund.
Starbucks (SBUX) is up 30.2% in H1 2019. The stock hit a 52-week high in June after Credit Suisse raised it to “outperform.” Optimism related to Starbucks’s strategy to accelerate its cold beverage innovations and expand its delivery service, along with its strong earnings results in the first and second quarters of fiscal 2019, has led to a rise in the company’s stock price. Its Q1 results were also better-than-expected. Pershing Square Holdings thinks that Starbucks’ latest results lend further support to its belief in the company’s wide competitive moat and its long-term, high-single-digit revenue growth outlook.
Howard Hughes’s (HHC) stock has gained 26.9% in the first half. We highlighted in Howard Hughes Corp. Explores Strategic Alternatives: Stock Surges that HHC is exploring strategic alternatives, including a possible sale. Ackman, who controls 4%–5% of HHC, is fully supportive of the company’s plan to explore its options. In his first-quarter investor letter, Bill Ackman said, “Despite significant progress in HHC’s core business, project delays and initial losses at HHC’s Seaport District (New York City) continue to consume the majority of analyst and investor focus and may have contributed to the recent decline in the company’s stock price.” After the news of the company exploring strategic alternatives came out, the stock surged 37%.
United Technologies (UTX) is another significant contributor to Pershing’s gains. It has risen 22.3% in the first six months of the year. While Bill Ackman is positive regarding the company’s three-way split that happened in November 2018, he is not happy with UTX’s recent bid to merge with Raytheon Company (RTN). We highlighted in Bill Ackman and Dan Loeb Oppose UTX-RTN Aerospace Merger that according to the Wall Street Journal, Ackman wrote in an email to UTX’s CEO, Greg Hayes, that it “makes no sense to us why you would consider a stock acquisition using today’s massively undervalued UTC common stock to buy a large business of inferior quality to the company’s existing businesses, and for which we cannot comprehend the strategic logic.” Ackman also mentioned that if UTX pursues the merger, he would publicly oppose it and so would a “substantial majority” of shareholders.