Bill Ackman is the CEO and founder of Pershing Square Capital Management, a well-known hedge fund that started in 2003. Before working at Pershing, he co-founded with David Berkowitz Gotham Partners. At its peak, Gotham had around $500 million in assets.
Through presentations, investor letters, and just flat out tracking Ackman for a long time, we've gotten a great sense as to how Pershing manages portfolios. The first (and most obvious) point is that it manages a very concentrated portfolio. Its managers focus on the best ideas and typically on 8 to 12 companies while always on the search for other opportunities. They like to say they only need "a handful of new ideas per year."
Their main objective is to generate long-term returns while avoiding permanent loss of capital. But then again, those are pretty typical objectives for an asset manager. For the main funds, Pershing tries to avoid leverage but is not opposed to using options. And, that is the case in the Pershing Square IV fund, which invests in Target common stock and options. It likes to use options in activist scenarios where its influence can reduce the risk associated to the timing of options and generally use long dated, in the money contracts.
I center on businesses that generate good returns on equity while employing little or no debt. Highly leveraged firms are vulnerable during economic slowdowns. I believe that Bill Ackman also shares this view, that is why I consider it interesting to analyze his main picks in order to get good "seed" investment ideas.
Citigroup Inc. is a globally diversified financial services holding company that provides a range of financial products and services including consumer banking and credit, corporate and investment banking, securities brokerage and wealth management to consumers, corporations, governments and institutions. It has approximately 200 million customer accounts in more than 160 countries and jurisdictions.
In February 2009, Citigroup rearranged its businesses into three principal sections: Citicorp (83%), Citi Holdings (16%) and Corporate/Other (1%).
C's current net profit margin is 14.12%, higher that its 2010 margin of 12.24%. I like companies that increased profit margins in comparison with other years. It is essential to know the reason why that happened. Its current return on equity is 6.50%. Lower than the +20% standard I look for in companies I invest and also lower than its 2010 average ROE of 6.72%.
In terms of income and revenue growth, C has a 3-year average revenue growth of 14.94%. Its current revenue year-over-year growth is -9.52%, lower than its 2010 revenue growth of 7.87%. I do not like when current revenue growth is less than the past year. It generally shows that business is decelerating for some reason. The current Net Income year over year growth is 4.39%.
In terms of Valuation Ratios, C is trading at a Price/Book of 0.6x, a Price/Sales of 1.4x and a Price/Cash Flow of 2.5x in comparison to its Industry Averages of 0.8x Book, 1.9x Sales and 3.5x Cash Flow. It is essential to analyze the current valuation of C and check how is trading in relation to its peer group.
About Valuation, at present, Citigroup shares trade at 9.6x our 2012 earnings estimate, a 19% discount to the industry average. According to a price-to-book basis, the shares trade at 40% discount to the industry average. The valuation on a price-to-book basis looks appealing, given a trailing 12-month ROE of 6.3% that is 29% below the industry average.
Citigroup is currently in good financial health, with a tangible common equity ratio of 7.5% since Sept. 30 and an allowance for loan losses sufficient to cover more than 5% of its loan book. The firm is also now consistently profitable.
Family Dollar Stores (FDO)
Family Dollar Stores, Inc. , founded in 1959 and headquartered in Matthews, North Carolina, operates a chain of self-service retail discount stores in the United States offering general merchandise in four categories: Consumables, Home Products, Apparel and Accessories, and Seasonal and Electronics. The company trades in merchandise typically priced in the range from under $1 to $10. Since November 26, 2011, the firm operates a chain of 7,120 general merchandise retail discount stores.
In spite of a challenging macro environment, Family Dollar's strategic efforts to improve the merchandising, marketing, and store operations have resulted in sustained growth in the top and bottom lines. Management currently expects a growth of 8% to 10% in net sales and an increase of 12.2% to 20.2% in earnings per share in fiscal 2012.
The firm's sustained investment in the multi-year Project Accelerate initiative, focuses on category management, price optimization, merchandise financial planning, and assortment planning to help improve and optimize merchandising and supply chain processes. These efforts help to manage inventory risk and react promptly to the shifting consumer behavior.
FDO's current net profit margin is 4.54%, lower that its 2010 margin of 4.55%. I do not like when companies have lower profit margins than the past. That could be a reason to analyze why that happened. Its current return on equity is 30.97%. Higher than the +20% standard I look for in companies I invest in and also higher than its 2010 average ROE of 25.03%.
In terms of income and revenue growth, FDO has a 3-year average revenue growth of 6.97%. Its current revenue year-over-year growth is 8.65%, higher than its 2010 revenue growth of 6.30%. The fact that revenue increased from last year shows me that business is performing well. The current Net Income year-over-year growth is 8.46%.
In terms of Valuation Ratios, FDO is trading at a Price/Book of 5.0x, a Price/Sales of 0.8x and a Price/Cash Flow of 13.5x in comparison to its Industry Averages of 3.1x Book, 0.5x Sales and 9.2x Cash Flow. It is essential to analyze the current valuation of FDO and check how it is trading in relation to its peer group.
As regards Valuation, Family Dollar's strategic efforts to improve merchandising and store operations have inspired top and bottom line growth. The firm's point-of-sale technology and store realignment efforts are driving traffic. Besides, the company is expanding, as it accelerates its pace of new store openings. Still, going by the pulse of the economy, there's a belief that consumers will remain cautious on their spending, and focus more on necessities, such as food, which generally carries lower margin. I expect margins to remain under pressure in the near term, until the demand for higher-margin product categories picks up.
Family Dollar Stores present trailing 12-month earnings multiple is 17.6X, compared with 20.8X, the industry average and 14.3X for S&P 500. For the last five years, Family Dollar's shares have traded in a wide range of 11.7X to 20.9X trailing 12-month earnings. The stock is also trading at a discount to the rival group, based on forward earnings estimates.
Family Dollar is in sound financial condition. Since November, long-term debt amounted to $234 million. Earnings before interest and taxes were a comfortable 43 times interest expense in fiscal 2010. I think the company generates sufficient free cash flow to support its expansion.
Kraft Foods (KFT)
With its headquarter in Northfield, IL, Kraft Foods Inc. is one of the largest branded food and beverage companies in the U.S. and the second largest in the world. Its products include six consumer sectors: biscuits, confectionery, beverages, cheese, grocery and convenient meals. The firm sells its products in approximately 170 countries.
The company informs its operating results through three geographic units: Kraft North America (48%), Kraft Foods Europe (23%) and Kraft Foods Developing Markets (29%).
Cadbury Acquisition Boosting Growth: The purchase of Cadbury has also placed Kraft in higher growth geographies and categories. Cadbury has opened new sales channels for the company through its wide distribution networks in developing markets such as India, Brazil, and Mexico. The acquisition is estimated to generate annual cost savings of approximately $800 million by late 2012 exceeding the original target of $750 million. In addition, the company has derived revenue synergies of $400 million from the purchase until the end of 2011, while its goal is to generate total revenue synergies of $1 billion from the acquisition.
Business Split Beneficial: The firm plans to separate its objective snacks operations from its North American grocery business, creating two independent companies. I believe the decision will help the company expand its global presence, apart from giving investors a chance to bet on a snacks business that is growing fast in emerging markets, or opt for the stable dividends offered by a slower growing general grocery business that includes Oscar Mayer meat and Kraft cheese.
KFT's current net profit margin is 6.49%, lower that its 2010 margin of 8.36%. I do not like when companies have lower profit margins than in the past. That could be a reason to analyze why that happened. Its current return on equity is 9.93%. Lower than the +20% standard I look for in companies I invest in and also lower than its 2010 average ROE of 13.33%.
In terms of income and revenue growth, KFT has a 3-year average revenue growth of 9.04%. Its current revenue year-over-year growth is 10.48%, lower than its 2010 revenue growth of 26.97%. I do not like when current revenue growth is less than the past year. It generally shows that business is decelerating for some reason. The current Net Income year-over-year growth is -14.27%.
In terms of Valuation Ratios, KFT is trading at a Price/Book of 1.9x, a Price/Sales of 1.2x and a Price/Cash Flow of 15.0x in comparison to its Industry Averages of 3.6x Book, 1.1x Sales and 14.4x Cash Flow. It is essential to analyze the current valuation of KFT and check how is trading in relation to its peer group.
With reference to Valuation, overall, I'm encouraged by Kraft's strategy of continued cost management, price increases, expansion into emerging markets and maintained strong momentum from the Power Brands. Besides, the split of its North American business is believed to allow Kraft to focus on its distinct strategic priorities and allocate resources optimally. Nevertheless, it is still concerned about rising input costs and vulnerability to currency translations.
Kraft's shares currently trade at 15.2x our earnings estimate for 2012, a 64.8% discount to the industry average of 43.2.
While the purchase of Cadbury saddled the combined firm with a significant amount of leverage (with debt/EBITDA around 4 times), I do not believe the firm will struggle to honor its debt, given the solid cash flows it generates. Within the next five years, there's a prediction of a debt/capital ratio of 0.4 on average and earnings before interest and taxes to cover interest expense 3.7 times. The firm has stated publicly that it intends to remain a solid investment-grade credit, but I will analyze its credit rating when additional details surface on the capital structure of the individual units.
General Growth Properties (GGP)
General Growth Properties, one of the oldest and most experienced shopping center owners, developers and managers in the United States, has ownership interests in, and management responsibilities for, a portfolio of regional shopping malls in numerous states.
GGP's current net profit margin is -11.42%, currently higher that its 2010 margin of -51.00%. I like companies with increased profit margins in comparison with other years. It is essential to know the reason why that happened. Its current return on equity is -3.37%. Lower than the +20% standard I look for in companies I invest in but higher than its 2010 average ROE of -26.42%.
In terms of income and revenue growth, GGP has a 3-year average revenue growth of -6.55%. Its current revenue year-over-year growth is -2.85%, lower than its 2010 revenue growth of -2.01%. I do not like when current revenue growth is less than the past year. It generally shows that business is decelerating for some reason.
In terms of Valuation Ratios, GGP is trading at a Price/Book of 1.8x, a Price/Sales of 5.9x and a Price/Cash Flow of 32.5x in comparison to its Industry Averages of 2.9x Book, 6.9x Sales and 18.1x Cash Flow. It is essential to analyze the current valuation of GGP and check how it is trading in relation to its peer group.