Bill Ackman’s 3Q18 Letter: Starbucks, Hilton, Fannie/Freddie

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  • YTD 11/13/18, NAV increased by 9.7% compared to S&P 500’s 3.5%

Starbucks Corporation (SBUX)

  • Purchased at an average price of $51/share
  • Built the world’s most valuable specialty coffee brand by first creating the category in the US and then expanding globally
  • Brand is synonymous with premium products and a high-end experience for both customers and employees
  • Operates and licenses over 29,000 stores that generate $35Bn in annual systemwide sales, with a roughly even mix of US and international locations as well as owned and licensed units
  • Specialty coffee category is secularly growing and attractive. It has a loyal customer base with a daily or greater consumption habit and trade-up potential, and a product that is well-aligned with health and wellness and sustainability priorities, which are increasingly important to customers
  • SBUX is the category killer with a wide competitive moat, underpinned by quality and innovation advantages over low-cost coffee and QSR players, with convenience, technological, and cost advantages compared with higher-end, boutique coffee shops
  • New SBUX stores have industry-leading unit economics, which we estimate generate a pretax return on investment of ~65% in the US and ~85% in China in their first full year of operations
  • SBUX is one of the rare mega-cap businesses with a long runway for reinvesting FCF at exceptionally high rates of return, as we estimate that every dollar the company spends on building a new store in one of its major markets is worth $10 to $15 after the store opens
  • Believe that the company should continue to grow its global store count at a high-single-digit rate for the foreseeable future driven by underpenetrated markets such as China where per capita coffee consumption is less than 1% of US levels
  • Phenomenal long-term track record with average annual same-store sales growth of 5% both in the US and globally, unit growth in the high-single-digits, and annualized total shareholder returns over the last 10 years of greater than 30%, more than double the S&P 500
  • Reported fourth quarter and fiscal 2018 earnings on November 1st:
    • US same-store sales grew 4% in 4Q, the best result in the last five quarters, driven by resurgence in SBUX’s core beverage category which contributed 75% of that growth
    • Also driving beverage innovation
    • Management guidance for fiscal 2019 projects same-store sales growth at the low end of its current long-term range of 3-5%, as well as underlying growth in organic revenue and EPS that is well within the company’s long-term targets of high-single digit and at greater than 12% growth, respectively
  • Management is acutely aware of the stock’s undervaluation and has implemented a large three-year share buyback program of nearly $20bn, shrinking the share count by 7% this past fiscal year and a further ~13% over the next two years

Hilton Worldwide Holdings (HLT)

  • Re-established a new substantially larger investment in Hilton during the recent market selloff
  • High quality, asset-light, high-margin business with significant growth potential led by a superb management team
  • Primarily franchises and manages hotel properties under more than a dozen hotel brands, including Hilton, Hampton, DoubleTree, and Hilton Garden Inn
  • Hilton’s extensive and growing network of brands and properties offers a significant and self-reinforcing value proposition to both guests and hotel owners, which creates a strong competitive moat around the business
  • For guests, Hilton provides a consistent and reliable experience in a large variety of destinations at divergent price points, as well as an attractive loyalty program with enhanced customer service, amenities, and awards
  • For hotel owners, Hilton provides access to its more than 80 million loyalty program members, large-scale marketing programs, reservation and IT systems, as well as supply chain purchasing power
  • Previously exited our position during the summer of 2017 to allocate capital to other investment opportunities. Since then, Hilton has grown its FCF/share by more than 30% due to a combination of strong RevPAR growth and net unit growth, margin expansion, a lower tax rate due to US tax reform, and significant share repurchases
  • Despite its meaningfully positive business progress and earnings growth, Hilton’s share price is only modestly above the price at which we sold it nearly a year and a half ago – while its valuation, due to increased FCF and reduced shares outstanding – is now 25% lower than before
  • While future RevPAR growth may decelerate from the 3% average achieved over the last couple of years, we believe RevPAR growth will remain positive. Unlike a typical hotel owner, Hilton’s high-margin, fee-based business model insulates the company from an outsized negative impact on profitability due to a slowdown or decline in RevPAR. Hilton’s pipeline, more than half of which is under construction, currently amounts to more than 40% of Hilton’s existing hotel rooms
  • At the current share price, Hilton is trading at only 20x our estimate of next year’s FCF. This is one of the lowest valuations at which Hilton has traded since the spinoff of its owned hotels and timeshare business at the beginning of 2017, significantly below our estimate of the company’s intrinsic value based on its high-quality, fee-based business model and strong future growth potential

Fannie Mae (FNMA)/Freddie Mac (FMCC)

  • Housing finance reform and the underlying businesses are performing well
  • Believe that result of US midterm elections make it incrementally more likely that the Trump administration will take the lead on housing finance reform
  • Treasury Secretary Steven Mnuchin has repeatedly cited housing finance reform as a priority for 2019
  • The first step in these efforts is likely the appointment of a new director of the FHFA, Fannie and Freddie’s primary regulator, when the current director’s term ends in January
  • We will be submitting a public comment letter on FHFA’s draft capital rules for Fannie and Freddie in November
  • On the legal front, we and other plaintiffs have filed papers opposing the government’s motion to dismiss 12 cases asserting an unconstitutional taking and related claims and, given delays in the briefing schedule, expect a decision on the motion in late 2019 or early 2020

Pershing Square Capital Management 3Q18 Letter, November 15, 2018

Image Source: Bloomberg

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