Pershing Square Holdings, Ltd. (ticker: PSH:NA) today released Semiannual Financial Statements including its Investment Manager’s Report to Shareholders. The report can be found below.
Pershing Square Holdings 2016 Semiannual Report
Dear Pershing Square Holdings, Ltd. Shareholder,
Below we provide PSH’s performance since its inception. The period of the last twelve months has been the worst period of performance by a wide margin since the inception of the strategy on January 1, 2004. Performance has improved substantially in the last few weeks with significant progress at Valeant and increases in the value of other holdings bringing year-to-date performance through August 23, 2016 to -15.S%.
We recognize that the last twelve months have been extremely challenging for PSH investors. As the largest individual investors in PSH and in the private funds that are managed side by side with PSH, we have also borne substantial losses. We are working diligently to maximize the value of our existing holdings and to identify new opportunities for profitable investment. I am encouraged by our recent progress and look forward to updating you with additional developments as they occur.
In the following Portfolio Update section, we discuss each of our portfolio investments in detail. You will note that our portfolio companies are demonstrating strong and/or improving performance which has contributed to their recent stock price appreciation. In light of recent stock price appreciation and the existence of other potential investment opportunities, we have elected to sell a substantial portion of our investment in Zoetis and all of our investment in Canadian Pacific which, when combined with a portfolio sizing adjustment to Mondelez, has freed up a substantial amount of capital for new investments. As a result, the majority of the investment team’s time is currently being spent actively researching potential new commitments.
The progress noted in the Portfolio Update below has begun to be reflected in performance. From the bottom (March 15, 2016) when PSH was down 26.4% year to date, NAV per share has risen from $15.42 to $17.70 (August 23, 2016), a 14.8% increase bringing year-to-date performance to -15.5%. PSH’s stock price has underperformed the increase in NAV as the discount to NAV (currently 14.9%) has expanded slightly over that time period. We are cognizant of the substantial discount to NAV at which PSH trades, which we believe has been driven by a loss of confidence by some PSH investors as a result of events at Valeant. We expect that our recent progress at Valeant, further increases in NAV, coupled with the identification of one or more new investments will contribute to the closing of the discount.
Below are the attributions to gross performance of the portfolio of the Company through June 30, 2016.
Pershing Square Holdings – Portfolio Update
Air Products and Chemicals, Inc. (APD)
Air Products’ recent quarterly results marked the eighth straight quarter of double-digit EPS growth as APD continues its impressive transformation under CEO Seifi Ghasemi and his team.
APD’s fiscal year third quarter earnings per share of $1.92 were up 16% while currency-adjusted EPS growth was 19%. These impressive results were driven by currency-adjusted sales growth of 4% and operating margins which were up 340 basis points (bps) to 23.0%. Sales growth was driven by 4% volume growth, largely due to volume contributions from growth investments, and flat pricing. Margins increased across each major operating segment, including each region for industrial gases as well as the non-core Versum materials technology business. We believe this broad-based operating improvement is a testament to the cultural impact Seifi has had on APD along with the benefits of the company’s decentralized operating model which has empowered local operating executives to drive performance and unlock the company’s latent potential.
On the strength of these strong results and its near-term outlook, APD increased the lower end of its fiscal year earnings guidance by $0.05 to $7.45 to $7.55, which at the midpoint reflects 14% growth over the prior year despite modest foreign exchange headwinds.
While APD has made significant progress improving its operating margin from ~15.5% to ~23% since our investment, and now has a consolidated operating margin in-line with best-in-class peer Praxair, we believe that APD has additional opportunities to extract operating efficiencies. Adjusted for non-core businesses, APD’s industrial gas margins remain substantially below Praxair’s. Management has provided guidance which suggests that APD can extract $225 million of additional operating efficiencies over the next three years.
The company remains enthusiastic about the growth capex opportunities for large on-site air separation units and hydrogen facilities. businesses in which APD has strong leadership positions. Seifi and his team are disciplined about investing capital in growth capex projects that meet appropriate return hurdles.
Air Products’ plan to sell and spin off its non-core materials technology and electronics materials businesses is also progressing as planned. Subsequent to its announced spin off of these businesses as a newly formed company named Versum, the company announced the sale of the materials technology segment of the business to Evonik for 16 times EBITDA, a price that will yield an attractive ~12 times EBITDA net price for Air Products’ shareholders after the company pays taxes on the gain from the sale of this business. APD is proceeding with the planned spinoff of the remaining electronics materials business in the coming months. The electronics business, which produced FY 2015 sales and EBITDA of $1 billion and $302 million, respectively, is a leading provider of materials and delivery systems equipment to the semiconductor industry and has strong secular growth prospects due to the proliferation of consumer electronics devices around the world. The electronics business has meaningfully improved its operating margins and competitive positioning under CEO Guillermo Novo and his team, and is well positioned to be a successful independent company.
Overall, we expect APD to continue to deliver double-digit EPS growth for the next several years as it extracts additional cost efficiencies, brings on-stream growth capex projects, drives organic performance, and allocates capital to acquisitions, growth capex or the repurchases of its shares in a manner which maximizes returns for investors. We believe the company’s long-term outlook remains robust and its shares remain at a discount to their intrinsic value.
Fannie Mae (FNMA) / Freddie Mac (FMCC)
Fannie and Freddie’s underlying earnings progressed modestly in the second quarter as their core mortgage guarantee businesses improved due to an increase in the guarantee-fee rate and lower credit costs. Their non-core investment portfolios continued to be reduced, which is leading them to a safer and more capital-light business model. As in recent quarters, reported earnings remained volatile due to non-cash-accounting-based derivative losses in the non-core investment portfolio. As a result of the derivative losses and the continued Net Worth Sweep, the companies remain at risk of being required to draw capital from the Treasury, as a result of the requirement to pay dividends to Treasury under the Net Worth Sweep of more than $125 billion in excess of the original 10% dividend agreement. As the risk of capital draws from the Treasury increases, we believe that Congress will become increasingly focused on seeking a permanent resolution for Fannie and Freddie.
In the litigation, the government recently released additional documents which