Billionaire investor Bill Ackman (Trades, Portfolio), the founder of Pershing Square Capital, an investment firm with around $18.50 billion in assets under management, released his equity portfolio for the first quarter earlier this week.
He focuses on buying value stocks with strong brands, strong cash flow and growth opportunities. Ackman often embodies contrarian traits and is not afraid to bet against the consensus.
In the first quarter of 2023, Ackman loaded up on shares of Alphabet Inc. (GOOG, Financial)(GOOGL, Financial) and Canadian Pacific Kansas City Ltd. (CP, Financial).
In this discussion, I will take a closer look at the two companies. Let's dive in.
Alphabet
Alphabet (GOOG, Financial)(GOOGL, Financial) had an atrocious 2022 as advertisers pulled back on ad spending amid the forecasted recession. Given the company makes approximately 78% of its revenue from advertising, this was a major blow.
If things could not get any worse, Open AI launched ChatGPT on Nov. 30, 2022. This rapidly became the fastest-growing app in history and has over 1 billion users. To put things in perspective, Meta Platforms’ (META, Financial) Instagram, which was founded in 2010, has a similar number of users (1 billion), but it has taken it 13 years to reach that level.
Therefore, Open AI’s ChatGPT is truly a disruptive technology. And it is disrupting the company's Google search engine, as more consumers turn to it to make queries.
Microsoft Corp. (MSFT, Financial) then proceeded to invest $10 billion into Open AI and integrate its tools into its Bing search engine. This caused panic at Google's parent company, so it was all hands on deck in order to catch up with regards to release times.
Throughout this turmoil (from early 2022 to March 2023), Alphabet’s share price fell approximately 34% to around $90 per share.
I believe this is where Ackman (and many other investors) saw a contrarian buying opportunity.
Pershing Square loaded up on a staggering 8 million shares of Alphabet's Class C stock, which traded at an average price of $96.56 per share during the quarter. The hedge fund also snapped up 2.18 million shares of the Class A stock. Given the bias toward non-voting stock, I do not believe this was an activist investment, but a simple contrarian bet.
Since that point and Ackman’s average buy zone, the stock price has rebounded by roughly 25%.
Alphabet is also catching up to the competition, having recently launched its Bard platform. At the Google I/O day earlier this month, the company also announced a series of new features, which included the integration of Bard into search results and export features to Gmail and other Google apps.
Further, having published the original paper on the transformer model, of which all major large language models are built on, Alphabet is a pioneer in artificial intelligence. Therefore, the company is still in a strong position.
Financials
Alphabet reported mixed financial results for the first quarter of 2023. Its revenue of $69.79 billion surpassed analyst forecasts by $951 million. However, the company’s growth rate did slow down substantially from around 10% year over year in 2021 to just 2.6%.
This slowdown was mainly driven by the cyclical pullback in the advertising market, which is expected to be a short-term issue.
Its YouTube ads segment also faced challenges, with revenue falling by 2.56% year over year to $6.69 billion. Again, this was likely driven by the macro environment surrounding the advertising market. In addition, the company has faced challenges monetizing its short-form video content, or Shorts.
On a more positive note, Shorts have been extremely popular, with daily views reaching billions and increasing 80% year over year, according to the earnings call.
Google Cloud also continues to roar, reporting revenue growth of 27.6% year over year to $7.4 billon. I believe the opening of Bard’s API will help drive greater adoption of the service.
The cloud industry is forecasted to continue to grow at a 17.9% compounded annual rate and reach a valuation of over $1.2 trillion by 2027, according to data from MarketsandMarkets.
Therefore, as the third-largest provider in the industry, I expect Google to benefit from growth in the cloud.
Moving on, Alphabet reported $17.4 billion in operating income, which fell 13% year over year. The silver lining was this was driven by $2.6 billion in extra costs related to a reduction in office space and former employee severance. Therefore, this is likely a one-off impact for the company and not a long-term margin drag.
Valuation
Alphabet trades with a price-sales ratio of 5.44, which is 14.78% cheaper than its five-year average.
The stock also trades with a price-earnings ratio of 22.4, which is abouut 16% cheaper than its five-year average.
The GF Value Line also indicates a fair value of $146 per share based on historical ratios, past performance and analysts' future earnings projections. Thus, the stock appears to be modestly undervalued at the time of writing.
Guru interest
Apart from Ackman, many other iconic investors bought both classes of Alphabet stock in the first quarter. These included Ray Dalio (Trades, Portfolio)'s Bridgewater Associates Jeremy Grantham (Trades, Portfolio), Tom Russo (Trades, Portfolio) and Seth Klarman (Trades, Portfolio), among others.
Canadian Pacific Kansas City
Ackman also increased his stake in an extremely traditional company, Canadian Pacific Kansas City (CP, Financial).
Having completed a merger with Kansas City Southern in April, the railway company now operates around 19,200 miles of track, connecting many major cities and ports across Canada, the U.S. and Mexico.
The railway carriages transport a range of essential products, from commodities such as grain, coal and fertilizer to chemicals and automotive products.
In previous interviews, Ackman has stated he has learned a lot from Warren Buffett (Trades, Portfolio) with regards to his investment strategies. For example, Berkshire Hathaway owns Burlington Northern Santa Fe, which is the largest railway in the U.S. and operates 32,500 miles of track.
Buffett admires the timeless power and moat of the railway business, which is hard to compete with due to the huge capital expenditure required and permitting for the routes.
I believe Ackman may have followed a similar thought process with his investment in the stock. He purchased 1,000 shares during the first quarter, bringing his total position to 15.24 million shares. During the period, the stock traded for an average price of $77.21, which is only 7% higher than where the stock traded at the time of writing.
Financials
Canadian Pacific reported strong financial results for the first quarter. Its revenue of $1.67 billion rose by 14% year over year.
This is a positive given the somewhat recessionary environment, which one would expect would result in lower demand for goods.
Its operating income of $685.9 million increased by a fantastic 30.72% year over year.
This was despite its earnings per share of 63 cents missing analyst forecasts by 4 cents.
Its balance sheet includes $214 million in cash and short-term investments. Total debt amounts to $14.3 billion, of which $13.4 billion is long-term debt and, therefore, manageable.
Valuation
Canadian Pacific trades with a price-earnings ratio of 27.99, which is 8% more expensive than its five-year average. Further, the price-sales ratio of 7.85 is 4.59% cheaper than its average for the same period, while the price-book ratio of 2.64 is 60% cheaper.
The GF Value Line indicates a fair value of $63 per share. As such, the stock appears to be significantly overvalued currently.
Guru interest
During the quarter, Jim Simons (Trades, Portfolio)' Renaissance Technologies, Ken Fisher (Trades, Portfolio) and Keeley-Teton Advisors, LLC (Trades, Portfolio) also added to their holdings of Canadian Pacific Kansas City. Jefferies Group (Trades, Portfolio) entered a new position.
Final thoughts
Ackman is an incredible investor who is not afraid of making bold bets against the consensus. In this case, his bet on Alphabet appears to have paid off so far and still offers value relative to its historic multiples. Questions have been raised about the company’s competitive position in an AI world, but given its huge cash balance ($115 billion), it should be in a prime position to compete.
Canadian Pacific Kansas City is also an interesting stock. While its operations are completely different from a tech business, it offers a solid competitive advantage that cannot be eroded overnight.
I cannot help but draw parallels between Ackman's holdings and Buffett’s bets on Apple Inc. (AAPL, Financial) and leading railway BNSF. It looks as though Ackman may be following a similar strategy, albeit on a smaller scale.
