by Lawrence Meyers | August 31, 2011 6:30 am
I don’t often look to hedge fund managers for investment ideas, but when I do, I like to keep an eye on Pershing Square Capital Management’s Bill Ackman. Often, his presentations about why he likes one stock or another are available to the public. They’re not only educational, they can provide us with a great stock idea.
Late last year, Ackman purchased a large stake in Fortune Brands (NYSE:FO). The company manufactures, produces, and sells liquor, home and security products, and golf products. These include familiar brands such as Jim Beam and Maker’s Mark bourbons, Sauza and Cruzan tequilas, Kemper and Diamond cabinets, and Titleist golf products. Ackman believed the company would be worth more if the divisions were split into three separate companies. Fortune agreed with Ackman — or at least agreed with him enough to take a non-confrontational approach to his position. That shows real character in management. They heard what Ackman had to say and saw merit in it.
The golf business was indeed sold off for over $1.2 billion in cash. The liquor business will remain under the Fortune Brands umbrella, but with a different name. The rest will be spun off on Oct. 3. But before you think the story is over and that Ackman is done, think again. He just boosted his stake from 10.9% to 13.5%. He obviously believes that his stake in the individual entities will still be undervalued. How undervalued remains to be seen, but one thing is certain: Ackman rarely goes into an activist position unless he believes the upside is substantial.
The company rebounded from the recession very strongly, with gross profit up 10% between 2009 and 2010, and net income up 22%. Cash flow had always been very impressive at Fortune. Fiscal year 2008 saw free cash flow of $641 million, with FY 2009 generating $709 million, and FY 2010 $547 million. Although the numbers are inconsistent, they are healthy. Imagine what might happen when these companies get spun off and become more efficient in their operating structures.
Still, increasing commodity costs and new brand-building initiatives are challenging the company. Last quarter the spirits business did great, with sales up 11.3%, but those aforementioned costs cost the company dearly on operating income, which rose only 0.5%. Home and security revenues were up only 1.3%. Overall, operating income was down 14.8%.
Once Fortune splits up, finds the cost efficiencies in its new structure and executes its new branding initiatives, I believe value will be unlocked. The spirits business is a good business to be in. Despite heavy competition, the company owns some outstanding brands. The big jump in sales this past quarter bodes well. Home and security should also pick up as the economy recovers. We’ve seen companies like Home Depot (NYSE:HD) see solid increases as homeowners begin fixing up their homes and again as entrepreneurs buy and renovate distressed properties.
It’s tough to give an exact valuation until we see the respective financials of each new company, but Ackman is in big, and a company director also purchased shares at the same time. They both added in the low 50s. My guess is they think the company is at least 20% undervalued, judging by Ackman’s past purchases. That’s good enough for me.
Lawrence Meyers does not hold any stocks mentioned.
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