Pershing Square Holdings, Ltd. (PSH.L) Earnings Call Transcript & Summary

Hello, and welcome to the First Quarter 2024 Investor Call for Pershing Square Capital Management. [Operator Instructions] Today's call is being recorded. It is now my pleasure to turn the call over to your host, Mr. William Ackman, CEO and Portfolio Manager.

Thank you, operator. So welcome to our Q1 investor call. As usual, we distributed a legal disclaimer, which hopefully someone reads. And we're going to do our best to answer questions that we've received in advance sort of in the context of the conference call to the extent we don't get them during the call or at least the beginning part of the call, we have extra time, we will address this any unanswered questions separately. If we don't get to them then, please contact the IR team for -- to follow-up. I think relatively strong start to the year, Q1, plus really up to the present. Most significant events since our annual letter, which really covered a lot of the previous year and even the early part of the year history. As we actually added -- as you know, we sold our position in Lowe's, which freed up a fair amount of capital. We've reinvested those proceeds in now 2 new investments that we are not yet prepared to discuss. But I think it sort of speaks to what has been a somewhat idea rich environment for us in the context of markets, which on a headline basis have performed very well, really driven by a handful of very -- sort of mega cap tech companies, principally. And sort of beneath the surface, there's been sufficient volatility that I think has enabled businesses that we've tracked for some period of time to get to price levels that we find interesting. And to that end, we too reasonably full-sized new investments in the portfolio that we look forward to discussing perhaps by sometime next quarter. With that, why don't we just cover the events on a company-by-company basis. With that, maybe, Ryan, you can walk us through developments at Universal.

Sure. Thanks, Bill. Universal reported results earlier this month, and they continue their streak of reporting very good overall results. For perspective, the organic revenues grew about 8% this quarter. And the highlight was really the subscription and streaming business, up again about 12% consistent last quarter, which was a very good result. I think one of the more interesting data point, though, was they were able to expand margins very strongly. Part of that was due to the streaming business being the highest margin part of the business that performed better than everything else. At the same time, though, they're exhibiting very good cost control, which has been part of our thesis that allowed their EBITDA to grow at about 16% to the prior year, which is just a very strong result. I think one of the things that's interesting, if you step back a little bit and look under the hood, though, the results were actually in the business momentum is actually a little stronger than that. This quarter had very negligible results from TikTok as they were in the middle of trying to renegotiate a new deal after the prior one expired, which they did at the end of the quarter, but they did not really have the benefit of that revenue stream during the quarter. So the underlying momentum was a little stronger. And then secondly, as we've talked about on prior calls, the company announced a EUR 250 million cost savings program to be implemented over the next several years, EUR 75 million of that this year. The first quarter did not actually incorporate that. So we actually expect a continued cost leverage and cost savings in the future quarters. So we didn't get the benefit of either of those things, which will be in future quarters, yet we still got a very strong result. Very good financial performance, but I would also say, as we've talked about on prior calls, the company has done a very good job of really leading the industry on a lot of kind of the future things that will be very important, such as AI. So we've talked about they've developed an artist-centric model and really took the leap with Spotify for the industry and that and how that's been very beneficial to artists. But I think the TikTok deal, which they announced in conjunction with the earnings call at the beginning of the month, that's going to be a very big positive for the overall artist community and as a result, for UMG as well. And clearly, the deal that they've struck is going to allow them to better monetize their business with TikTok versus what it had been and helped over time, we think a lot of these services will be better monetized, as they get a little bit more advanced in their own ability to advertise the revenues. But most importantly, we really think this is about protecting the artists from AI. One of the dynamics that had happened on Spotify that was also happening on TikTok, is you get a lot of fake artist AI that is flooding the system and not allowing true artist content to be able to take its appropriate share of the royalty pool. And the deal with TikTok much like with Spotify is helping remove some of those headwinds for artists. And in particular, in TikTok, there has been a lot of AI that was coming on that was really taking advantage of the artist intellectual property and creating something through AI, which really was misusing the artist IP. And they've also in this new agreement been able to solve that. So I think in multiple deals now, we've seen partners of UMG, where they've taken the lead to really protect their artists. We think it's going to be very foundational for the future growth and making sure that as we get into this new digital world, artists are protected. And we think both artists and ultimately, UMG will benefit as well. Remain very pleased with the financial performance, but as well as strategically, a lot of the deals that they're doing with their partners.

Excellent. Why don't we jump to Chipotle. Anthony?

Sure. Thanks, Bill. So Chipotle is off to another fantastic start in 2024. Same-store sales in the first quarter grew 7%. That was really mostly driven by transaction growth of 5.4%. So virtually the entire comp came from transaction growth with minimal pricing. 5-year stacks growth or cumulative growth since COVID was 57%. That was up slightly sequentially from the fourth quarter and -- that represents a 9.4% compound annual growth rate since 2019. And management commented that the strength in the business has continued into April. Management raised their guidance only 1 quarter into the year for full year 2024 same-store sales from mid-single digits to mid- to high single digits. I think this speaks to management's confidence in the current business momentum continuing for the foreseeable future. If the current momentum continues, just based on kind of prior year comparisons, we think that management should comfortably be able to hit the high end of that range, so kind of solidly in the high single digits. Q2 looks like it could be in the double digits, given a 1-point tailwind from the timing of Easter, shifting into Q1 this year. Chipotle stores are closed on Easter. There's clear drivers of robust same-store sales for the rest of the year. One is continued share amongst all the income cohorts, so they continue to gain share amongst low-income consumers, high-income consumers, middle income. And we think that just speaks to the fact that Chipotle is offering a fantastic value for money. The company is very focused on improving throughput. That means getting customers through the line faster. And that's a combination of some operational training programs. They've been rolling out a live dashboard that lets the workers in the store to see how they're doing on throughput everyday kind of fosters the competitive juices amongst the team there. And then there's been lower turnover in the stores, which really helps with the efficiency of labor. The immensely popular Chicken Al Pastor store came back in March. It looks like that's doing really well again. And it seems that brisket is potentially on docket for the fall. The company did take pricing in California at the beginning of April, that's going to be a 1-point comp tailwind. So putting all that together, we think solidly in the high single digits is imminently achievable for the balance of the year. Given the company's powerful economic model, this robust same-store sales growth translates into very attractive margin expansion and restaurant margins were up about 185 basis points in the first quarter to 27.5%. New store openings are continuing at a robust pace, 8% to 9% is forecast for this year, and management believes that they can increase that growth rate to 10% starting in 2025, assuming the current construction and development headwinds don't worsen from here. So they don't need it to get better, they just needed not to get worse, which it's been kind of slowly improving very, very incrementally since COVID. Just stepping back from kind of the quarterly results. The pushback on Chipotle since we first invested at around $405 a share. It was that the multiple was high. It's interesting. High earnings growth buys down your multiple really quickly. So that $405 purchase price in the summer of 2016, was an entry multiple, about 35x our view of next 12-month earnings at the time. $405 now is about between 6 and 6.5x our view of next 12 months earnings. It just shows you how powerfully the multiple can be brought down with a business that grows rapidly. So how do investors kind of get this wrong in the stock 7.5x our purchase price from about 8 years ago. I think they missed 3 big things: one, underestimated same-store sales. So consensus has this tendency to assume everything will revert to a mean. And if you look beyond 2024, it's like, okay, the company is going to go to 5% same-store sales and maintain that going forward. And that's just wrong. I mean, in the 10 years prior to the food safety crisis, so -- 10 years ending 2015, the company averaged [ 80.8% ] annual same-store sales growth. And it's interesting in the 6 years that Brian Niccol has been CEO, that average same-store sales growth has been 8.7%. So this is a high single-digit same-store sales growth brand. Second thing that investors underestimated was the power of the economic model. So there was a lot of pushback when management introduced this 40% incremental margin framework a few years ago, lot of skepticism how they really hit it bubble bot. Well, it turns out they've delivered almost exactly at this level. So Q1 was right at 40%. 2023 full year was 42%, and the average over the last 3 years was 39%. So is that below 40%, sure. But I'll call it 40% just in the interest of funding. You look forward, consensus is forecasting kind of restaurant margins just flatlining in the 28% range. I don't think that's reasonable. The third thing that has been underestimated is unit growth. So our view -- the view kind of in the market of Chipotle store potential in North America when we invested in 2016, it was 5,000 store total addressable market. That's since been increased by management to 6,000 in October of 2020, then 7,000 at the beginning of 2022. 8,000 is the next step, we look forward to that. And growth overseas beyond the U.S. and Canada presents upside to that figure. None of our forecasts or kind of anticipations that I've mentioned to take into account massive upside levers that are potentially on the horizon. The most exciting to me being automation. So the company has various initiatives, including a machine that can cut core avocados. They have these dual-sided grills that can reduce the cooking time of chicken from 12 minutes to 3 minutes, something like that. And they -- perhaps most excitingly, they have a fully automated digital make line, which would ensure much faster throughput on the digital line as well as portion consistency, which would be kind of a big unlock. If automation is successful and they can push food prep from kind of 7:00 a.m. to 10:00 a.m. for lunch, I think that opens the door longer term to breakfast, which will be really exciting. And then as I mentioned, a large international success story beyond Canada is also not factored into our estimates. So we see kind of after this year, a very long runway of 25% annual earnings per share growth for this company. And that can produce some really attractive returns even from the current valuation, which is up nicely from the beginning of the year.

Very bullish take. What makes this a 8.7% or 8.8% same-store sales grow? In your past isn't necessarily prologue. What is it -- obviously, every restaurant brand, is it the uniqueness of the franchise, really the lack of a direct competitor, what's driving that?

Yes. So I'd call a few things. So obviously, they're gaining a lot of market share in the restaurant industry, right? And the way they're doing that is, first and foremost, I think it's fully aligned with how consumers want to eat. If you look at kind of traditional fast-food brands, most of them were invented in the 1950s. It was based on kind of dietary preferences at that time. Chipotle was invented in the '90s. We've learned a lot from the '50s to the '90s in terms of what's -- how to eat healthy, the importance of protein, the importance of fresh, whole ingredients, et cetera. And I think Chipotle is kind of hitting right on the mark in terms of how consumers want to eat and how younger generations especially want to eat. Secondly, I would call out the resonance of Mexican and Latin -- Latino culture in the U.S. is a huge powerful driver. You see that in music. A lot of the top artists are Reggaeton or Latino artists, which wasn't the case certainly 10 or 20 years ago. You see that in beverage alcohol. Tequila is one of the fastest-growing categories since then outgrowing kind of traditional categories like vodka has for a long time. So -- and you see that in terms of preference for spicy foods and kind of markets as well. So it's really fully aligned with how consumers want to eat. I think it is phenomenal, phenomenal value for money. So when you look at what you're paying for the quality of the meal that you're getting, and you know that there's only 53 ingredients in the entire restaurant. There's no kind of artificial preservatives or any junk added to the food. That's really hard to find at scale. And no one's been able to do what Chipotle does at scale and make it kind of good for you, good value for money and most importantly, great taste and craveable. I think there are some other concepts out their scale is way less. You're talking a few hundred restaurants, the food is not that craveable, it's not great value for money in terms of perhaps hungry, a couple of hours later. So all those things, I think, are reasons why Chipotle is just continues to gain a ton of share over time, and I think that's set to continue for.

One last question. You see the occasional meme on social media about portion size at Chipotle. Is that -- these are anomalies? Is it -- what's going on there?

Yes. Look, I think it's an interesting situation. The benefit to it is it's something that's imminently fixable, right? If there is -- it is likely more anecdotal than not. And I think because the food is freshly prepared and because it's not kind of like an assembly line making it, I mean you go into a Chipotle, and you watch someone make your bowl. It's a human being scooping rice, scooping chicken, scooping beans into your bowl. And there's going to be some inconsistency there. So I think there's probably a range in terms of -- is individual worker more or less generous than others. I've seen this myself, usually, the workers are very friendly and accommodative and willing to give you extra, is you say there's a little kind of light on the right, they'll throw some more and no problem. So I think what's likely happening is in that spectrum of kind of -- there's obviously some variation around portioning the smaller portion occasions are getting called out on social media, particularly in light of the substantial pricing that we've seen across the industry. So I think the good news there is it's a really easy fix. Management can reiterate the frontline, the importance of giving the true portion sizes. The company has definitely not changed their portion sizes. So it is not at all comparable to the shrink inflation that we see certain individuals in the country calling out like grocery stores were like. Obviously, if there's a package of OREO's and there's less OREO's in there, as an example, that's a conscious decision on the brand to change the portion size. There has been no change in the portion standards at Chipotle or the same as they always were. What I think is happening is there's a little bit of inconsistency in terms of execution, and that's going to be fixed. So...

Thanks so much. When we go to Alphabet, Bharath.

Sure. So it's been a little over a year since we initiated our position in Alphabet. And just as a quick reminder, our investment thesis was really predicated on one, the company's underappreciated competitive positioning in AI; and two, it's high earnings growth potential, which is backed by a large margin expansion opportunity and its robust capital return program. Google's results both this quarter and if you look more broadly over the last few months, it's a steady cadence of product innovation, continue to validate both elements of our investment thesis. So starting with AI, the company's leadership in this space was on full display earlier this month at their annual developer conference, Google I/O Day. The most exciting announcement at the event was the broad rollout of AI-powered responses for their core search product, which the company is calling AI overviews. And the early results from the introduction of AI overview has been highly promising, with management specifically calling out 3 very encouraging user trends. One is just higher frequency of search. So users who are shown these AIO results are searching more. Two, their conversions are much higher quality. So when they click through into websites from these AI overview results, they're spending more time on the website that they could click through into. And thirdly, their search queries are getting much more detailed. So if you look at the volume of search queries of 5-plus words, it's increasing at 1.5x the rate of much shorter queries. These early findings help counter a key bear concern around the company that get AI responses reduce the efficacy of search and reduce the potential for ad monetization. I think instead, what these results highlight is that thoughtful integration of AI not only enhances the user experience, but also paves the way for better ad monetization through more context-rich responses and higher quality, more frequent conversions and click-throughs. Equally importantly, the company announced that they're rolling out AI overviews to over 1 billion users around the world by year-end. That ambitious scaling plan is enabled by Google's unique technical infrastructure, which has been optimized for these machine learning AI applications for the better part of a decade and continues to improve very rapidly. So as a proof point, the compute cost associated with serving these AI overview results is down 80% from just a year ago. And when you look at the competitive landscape and look at peers and other upstart competitors, we think this deep technical expertise, combined with their wide distribution reach is going to be a durable competitive advantage that differentiates their ability to launch AI products at scale to over 1 billion-plus user bases. Now moving on to operating results. When the company's financial performance this quarter is very characteristic of its high earnings growth outlook. So revenue growth in both Search and YouTube accelerated to 15% and 21%, respectively on the back of a recovery in the broader digital ad market as well as, varied company-specific tailwinds like increasing adoption of advertiser automation tools on the advertiser end and YouTube's success in the connected TV format. On profitability, margins expanded an impressive 390 basis points this quarter as the company's headcount discipline and various cost control initiatives are starting to bear fruit. Looking forward, we think operating leverage in some of their underearning segments like YouTube and Cloud as they scale will be another powerful driver for continued margin expansion. And then finally, on capital return, they initiated a quarterly dividend of $0.20 last quarter, which equates to about a 50 basis point dividend yield. In addition to that, they reaffirmed their buyback authorization for $70 billion, which is -- which reflects another 3% reduction in their share count. So between the newly initiated dividend and their ongoing share buyback, their capital return program is yielding close to 4% of the market cap in a year. Stepping back, we're very pleased with the way the business has performed since we made our investment. The share price has nearly doubled from our initial cost, but we still think there's significant upside just from earnings growth and continued multiple expansion. So at today's levels, the stock is trading around 22x NTM earnings, which we think is a very attractive valuation for a business of that quality that can grow earnings at a mid- to high teens rate.

Just in the last couple of days, Musk announced that xAI raised $6 billion and an $18 billion pre-money valuation. Another -- and again, this is a in effect, a joint venture between X.com and Musk Enterprises, infinite ability to raise capital, and in fact, at a pretty attractive valuation, I would say, for a Series B pre-revenue company. What are your thoughts on the AI landscape?

Yes. Yes. So whether it's xAI or the rumored Apple OpenAI partnership or other the Bing OpenAI partnership that took way a year ago, this is a very nascent technology with a lot of transformative potential. So it's understandably attracting a lot of attention from investors and partnerships from the big tech companies. And we do expect sort of a cadence of well-capitalized competitors center of the space. I think what -- any potential when you entrants will really need to overcome certain very durable advantages that Google currently benefits from; one is scalability, and this goes back to my discussion on their technical infrastructure. And the company has spent almost a decade optimizing not only the hardware, right, including developing their own proprietary chips, but also the software and algorithms required to route these machine learning applications in the most efficient way possible, right? And the software innovation is not something that a capital -- large capital investment alone can overcome. So I think that's a pretty critical barrier to entry for other players. Two is, just their distribution and reach. I mean I think there's a big difference between serving 10 million or even 100 million consumers with a $20 per month subscription model versus serving 2 billion users with basically a free product for consumers that you've created an incredible advertising auction engine to monetize that platform, and Google has 6 different products with over 2 billion users each, right? So I think replicating that distribution will be another barrier to entry. And then lastly, just the brand and the trust the company has developed, right? The consumer habit of Googling has been ingrained for the last 2 -- more than 2 decades. And that's why even when Google has these occasional missteps, they can fall back on the -- the consumers give them the benefit of it's out and they can fall back on the trust that they've built over time, which other competitors don't necessarily have the benefit of. So we're monitoring the competitive landscape closely, but we're very optimistic about their longer-term differentiation.

Great. Thank you, Bharath. Charles, Hilton.

Sure. Thank you, Bill. So Hilton is off to a very solid start to the year. And I'd characterize this as kind of the first normal quarter that they've really had since the start of COVID. And so to that end, Q1 results featured 2% growth in revenue per available room or RevPAR, a 5.5% growth in net unit room count or NUG, as they call it, and exceptionally strong ancillary licensing fee growth for a combined revenue growth of 12%. Combined with strong cost control, adjusted EBITDA grew 17% year-over-year and earnings per share grew 23% year-over-year. Shares declined roughly 5% due to Hilton's best-in-class capital return program, which sees them repurchase approximately $3 billion of stock per year. And in the current environment...

What you say shares outstanding decline, not the shares declined?

Yes. Shares outstanding decline.

Okay, good.

Apologies. In current environment, what you're seeing is strong demand from both group and international and continued sequential improvement in the large corporate accounts with resiliency in the small- and medium-sized business accounts -- offsetting that, although in line with expectations, you are seeing some moderation in the leisure transient customer, which is normalizing from very high levels, which were affected during COVID really in the 2021 and 2022 period. And those are kind of normalizing into kind of a more steady state pattern. On the back of strong Q1 results, the company, they increased full year guidance. So overall, I'd say, it's a very kind of strong start to the year. And what I'd really kind of want to highlight and double quick is what this quarter remind me again is like how unique Hilton's business model is. And by that, I mean, even in the quarter, we saw a very modest RevPAR growth and minimal capital investment. Hilton is still able to generate exceptionally strong earnings growth. And this is really driven by their best-in-class net unit growth and strong growth in ancillary fee revenues. And so to double click on this, this past March, Hilton hosted their first Analyst Day since 2016. And to just spend a moment reminding everyone how unique Hilton's business is and kind of this economic flywheel that they've generated, which is really central to their ability to sustainably generate attractive financial returns. So again, what makes Hilton so unique? So first, Hilton owns, and with very limited exception organically has created best-in-class category killer brands, where they consistently meet their customers in every geography around the globe and in every price point. Second, they take these brands in this hard product, i.e., the hotels, and they wrap them as authentic and consistent hospitality and customer service experiences. That generates best-in-class customer satisfaction. And once you have best-in-class customer satisfaction, that translates very directly into customers affirmatively seeking out Hilton properties and brands and stay occasions and critically, this translates into an average RevPAR premium of 116%. So said another way, like-for-like, customers are willing to spend 16% more to stay at a Hilton property than a comparative chain scale, but unbranded or competitive branded property. And that's very, very powerful. So this RevPAR premium combined with Hilton's obsessive focus on value engineering hotel operations, drives best-in-class economics for the owner and developer communities. So as such, owners are enthusiastic to allocate their incremental dollar of capital behind Hilton's growing network. Now this dynamic in totality causes Hilton to have best-in-class net unit growth, which is roughly 6% to 7% over long periods of time, and this is a premium to its large competitors. They are truly unique in the scale at which they're able to grow their room count at that level. And this NUG growth rate of 6% to 7% that anchors a superior top line growth algorithm, which cascades into best-in-class financial performance for shareholders. So it's truly the -- this flywheel of economic activity, which generates best-in-class experiences, best-in-class unit economics, and then a best-in-class growth rate. Now at their Analyst Day, Hilton spent most of their time qualitatively coloring in how they create these authentic and unique customer experiences and why that translates into premium RevPAR indexes across the brand portfolio. I could go into great detail on this topic, but suffice it to say, we came away incrementally confident in Hilton's unique value proposition, both for its customers, but also for the owner community. And to that end, we continue to have great confidence in Hilton's ability to generate high single-digit to low double-digit revenue growth over the long-term, driven primarily by best-in-class net unit growth and ancillary fee revenue growth. In line with their excellent cost control, periodic releveraging of their balance sheet and best-in-class capital return, Hilton should sustainably be able to grow earnings at a mid- to high teens rate for the foreseeable future. And we continue to view Hilton as a best-in-class business run by an exceptional management team. The stock is currently up roughly 10% year-to-date for context.

Speak to the impact of a weakening economy on Hilton. Let's assume we find ourself in a recession as we turn the year -- after the election, let's say.

Sure.

How does that impact the business?

Sure. So I mean, this has kind of been a concern that has been floating out there for Hilton in particular, for probably about 1.5 years and the reality...

Actually, I would say longer.

Yes.

I remember when we bought the stock there was concern about the economy, and that's what enabled us to buy at a very attractive price.

Yes. And -- sorry, I'd say, in the post-COVID era, there has been a narrative that, okay, there's going to be a deceleration. There's going to be moderation. You are seeing that in pockets of their business right now. So leisure is kind of decelerating somewhat to a more normal cadence. Now offsetting that, if you take a step back aggregate occupancy is actually still slightly below or just right around where normalized occupancy would have looked like pre-COVID. So there's still other segments, namely large corporates and then the group business which has not fully recovered. Group this year is now, for the first time, set to exceed the pre-COVID period. And these are very long -- it's a small piece of the business, but it's a very long lead time. You plan a major group event, a major conference, you're planning at 1 year and 1.5 years out. So in the near-term, there are kind of locked in large conferences, large events, which will provide a tailwind for business. You also have this structural opportunity to continue to close the occupancy gap in the large corporate accounts. And then you've also had a number of years of ADR or pricing growth, which is actually slightly below or roughly in line with broad inflation, which should also, over time, be a tailwind to the business. So absolutely, there can be volatility in RevPAR, and we've seen this over time. Over long periods of time, RevPAR generally grows at a slight premium to GDP growth. And then what -- why we like Hilton so much is mathematically, even if you said, okay, RevPAR declined 1-year by 2%. If you have an algorithm where they can still grow net units by 6% to 7% and ancillary fees at 15% to 20%, which is what they're doing right now, you can still generate high single-digit revenue growth even in a year which would see a RevPAR pullback. And because they're so tight on their expenses, their cash expenses, you can get into an environment where even in a recessionary period or a modest recession, I think Hilton could generate earnings growth in the high single digit or even double-digit rate depending on the specific ancillary fee revenue growth and net unit growth in that particular year. So volatility, it exists in this industry. But over long periods of time, I think we're very confident in our ability to kind of CAGR into a mid- to high-teens earnings growth algorithm.

Thank you. Feroz, Restaurant Brands.