3 of Pershing Square's Top Picks

Madhukar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Pershing Square Capital invests in mid-cap and large-cap stocks of  businesses with little financial leverage. The firm also invests in low-volatility stocks. This investment style provides larger margin of safety, which is generally preferred by value investors. In this article, I am analyzing its top-three holdings as per the last 13F filed by the fund. Overall, these three companies constitute 67% of Pershing Square Capital's portfolio.

Company

Percentage Holding

Canadian Pacific Railway 

31.2%

Procter & Gamble 

21.32%

General Growth Properties

14.71%

An analysis of these companies will indicate if these top holdings provide strong investment opportunities.

Two major segments will generate high revenue

The bulk segment of Canadian Pacific Railway (NYSE: CP) is comprised of grain, coal, sulfur and fertilizer transportation. It is one of the company's largest segments, accounting for 41% of its total freight revenue in 2012. At present, the company transports 65% of the total grain produced in Canada. It is expecting  production increases of grains and oil seeds in Canada of 6% in 2013 and 2014 as the result of good harvests. These increases will raise demand for transportation, thus benefiting the company.

In April 2011, the company signed a 10-year contract with one of its top customers, Teck Resources, to supply coal. Tech Resources is expanding its production capacity and is expecting a sales increase of 2.5% to 24.6 million tons in 2013 and 5.7% to 26 million tons in 2014, benefiting Canadian Pacific. This year, it is expecting a rise in revenue of 7.9% year-over-year from its bulk segment due to increasing demand for coal and grains.

Canadian Pacific's merchandise segment contributes 34% of freight revenue. The main revenue producer for this segment is crude oil. Canadian Pacific supplied 53,000 carloads of crude oil in 2012, compared to 13,000 carloads in 2011. Increasing demand of oil transportation by rail is primarily due to inadequate pipeline infrastructure. The company is expecting an upsurge in crude oil production in the U.S. of 815,000 barrels of oil equivalent per day year-over-year to 7.2 million in 2013.

Further, Canadian Pacific Railway entered into a five-year deal with Phillips 66 and Global Partners. Since January, the company has been providing transportation services between these two companies. Canadian Pacific will supply about 50,000 barrels per day over the contract period. This will increase its carloads two-to-three times by 2015. The company forecasts 17.3% growth year-over-year in freight revenue from this segment this year.

Boosting investor confidence with strong dividends and emerging markets

Procter & Gamble (NYSE: PG) declared a cost restructuring plan worth $10 billion to be completed by 2016. This restructuring includes reducing its headcount and a reduction in its advertising budget by 10%. These steps were taken in order to offset its slow growth in developed countries like the U.S.

Under this initiative, it plans to expand its footprint in emerging markets like India. It recently announced a plan to invest up to $1 billion in India over the next five years to increase its product categories. The capital will be used to set up new plants and product marketing.

At present, Procter & Gamble hygiene and health care, Gillette India, and P&G home products together generate more than $1 billion of revenue in India. With these initiatives, P&G is expecting an increase of more than 20% per year in revenue in India.

The company has a long history dating back to 1890 of paying strong dividends. In April it declared its dividend of $0.60 per share quarterly, an increase of 7%. The company expects to generate free cash flow of $18.7 billion in the fiscal year ended June 2013 and $19.7 billion in the fiscal year ended June 2014. This compares with $18.6 billion in the year ended June 2012.

With the expected rise in cash flow and long dividend distribution history, the company is continuously gaining investors’ confidence.

Two revenue drivers will lead to higher market share

General Growth Properties (NYSE: GGP) is currently holding the portfolio of 140 assets in the urban areas of which 123 are malls. To increase its rental income, it recently bid on an expensive New York office building along with Brookfield Office Properties. The deal is expected to exceed $1.3 billion. The 27-story, 600,000 square-foot building is at the center of the city. It includes 20% for retail space and the rest for offices.

The rental fees on Madison Avenue were $1,509 per square foot in the first quarter of 2013 for retail stores, and $102.92 per square foot for offices. General Growth will increase its leasing occupancy up to between 92% and 93% by the end of this year through this bid. The company expects to raise its rental income to $857 million in the fourth quarter of 2013 compared to $771 million in first quarter of 2013.

Another revenue driver of the company is its ‘’Sears Redevelopment Plan’’ of approximately $572 million. Due to the rising demand for in-store leasing and departmental stores, the redevelopment plan is being executed. It has filed an application for expansion to add another center court at Ala Moana Center, along with 1,000 new parking stalls in an additional five-level parking structure located at the Sears store.

At present, the company generates net operating income of 10% from its Sears store and is expecting an increase in net operating income of between 8% and 10% on the additional redevelopment plan by 2015. It is planning to spend an additional $500 million next year.

Conclusion

The bulk and merchandise segments of Canadian Pacific Railway will accelerate company’s revenue in future.

Procter & Gamble’s entrance into developing countries will boost its earnings. Its long-term history of dividend payment will help it to gain investor confidence.

A new rental property and the redevelopment plan of General Growth Properties will increase its portfolio, thereby increasing rental income.

Therefore, a buy is recommended for all of these stocks.

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Madhu Dube has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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