Three Stocks Hedge Funds Love Right Now
Last week I introduced Stock Genius, a brand new iPhone app that tracks and publishes the top holdings of some of the world’s most successful hedge fund managers.
Each quarter, hedge fund managers are required by the SEC to disclose their stock holdings in what is called a 13-F filing. After a 45 day lag, these holdings are released publicly on the SEC’s website. If you are lucky enough to have a Bloomberg Terminal, check out FLNG<go> for a breakdown of these filings.
Stock Genius has been tracking the holdings of a select group of successful hedge fund managers for years. Each quarter, we publish the 10 stocks that these managers collectively like the very best. Since 2010, the holdings identified by our strategy have outperformed the S&P 500 Index by over 100% (269.9% versus 168.8%).
Yesterday, the holdings for the period ending on June 30th were released, marking the beginning of a new quarter for Stock Genius. To see our new list of picks, or all of our old picks and their performance, you can download the app here and start a 30-day free trial.
1. Alibaba (BABA)
Chinese E-Commerce giant Alibaba is up over 77% YTD, but that didn’t stop three hedge fund giants from adding brand new (and sizeable!) positions of the stock to their portfolios.
Julian Robertson’s Tiger Management disclosed a new 214,000 share stake in the stock, a position worth over $33 Million. This constitutes over 5% of the market value of Tiger’s long holdings.
Dan Loeb (Third Point Management), and David Tepper (Appaloosa) made even bigger bets on the company. Loeb disclosed a brand new stake of 4.5 Million shares, worth $700 Million or 5.6% of the market value of Third Point’s long positions. Tepper similarly disclosed a new 3.6 Million share stake which constitutes about 7.8% of the market value of Appaloosa’s long positions. (Yes, these guys manage a shitload of money).
It is unusual to see multiple managers take up brand new positions of this size, of the same security, all in the same quarter. This information became public yesterday, just a few days before Alibaba’s 2018 First Quarter Report which is due Thursday before the market opens.
According to Bloomberg, the stock currently has 45 buy ratings, 4 hold ratings, and 0 sell ratings amongst sell side analysts. That’s so one sided that its almost alarming, but obviously the analysts aren’t the only ones who think Alibaba’s momentum will continue.
2. General Motors (GM)
Throughout 2016, David Einhorn (Greenlight Capital) legged into a sizeable position in General Motors. Last quarter he added on to that position, and now owns a whooping 54 Million shares of the company, a stake worth over $1.9 Billion and over 30% of the market value of the long positions in his fund. Here he is discussing his GM position on Bloomberg:
David’s thesis is that the market is undervaluing GM, and that some clever financial engineering could unlock the value of the shares for stock holders. He even recently waged a very public and unsuccessful proxy battle to place three new members on GM’s board who were amenable to his plan to split the company’s shares up into dividend and growth components.
It’s worth noting that in late 2013, David’s firm took a similarly sized position in Apple (AAPL) making many of the same arguments about the stock that he’s making with GM now. He even took a proposal to their board advocating for the issuance of “preferred dividend” shares. Apple did not take him up on his proposal, but they did shortly thereafter announce a 7–1 stock split and a $130 Billion capital return program in April of 2014. Apple is up over 200% since this announcement (29.5% annualized).
It’s unclear what will happen with GM, but it does appear to be a solid value play with a great balance sheet and underappreciated earnings. When an investor like Einhorn takes out an almost $2 Billion stake in a company, it’s worth paying attention to.
3. Baxter International (BAX)
Two years ago, Dan Loeb’s Third Point Management disclosed a purchase of Baxter International, a healthcare company that sells medical products including IV systems, syringes, and dialyzers.
That position has grown substantially, and as of the most recent 13-F filing Third Point now owns 41 Million shares of Baxter. This stake is worth over $2.4 Billion and comprises over 22% of the market value of the firm’s long positions.
Loeb released a letter a few weeks ago to his investors in which he spoke at length about his Baxter investment.
Two years ago, we initiated a 9.9% position worth over $1.5 billion in Baxter (NYSE:BAX). An under-earner in the medtech industry with margins trailing its peers, Baxter was about to spin out its biopharma business, Baxalta. Shortly after the spin-off, Baxter’s long-time CEO announced his intention to retire. We believed these two major changes at the company presented an opportunity to create a more focused Baxter, cure its under-earning problem, and even make it an industry leader in operational performance — if the company took the right steps. Third Point’s Munib Islam joined the Baxter Board of Directors in September 2015. Munib also participated on the search committee that successfully recruited former Covidien CEO José “Joe” Almeida as Baxter’s new CEO starting on January 1, 2016.
Mr. Almeida’s sweeping changes to Baxter’s business over the past 18 months have created meaningful shareholder value. His tenure thus far is a case study on how leadership and cultural change can be transformational. Prior to his arrival, Baxter had guided to 2016 operating margins of 10%, growing to 14% by 2020. Under Mr. Almeida’s leadership, Baxter delivered 2016 operating margins of 13.6% and in May 2016, updated 2020 guidance to 17–18% operating margins. Due to continued strong operational performance, Baxter subsequently upgraded its 2020 guidance to ~20% operating margins on the Q2 2017 earnings call. The increases have been driven by multiple factors including:
•Cost cutting initiatives: Mr. Almeida instituted a Zero-Base Budgeting process that had immediate impact: SG&A spend declined over 10% in 2016 vs pro forma 2015 levels, while R&D spend also declined year over year in absolute dollars.
•Addition by subtraction: As part of an extensive portfolio review, Mr. Almeida made decisions to exit certain unprofitable product lines/markets and legacy R&D projects with negative expected value.
•Focus on high gross margin businesses: Baxter supplemented its generic injectable drug pipeline through three transactions and strategic partnerships (including the proposed acquisition of Claris Injectables). As the pipeline matures and products are approved, the high gross margin products will naturally improve Baxter’s underlying operating margin.
Baxter’s free cash flow generation has benefited from the improved operational efficiency. The prior free cash flow guidance was for $400 million in 2016 growing to $1.1 billion by 2020. Under Mr. Almeida, Baxter reported $ 935 million in 2016 free cash flow that is forecast to grow to ~$2.0 billion by 2020. Through the Zero-Base Budgeting process, the company has cut capex spending by nearly $200 million to $720 million in 2016 and forecasts continued reduction in capex through 2020.
In addition to continued margin expansion and improving free cash flow generation, there is renewed anticipation about how Baxter might deploy its pristine balance sheet. Since the spinoff, Baxter successfully monetized its Baxalta retained stake and currently sits at a zero net debt position; this contrasts with medtech peers who carry 1–2 turns of net leverage. Mr. Almeida has significant capacity to create value for shareholders through a combination of business development, share repurchases, and potential dividend increases.
Investors have clearly approved of Mr. Almeida and Baxter’s improved performance. Between January 1, 2016 and June 30, 2017, Baxter delivered a Total Shareholder Return (TSR) of 61%, nearly 3x the S&P 500 return of 22.4%. Despite the 18 month outperformance, Baxter’s forward EV / EBITDA multiple has remained largely unchanged at 12.5–13.0x; stock appreciation has been driven almost exclusively by an increase in Baxter’s underlying earnings power. Looking forward, we are confident that Mr. Almeida can combine operational efficiency with an unlevered balance sheet to drive continued earnings growth which — even absent any multiple expansion — should drive strong returns for Baxter shareholders.
The fact that Loeb hasn’t pared back his 22% stake in Baxter after two years of strong performance is a good indicator he’s confident the stock will continue to do well.