Bill Ackman (Trades, Portfolio), the billionaire founder and CEO of Pershing Square Capital Management, has built a solid reputation as an activist investor who bets big on his high-conviction stock picks. The guru famously shorted the stock market through credit default swaps in March 2020 just before Covid-19 wreaked havoc on global markets – a trade that netted Pershing Square north of $2 billion.
He is also known for maintaining a highly concentrated portfolio, which sets him apart from many other investing gurus, who invest in dozens of stocks to realize diversification benefits. Today, Pershing Square's investment portfolio is concentrated on just eight stocks, with Chipotle Mexican Grill Inc. (CMG, Financial) being the largest holding. The guru has been consistently increasing his ownership stake in Howard Hughes Holdings Inc. (HHH, Financial) this year despite rising interest rates that have threatened the earnings growth sustainability of the real estate sector. Ackman's vote of approval for the stock amid macroeconomic challenges calls for some scrutiny.
The business and recent financial performance
Howard Hughes is one of the largest premier property developers in the U.S., specializing in large-scale master-planned communities. The company's property portfolio is spread across multi-family units, communities, office space and retail properties, making Howard Hughes a real estate company with a wide reach across several end markets.
Exhibit 1: Portfolio snapshot
Source: Investor presentation
The eight communities developed by the company are spread across several affluent locations across the country, which helps Howard Hughes benefit from favorable demographic trends in key markets.
For the 12 months ended June 30, 2023, Howard Hughes reported net operating income of $243 million, a record high for the company. As it is one of the most important financial performance metrics that needs to be closely monitored by real estate investors, the company has done a remarkable job of growing NOI consistently after hitting a low in 2020 due to the unprecedented events that followed the pandemic.
Exhibit 2: Net operating income
Source: Investor presentation
The company's multifamily portfolio is performing exceptionally well, which is evident from the substantial rent increases enjoyed by these properties in recent quarters. As illustrated below, all the multifamily properties that were opened recently have enjoyed meaningful increases in rents, which is a testament to the strong demand for these properties even at a time when interest rates are rising.
Exhibit 3: Multifamily portfolio
Source: Investor presentation
The company's key retail operating assets – Hughes Landing, Downtown Summerlin and Ae'o Whole Foods – are all performing well with lease rates surpassing 93% in each of these properties at the end of the second quarter. In fact, Downtown Summerlin remained fully leased by the end of the quarter, highlighting the appeal of these properties to high-value retailers such as Nike Inc. (NKE, Financial) and Chanel.
Despite strong net operating income growth and the robust performance of the retail portfolio, Howard Hughes has failed to grow its revenue since the fourth quarter of 2022. In the second quarter, land sales revenue declined by 50% compared to the prior-year period, which was the primary driver of the decline in total revenue. Howard Hughes, however, has guided for robust land sale revenue growth in the second half of this year.
The long-term outlook is promising
One of the key factors influencing Ackman's continued investments in Howard Hughes could be the promising long-term outlook for the company despite being faced with short-term challenges. Growth will come from several avenues.
First, Howard Hughes is experiencing strong demand for its master plan communities, with significant home sales projected for the coming years. This strong demand suggests the company's land sales revenue will also recover in the coming quarters despite a recent setback. Commenting on this during the second-quarter earnings call, Howard Hughes CEO David O'Reilly said,"We delivered solid MPC EBT highlighted by continued strong land sales at attractive prices in our used in MPCs. We also saw a sharp increase in new homes sold, a leading indicator of future land sales providing increased confidence for robust land sales activity in the coming quarters."
Second, there is potential for continued growth from the multifamily segment, where the company reported strong leasing activity and record net operating income in the second quarter. Amid elevated interest rates, the demand for multifamily properties and offices remains strong, which is a good indication of what to expect in the next phase of the business cycle, where interest rates will decline sharply, boosting the growth of the multifamily sector.
Third, the company's condo business in Hawaii, called Ward Village, is seeing strong demand, especially for premium condos that help the company's margins. According to management, 92% of units were pre-sold before construction began, which is an early indication that Ward Village will turn out to be a revenue driver in the future.
Exhibit 4: Ward Village condo sales
Source: Investor presentation
Fourth, Howard Hughes has a few interesting projects in its pipeline that are expected to surpass a yield on cost of 7%, which include Victoria Place and South Lake Medical. These pipeline projects will contribute to the company's bottom line in the coming years.
Overall, the company seems well-positioned to grow sustainably in the next five years even if it ends up feeling the wrath of rising interest rates in the short term.
Howard Hughes is a well-managed business
When it comes to investing in real estate developers, one of the main risks facing investors is the massive debt burden accumulated by these companies to develop new projects. During times of ultra-low interest rates, real estate developers often accumulate substantial amounts of debt as they try to cater to the surging demand for new homes and other types of real estate. Howard Hughes is one of the few companies in this sector with a strong track record of exceptional balance sheet management.
Through strategic refinancing of debt at low interest rates between 2020 and 2022, Howard Hughes has improved its debt maturity profile by pushing the bulk of its maturities beyond 2027. This strategy will pay handsome dividends in the short term as the company will be able to weather a deterioration of net operating income and profitability without facing a liquidity crunch. According to company filings, 98% of debt is fixed or capped-rate debt, which adds a degree of stability for expected cash outflows to service the debt. With a weighted average debt maturity of six years, Howard Hughes is one of the few real estate development companies that enjoys a long-dated maturity profile.
Exhibit 5: Debt maturity profile
Source: Investor presentation
Over the last five years, Howard Hughes has taken several strategic steps to reduce its recurring expenses base while improving recurring income, which has led to strong free cash flow generation. This, coupled with the prudent management of its debt maturity profile, makes Howard Hughes an attractive bet at the right valuation.
Valuing Howard Hughes is tricky
Howard Hughes, with an attractive portfolio of assets in key markets and the backing of Ackman, seems well-positioned to grow in the long run. The biggest concern for an investor would be the difficulty in valuing this business due to the unpredictability of earnings in the foreseeable future. Unlike real estate investment trusts, Howard Hughes does not pay a dividend, which eliminates the possibility of estimating the intrinsic value using a dividend discount model. The cash flow volatility makes it difficult to value the company based on net operating income, and from a price-book perspective, Howard Hughes seems attractively valued at the current multiple of 0.99 compared to the five-year average of 1.28.
Takeaway
Howard Hughes Holdings is a well-managed company. On the back of a strong financial position, the company is expanding into new markets to ensure sustainable earnings growth in the future. Following Ackman into Howard Hughes seems a rational move for investors who are looking for stable, risk-adjusted returns in the next five years, but investors will have to weather some short-term volatility in stock prices resulting from the uncertain macroeconomic environment for the real estate sector.
