Welcome to our first quarter conference call. It's been an interesting year, for sure. I think for all of us. The story here is really not so much about Q1. Q1 fund was down about, system-wide, a little under 2%. Really, the excitement, if you will, is the period since the end of the quarter, and year- to- date, we're down in the low 20s for our biggest fund, and it was somewhat less, high teens in the smaller funds. What's driving that is really the mark-to-market performance of our portfolio. We're gonna spend, as usual, a lot of time talking about individual names in our portfolio.
I thought before we did that, it's sort of useful to kind of review what we try to do at Pershing Square and what we don't do. We are not a trading firm trying to position ourselves so that we're gonna outperform the market over the next three months, six months, nine months, even sort of 12 months. What we do is we look to find businesses that we think we can own for years, in some cases, decades or more, businesses that will compound their values at high rates, that are extremely durable and resistant to market, to you know, extrinsic factors we can't control, things like pandemics, things like higher interest rates, things like commodity price moves, sort of what we call super durable growth companies.
We assemble a portfolio, we become an important influential shareholder of these companies, and we help guide them to the extent they need our help, in becoming, even more successful companies, over time. What that means is we are not constantly shifting the portfolio based on what we think other people are gonna do based on short-term, events in the marketplace. That means the result of that is, while most of the companies we own come from the S&P 500, our portfolio compositions are different from the S&P 500. That difference is really what has enabled us over an extended period of time, you know, approaching our 19th year, to earn well above market, returns, over the period.
It also means that there are gonna be times where our variant portfolio is gonna underperform the market. Since the end of the quarter, energy stocks have done well, and historically we've owned no energy stocks. Again, we don't like businesses, which have exposure to commodity prices, that we can't control. But if we were a trading firm and we anticipated the move in, let's say, commodity prices, we would have sold out of our existing assets and bought energy stocks. If we thought banks would perform better because of interest rates going up, we'd buy banks. In fact, there's been very little drama in the portfolio. We own pretty much the same businesses we owned at the start of the year.
The most significant drama, if you will, was a relatively short-term investment in a company called Netflix, which we talked about in our letter. Unusually, I would say, it's about the fastest turnaround in a business we've purchased and a business we've sold about three months. That was a real loss. We did lose approximately 400 bps of capital, and that is a permanent loss. We do our best to avoid permanent losses. Although occasionally, they do take place. We actually view the decline in the market value of the rest of the portfolio as not at all a permanent loss, but more a function of kind of short-term or even, again, depending on how long this goes on, longer-term market dynamics.
In each case, our businesses, in our view, are increasing in value and have increased in value over the last three months despite a move in rates because of continued progress in their underlying businesses. The market's willingness to pay a premium multiple for some of these businesses has declined. Everything we owned at the beginning of the year we chose to own because we believed at the price the stocks were trading, we thought they would be attractive investments for us over the very long- term. I think what's going on from a general market perspective? You know, what's causing the decline? I think, you know, most people would point to three fairly obvious factors.
Perhaps number one on the list is uncertainty about Federal Reserve policy and the impact of that policy on markets generally. Our view here, which has been our view for some time, is that one, we would have very significant inflation, that two, the Federal Reserve would have to be very aggressive in raising the Fed funds rate to counter that inflation, and the impact would be a negative impact on markets. Part of our job we view is finding the great businesses that will withstand the test of time, compound their intrinsic values over time. Part of our strategy is to find what we call asymmetric ways to hedge unexpected market events, things like pandemics, things like financial crisis, and most recently an unanticipated you know rise in inflation and interest rates.
We began that effort in late 2020, early 2021 with a large notional, if you will, purchase of a bet against, or a bet that short-term rates would rise. We monetized a chunk of that investment for about $1.4 billion. I took a chunk of those proceeds and purchased Netflix, and then rebuilt most of them, I would say majority of that investment as quickly as we could, to and extended the maturity of that bet, because our view was, again, the Federal Reserve, despite steps toward raising interest rates and a change in tone, that there was a lot more to come. When you look at our performance year- to- date, you know, in the ending, you know, down 18%-22%, about 800 - 1,000 bps .
It would be 800-1,000 bps worse, if you will, if we did not have, you know, that hedge, if you will, in place. We've actually seen quite a dramatic average decline in our portfolio, offset somewhat, by this hedge on interest rates, which we have in place today. We are still strongly of the view that Federal Reserve policy is gonna have to get a lot more aggressive. We are seeing, you know, witnessing, reading the newspaper and, you know, by virtue of our often seat on the board of directors or our close understanding of the businesses that we own and following other companies in the market, that there is a, you know, inflation conflagration, if you will. There is a fire raging.
Unfortunately, we think the Federal Reserve has not been aggressive enough in putting out that fire. In fact, we are right now. One way to think about it is, you know, the entire neighborhood is on fire. You know, flames everywhere. Instead of the fire department coming out and putting out the flames, they are still actually, if you will, spreading gasoline around. That's when you have a Fed funds rate that's under 100 bps , that is a very aggressive, you know, monetary policy in terms of subsidizing the economy. The Federal Reserve is not talking about getting to a neutral rate until something like the end of this calendar year.
We have, despite the fire, we still have gasoline being poured on the fire, over the next six months, and that is something that we are surprised by. We think ultimately, the Federal Reserve's gonna have to take a much more aggressive posture. Otherwise, we're gonna find ourself in a you know something worse. You know, a holocaust-type fire. These conditions are, you know, really destructive to businesses. You're starting to see that effect when companies like, you know, Walmart, who we think of, one of the great businesses in terms of managing its cost and supply chain, you know, dramatically, you know, missing a quarter because of inflation, that's affecting their ability to control their costs.
You know, interestingly, the Federal Reserve, in trying to perhaps not impact markets and give a lot of visibility on their plans, has now, I think, the biggest risk. In fact, my view would be, Federal Reserve actually got aggressive at eliminating inflation, you know, stocks would stabilize and in fact, they might start to rise. But what's hurting us is a lot of uncertainty about, are we gonna find ourselves in a, you know, 1970s or very early 1980s environment where we're gonna need a Paul Volcker type response. And that is obviously something that market participants worry about. That's my soapbox on interest rates. We'll talk a little bit more about that, when we talk about our hedge position. But why don't we start. We're gonna go largest to smallest.
Our biggest investment is Universal Music Group. As we talk about each of these names, you know, think about the business in the context of the environment, and you'll have a good understanding of how we think about the company's durability. The only significant announcement we have from the firm's perspective on Universal Music is I'm delighted to announce that I was added to the board of directors of UMG. I've not yet attended my first board meeting, but I'm looking forward to being a member of this board. With that, I'll turn it over to Ryan just to give an update.
Sure. Universal continues to show very strong results. You know, in this last quarter, the company increased revenue by 17%, and that was against a similar increase of that magnitude in the prior year's quarter. Really very strong growth over the last two years. I think that really just reflects the tremendous execution of the management team, as well as a really strong industry tailwind in terms of the growth of streaming. We think that growth of streaming has a long way to play out really over the next decade.
Aside from the strong growth profile of the business, one of the things that we like about Universal and that we're really, we believe gonna see in this environment, is how much of a beneficiary the business model is from inflation and how well protected it is from inflation's downsides as well. Just to kind of frame this overall, one of the things that is unique about music streaming is our view is it is the lowest cost, high value form of entertainment that you can find. As a result, kind of the hourly cost for streaming is very cheap. The overall monthly subscription that you pay to, whether it's a Spotify, Apple Music or Amazon, is very low relative to other streaming services and just a lot of other forms of entertainment overall.
Given that inflation in the broader economy is running in the high single-digit rates, these companies have not taken pricing. We think it's very likely in the future that they may decide to take some pricing. Because Universal's effectively a royalty over the overall streaming revenues, any pricing that the music providers would take would flow directly to Universal's revenues.
To the artists.
to the artists as well. To that point, one of the things that we like about the business model structure is that its largest cost by far and away are the royalties that it does pay out to the artists. That is really just a you know percentage of the revenues, a formula, if you will. When Universal does better, its artists do better, but at the same time, that's its largest cost. When you think about typical businesses that have these inflationary cost pressures that they're trying to pass along to their customers, Universal's business is very different. It's a direct beneficiary of the prices and the growth in streaming. It shares those with the artists. Then the rest of its costs, which may be subject to that inflation, are a relatively small part of the business.
We think that overall business benefits from inflation on the top line, and its margins are likely to expand because it's not dealing with the same inflationary pressures on the bottom line. We think the company, you know, despite having a negative, you know, share price performance in line with the broader markets year -to- date, is doing tremendously well. It's growing very quickly, and we think we'll likely see perhaps even better growth in the future if the service providers, the Spotifys of the world, do take price.
One obvious question, particularly in light of our Netflix experience. Netflix is a streaming company. Netflix has experienced some competitive, you know, negative competitive dynamics. People, perhaps turning off Netflix versus other streaming services. Why don't you just cover that dynamic here? I think it's useful.
Absolutely. We think that the streaming model is, whether it's video or it's music, that has a long runway for growth. Both of those companies share, you know, that characteristic, and we expect that the streaming markets will be significantly greater in the future for both. One of the key differences that I think really highlights why Universal, the much more predictable kind of certain growth business is competitive position. In streaming, you know, one of the main differences is all the streaming players make their own content, which is expensive, and they put it out there on the network. As a result, if you wanna be a streaming customer in the video space, you're very likely going to have not just one, but several different, you know, providers. It's very different than music space.
Every one of the companies, Spotify, Apple Music, Amazon, they all have the same music. That music only comes from three players, and Universal is the largest. That creates a fundamentally different competitive profile. It's very unlikely that consumers will shop around for several services. Even if they did, because Universal's music is on all three of those services and they're the largest, Universal really is indifferent to which service the subscriber listens to. That is a much more competitively advantaged business model than Netflix. At the same time, it is much more capital-light business model, and therefore, you know, smaller changes in your view about how the market will evolve over time or the competitive share shifts have much less of an impact on the bottom line.
We think that this really does highlight why Universal is also a great streaming growth concept, but has just a very enviable competitive position in the overall favorable industry dynamics.
When you think about the hierarchy of sort of utilities that people turn off, right? I think they'll turn off. You know, someone might turn off their rent and move back in with mom and dad, but they're less likely to turn off their music subscription. I think that makes this one of the great durable growth businesses. It's also effectively a, you know, nominally levered company today, particularly when you monetize some of their non-core or where their on balance sheet assets. Basically an unlevered company growing in the high teens, revenues in the high teens, run by a superb management team, just becoming public. Some of those spin-off dynamics, I think, over time will play here.
Just in terms of size, this is a low 20s to mid 20s size investment on the absolute high-end of our kind of range of typical position sizes, but the business quality, its growth characteristics and the price we paid made this a position we wanted to make quite large. Next largest is Lowe's, kind of mid- to high teens, depending upon the fund. You know, Charles, obvious place to start. A lot of drama in retail earnings announcements. Lowe's seem to be above the fray. You know, why? Bring us up to date.
Sure. As it's kind of well documented at this point, the home improvement sector has experienced very robust demand since the start of COVID-19. The American consumers have really focused on the expanded role and the importance of the home in their everyday lives. In focusing on the macro, you know, I think that's obviously the question, with Lowe's and kind of retail broadly. What we're seeing right now is despite kind of a rapid rise in mortgage rates, which is very clearly weighing on Lowe's and Home Depot and other home builders, the narrative at least coming out of the sector and Lowe's and Home Depot specifically is they see a very supportive medium-term economic outlook, actually, which is really informed by consumers' enhanced focus and appreciation on the importance of the home. Higher home asset utilizations.
The more time you spend in your home, the more likely things are to break, basically. Continued strong home equity values. Despite rising mortgage rates, home equity values are still very, very robust and that continue to rise. Aging housing stocks. Homes are basically as old as they've ever been in the United States. You have this kind of decay curve where homes get over kind of 35 years old, they begin to become much more capital intensive to repair the home. Still very strong consumer balance sheets. Then lastly, I'd say there is a general lack of new housing inventory. On that last point, you know, it's actually fairly well documented that the U.S. has structurally under-invested in housing for the past decade.
We think there's good evidence that the current home improvement demand environment may simply be a reversion to something which more closely resembles a long-term historical average. If I kind of comparing contrasting Lowe's to broader retail, this is a category I think, which perhaps was under-invested for a long period of time, is seeing what I might characterize as a catch up towards a long-term historical average. Still by all accounts, has an extremely supportive macroeconomic backdrop. Look, that could always change, but there's really no indication at present that there's any kind of slowing for this category. You are seeing some mix shift underneath kind of headline numbers, you know, which we'll talk about a little bit more in a second. Focusing on their quarter, coming back to the results.
They reported negative same-store sales growth of 4% this quarter, which saw 20% growth in their pro customers, which was more than offset by declining transactions with do-it-yourself customers. That was really because you're growing over these really high comps in 2020 and 2021 during the height of the pandemic. Customers were staying at home and engaging in small projects around the house, and now you're seeing a shift from these small projects to larger renovations and remodel activity, which requires professional installation. In this quarter specifically too, I'd note, so March, they lapped over, as many retailers did, very substantial stimulus payments from the prior year period, which impacted March results. April was one of the coldest and wettest starts to spring in the last, like, 20-25 years.
There is some seasonality to this business where, depending on the precise arrival of spring, you know, spring for them is kind of their main category, unlike other retailers, which are more heavily weighted towards kind of the holiday season at the end of the year. For them, it's really that spring selling season. You saw some shift from Q1 into Q2 this year, which kind of pressured Q1 results, but management believes they'll entirely recover those lost sales, if you will, in Q2. Now just focusing on the strength of the business model, you know, notwithstanding kind of the headline sales decline, they very deftly manage through inflationary pressures at the gross margin line and drove significant operating leverage at the SG&A line, which benefited from improving labor productivity.
Unlike perhaps some other retailers too, what you're seeing is despite kind of high single-digit inflation, the consumer is basically accepting inflation entirely, and they're basically passing that through. Their gross margins actually rose substantially this quarter, which is somewhat anomalous to other retailers. Taken together, operating profit grew 2% and EPS grew 9% this quarter, which was aided by -8% in their share count. They bought back $4 billion of stock this quarter. Just to remind everyone, they're actually targeting $12 billion of share buybacks this year, which is 10% of the current market cap, which is pretty incredible.
That's with the balance sheet, with what kind of leverage, Charles?
They basically target kind of 2.75x net debt to adjusted EBITDA, which capitalizes the rent expense. They're still actually below their historical range, and they increased their leverage earlier this year to get back to something that more resembles their long-term targets. I'd say they're very well capitalized. They have a very defensive balance sheet. They also own the vast majority of their real estate. You know, I'd say it's a you know strong investment-grade credit. They have basically best-in-class capital return in the form of the buyback program.
Focusing on the demand environment and kind of our view on the outlook here, we think they're likely to see roughly flat sales this year as the market kind of consolidates and you see some of these mix shift dynamics that we previously discussed. That coupled with margin expansion and share buybacks, we think they have another year of accelerated double-digit earnings growth. We believe that over the next 12 months, they're likely to generate roughly $14 in earnings per share. They're essentially trading at 13x our view of next 12 months' earnings, which is the lowest multiple that Lowe's has traded at in the last decade.
The stock is down meaningfully this year, 29% to be precise, but that's entirely due to the multiple compression of roughly 35% and earnings have actually increased or expectations have increased since the start of the year. We think it's very cheap in the near term. In longer- term, we see continued line of sight for them to grow earnings off the current base at a double-digit rate as they close a revenue productivity gap and the percentage margin gap with Home Depot.
One thing you mentioned actually in our investment team meeting earlier last week was just the nature of the demographic of the customer, right? Essentially, Lowe's customers are homeowners.
Yeah.
They generally have fixed-rate mortgages, so they're very advantaged versus the typical Walmart customer, for example, may not own their home and has to face rising rents as well.
Yeah. The Lowe's, you know, as Bill noted, it's a homeowner by and large who's taking on small projects around the home. They're repairing things or engaging in remodel activity. It does skew to a slightly wealthier customer relative to kind of the median in the United States. You don't really have renters who are doing major renovation projects, obviously. To Bill's point on the fixed mortgages, both Lowe's and Home Depot got a question about this on their call. The concern is, okay, mortgage rates are rising rapidly and is that gonna suddenly pressure spend? You'll see two things there. One, both Home Depot and Lowe's would note that roughly two-thirds of the spend in the store or closer to 75% is repair and remodel activity.
It's basically just fixing things that are broken or taking on remodel projects. They're not quite as sensitive towards like the specific turnover in housing or how many homes start in a given year. They don't actually have that much product going into new builds, which is somewhat relevant. Then there's a dynamic too where if mortgage rates rise rapidly and you have a fixed rate mortgage, you're unlikely perhaps to buy a new home because you'd be resetting your mortgage at a much higher rate. In that scenario, you'd be inclined to stay in your current property and perhaps engage in a remodel activity. It kind of remains to be seen, but I think there's a strong counter-narrative here that rising mortgage rates may actually benefit this industry over the medium- term.
Great. With that, let's go to Anthony to talk about Chipotle. Maybe start with how much the stock price is down. The badge of honor.
Thanks, Bill. Yeah. Chipotle stock last I checked this morning was down about 27.5%, year- to- date, which is right in line with the Nasdaq. You know, that's I attribute that primarily to kind of the impact of the rising interest rate environment on, you know, high multiple stocks. You know, at the beginning of the year, Chipotle was trading in the high 40s as a multiple of forward earnings. Today, it's in the low 30s. So that's kind of most of the decline. You know, there was a. They did miss kind of consensus on margins for Q1, which I'll talk about in a bit. But it's really kind of a rising interest rate story in terms of the stock price decline because the performance of the business is just excellent.
In the first quarter, same-store sales grew 9%, year-over-year. That implies 32% growth on a three-year cumulative basis. What that means is basically since the pandemic began, the average sales per Chipotle store are 1/3 higher, which is just incredible performance on both an absolute basis and relative to their competitors. The second quarter, which we're currently in, is also off to a great start. You know, management is forecasting same-store sales for the quarter of 10%-12%, which implies a sequentially consistent three-year stack kind of in the low 30s. There's three key drivers of the current momentum. First, you have an ongoing recovery of in-restaurant sales as consumers kind of resume their normal routines. You know, in-restaurant sales were up 33% in Q1.
Despite that, digital sales only declined by 1%. What that shows you is the digital sales gains that Chipotle was able to layer on during the pandemic. A lot of that has proven sticky. You know, perhaps new occasions like dinner and other things. The mix of the business is now 42% digital, 58% in-store, you know, up from a 20/80 mix pre-pandemic. The second driver is price increases to cover inflation. Those increases are seeing very little resistance. You know, the Q1 comp of 9% was comprised of 10% price, 5% transaction growth, and a - 6% impact from mix.
That mix impact is really driven by the shift of the business back to a little bit more in store, a little less digital than at the height of the pandemic. Digital orders tend to more often be group orders versus individual orders that you see in store. The digital orders also carry higher rates of side attachment, like guac and queso. The third major driver here is a continued cadence of menu innovation. The current limited time offering, Pollo Asado, has been the most popular protein offering to date that's been launched by the company. The pipeline is just really exciting and robust. You know, they're testing items like Garlic Guajillo Steak and then several different dessert offerings.
They're on track to open between 235 and 250 new restaurants this year, which implies 8% net unit growth. You know, the 8% unit growth, 9% same-store sales, you know, this is one of the highest unit growth and same-store sales growth stories in the restaurant sector. You know, you're talking about a company that's growing revenue in the high teens, which is incredible. You know, the current challenge is really inflation, as it is for a lot of our other businesses. You know, we believe that Chipotle is one of the most well-positioned companies in the restaurant industry for an inflationary world. It is a premium offering. It's marketed based on food quality and freshness. They don't really advertise price.
It's fully aligned and on trend with how consumers want to eat. Real ingredients, robust flavors. It's customizable. It's planet positive. You know, zeroing in a little bit on how cost increases are impacting business. In the first quarter, you know, restaurant margins were 20.7%, which was down 160 bps from the prior year. This did not have the benefit of the price increase that they took to cover the commodity inflation that really drove a lot of that margin decline.
You know, not surprisingly, with the Ukraine war and other kind of causes of commodity inflation in the first quarter, Chipotle's cost of sales inflation was 12%-13%, and they didn't take the price increase to cover that inflation until the end of the quarter, you know, when they raised menu prices by about 4%. You have kind of a lag, which you see in the guidance that management has issued for Q2, when they're expecting a 25% margin. You know, up over 400 bps from Q1. You know, some of that is seasonality, but the majority of it is kind of the impact of flowing through that price increase.
Management also reiterated longer- term that a 27% margin on a full- year once average restaurant sales reach the $3 million level is still in play. Those average restaurant sales sit at just under $2.7 million today. The company's labor situation is actually excellent. You know, other companies in the space are experiencing labor challenges. Chipotle was experiencing some of that kinda last year. They did a big wage investment in June, and you know, since then have kind of gotten to staffing levels that are actually above pre-pandemic levels, which is really incredible. The current underlying wage inflation that they're seeing is only in the mid-single-digit range, which is quite manageable. The employees, you know, why do they love working at Chipotle?
You know, the wage increases have helped, obviously. But what's actually resonated most with employees is the career growth opportunities that are available at the company. When you have a company, excuse me, that's growing units by 8% per year, promotion opportunities are available broadly and rapidly if you're a top performer. That has really resonated, you know, with their people.
Thank you. Just based on your sort of opening comments, just want to describe how we value businesses generally by building a model of the future cash flows we expect the business to generate over time, and we discount those cash flows back into the present. The discount rate that we use to discount cash flows is not particularly what I would call market sensitive. We've generally used, you know, call it a 10% or so discount rate to discount cash flows regardless of the interest rate environment. We do that because one, you know, projections are inherently imprecise.
We build in a margin of safety, not just in the numbers that we put together for the business, but also in the interest rate, if you will, that we discount the cash flows back. That means that when rates rise, we're not embedded in our assumptions are the fact that interest rates aren't gonna stay low forever. While the stock market appears to have reassigned a much lower multiple to Chipotle at the multiple at which it was trading at the beginning of the year, based on our model, we still expect it to earn very attractive return. You know, high teens, twenties type returns owning this business over time. Obviously, the stock comes down 30%, our IRR goes up higher.
Nothing we've seen about the operating performance of the business suggests, in any way, that I would say our projections are off about the company. They're doing great and a tremendous credit to the management team. Hilton. Ryan, why don't you update us on Hilton?
Sure. Hilton continues a really impressive and dramatic recovery. You know, given this business was kind of at the eye of the storm of COVID. They've really taken their RevPAR, which is the industry metric for same store sales. It's less than 5% below where it was right before the pandemic. Our expectation is that they will exceed before the end of the year, they'll be higher than where they were in terms of RevPAR right before the start of the pandemic. That's based upon just the industry data we follow, some of the commentary on what management is seeing in the business. More broadly, when we look at other travel companies that we pay attention to, a lot of them are predicting that this summer will be the best summer ever for travel.
We think that not only will Hilton get back to, you know, its pre-COVID levels very rapidly, but we actually expect a lot of growth from those levels in the future. The business has recovered. In terms of the business model, I think, you know, we've talked a lot about the appreciation we have for its capital light nature and the high growth that it's able to achieve having other people build out units with, you know, the branding that Hilton provides. I think in an inflationary environment, the business model is all the more powerful. I mean, when you look at the structure of the hotel business overall, you really can't think of a business that is more kind of inflation protected in the sense that they reprice their product literally every day.
Hilton is a beneficiary of that overall industry structure. At the same time, by being a franchised business model, when its underlying franchisees take up price, Hilton is getting that benefit on the top line. At the same time, it's a capital light business that does not have, you know, the overhead, and the high degree of labor costs that the franchisees do. As a result, its bottom line is able to benefit. When you think about what Hilton went through in the pandemic, they significantly reduced their cost structure to allow them to stay cash flow positive for the majority of quarters during the pandemic. Now they found a way to operate more efficiently. Even their cost structure, while there will be some inflation, it's still gonna be lower cost than it was before the pandemic.
Our expectation is that in an inflationary environment, Hilton will be the beneficiary of higher pricing. At the same time, it should be able to keep its costs below where they were pre-pandemic. We're very excited about the earnings growth that should generate. Then lastly, in terms of the long-term characteristics, we've talked a lot about in past calls, how we like the fact that other people are putting up the capital to benefit Hilton's future growth, which, you know, generally units, they have grown at a 6%-7% rate over time. Due to some supply chain issues, it could be a little bit lower. They're targeting maybe a 5% rate for the next couple of years.
The benefit of that again is the returns for the franchisee who puts down the capital to build these hotels is still very strong, and Hilton is not being hit when commodity prices go up in order to build those hotels. We really think it just benefits the business significantly to have this a franchise business model. Now, that has not allowed the company. While the earnings growth is very strong, certainly the stock market has declined and as a result, Hilton has declined with it. It's down about a mid-teens% on the year, just slightly outpacing or beating the stock market. The great thing is the company is now buying back shares.
Based upon their expectation outlined in the recent conference call, we think they'll probably buy about 4%-5% of the company back this year, based upon the current market cap. Our expectation is that as the business trends improve, they'll get back to the historical levels where they've been buying back, you know, anywhere between 6%-9% of the company, over recent years before COVID. We remain really excited about the earnings growth, and we think that the business model will show even better, as inflation, if it does indeed continue at the current levels.
Sure. Just to add to what Ryan's saying, not only did Hilton, the parent company, figure out how to operate more effectively during COVID, but hotels have done the same. There's a lot of use of technology, no longer having to wait online to go find your room, you know, kind of the digital key and check-in, and even how people think about how often they want their rooms cleaned. All of these sort of benefits are enabling the hotels actually to improve their margins. So a franchise system only works if both the franchisor and the franchisee are doing well, and that is the case here. You wanna add anything about, you know, the future of business travel and, you know, the impact on the company and how we think about that?
Sure. I think at the beginning of the pandemic, that was one of the big questions that people struggled with was, in a world in which you can just Zoom, was there ever really any need to take a lot of those incremental trips? Our view has always been that those trips were very valuable and that Zoom could allow you to be more efficient, but that you wouldn't just decide to stay at home and Zoom with clients or Zoom with other colleagues, but rather you'd use that as something to supplement existing travel that you wanted to do. We're actually starting to see that come back. You know, Hilton actually, its leisure traveler is actually already back at very strong levels prior to the pandemic. What we haven't seen yet is a full recovery for the business traveler.
when you look at the results that the airlines are reporting and their expectations for summer travel, they think it's very likely that the business traveler is coming back. Our own experience suggests that that's also the case, which is you really wanna increase your high value travel, and you wanna save the Zoom meetings. We think that the productivity from Zoom is a great thing and will actually just allow for more high value travel going forward. We think that Hilton will be a real key beneficiary of that. That's still kind of like a loaded spring, if you will, that's kind of waiting to be released. We think that's kind of starting to happen, you know, right now and will be even stronger in the coming months.
Okay, great. Let's go to Restaurant Brands, Feroz.
Sure. Thanks, Bill. Restaurant Brands reported another quarter of improving performance in its key home markets, while its international markets continued their strong streak of performance. Tim Hortons in Canada is now only about 500bps below pre-COVID levels. Management provided guidance that leads you to believe that it should recover by the end of the year or at worst, by early next year. The company actually held an investor day focused on its Tim Hortons Canada business, where leaders from across the business showcased and shared some updates from their back-to-basics plan. On top of that, not only has Tim's maintained or gained share in hot beverages, breakfast foods, and baked goods, the company thinks they have a meaningful opportunity to expand their share in new product lines, specifically in cold beverages and afternoon foods.
The company highlighted several growth initiatives and believe that over the long- term, they can grow same-store sales by 2%-3%. At Burger King in the U.S., Tom Curtis, the new leader, and his team, continue to lay the foundation to return the brand to long-term sustainable growth. During the quarter, the company actually closed the gap relative to its peers by revamping its menu and actually also launching a simplified late-night specific menu, which actually allows franchisees to stay open longer and actually minimizes complexity. We believe the company has a meaningful opportunity to also modernize their store base, which a lot of their competitors have done. We look forward to hearing their plans on that later this year.
Elsewhere, Burger King International, Popeyes, and Firehouse Subs, their newest acquisition, continue to perform very well with double-digit comparable sales when you compare them to pre-COVID levels. When you look long-term, management's recent investments are also showing results. On digital sales at each of their brands are now at their highest levels for each of the brands, led by over 36% at Tim Hortons. The company actually highlighted some interesting stats at their investor day, where they said that digital guests spend four times more and visit a Tim Hortons location five times as much as a non-digital guest. That gives you a sense of the opportunity the company has by converting its guests to digital. In terms of unit growth, the company is also seeing broad-based growth in its international businesses.
They're also very excited about growing some of their smaller brands, both Popeyes and Firehouse Subs, both in the home markets as well as globally. Then obviously with the rest of our holdings, the impact of inflation is impacting both Restaurant Brands as well as its franchisees as they're seeing rising wages as well as input costs. With the help of the franchisor, the franchisees are taking pricing actions, they're reworking promotions, reducing item counts, and all with that, just very little modest impact on demand so far. We think with the diversified nature of Restaurant Brands' portfolio and the many levers they have in place, the company and its franchisees are actually fairly well-placed to combat inflation.
Also, you should note that the company's franchise-based royalty business model means that it's able to actually benefit when its franchisees take price, but that its cost structure is obviously not subject to the same inflationary pressures. The business model's unique attributes are actually particularly attractive in an inflationary environment like this. With all that being said, Restaurant Brands now trades at 16x next year's free cash flow per share, and that's among the cheapest the shares have ever been since the onset of COVID. Thankfully, the company is repurchasing and retiring shares at what we think is a pretty compelling valuation.
Thanks, Feroz. You're hearing a bit of a theme here. We like businesses that have royalty-like characteristics. Universal top of the list. You know, what's interesting here is the artist is really the franchisee in a way. The artist is creating the content in which we receive a royalty. You know, Hilton, a royalty on people staying in Hilton-branded hotels. Restaurant Brands, a royalty on people eating in our various concepts that are franchised by Restaurant Brands. What's interesting is we've always owned these businesses 'cause we like their inflation-protected nature, but we haven't lived in an inflationary sort of period of time. We shall see. We do think these businesses have very powerful economic characteristics and all these stocks are cheap.
I meant to give kind of relative sizes of all of our investments on the way down. Again, the low end of the range are our private funds. The higher end of the range are our public entity because it uses leverage. But call it 11.5%- 13.5% for Chipotle. Hilton is between 9%-13%. Restaurant Brands between 9%-12%. And now Howard Hughes position size about 9.5%-11.2%. And Ben wanted to update us on that business.
Sure. Howard Hughes actually also just had investor day in April, where they showcased their 2021 results, which was the strongest year in its history across all segments of the business. In its master-planned community segment, Howard Hughes produced record land sales in 2021 while recording high single-digit price increases in its communities. In its operating asset business, its net operating income reached all-time highs in 2021 with a roadmap to stabilize the existing portfolio with over $350 million of recurring NOI. In Ward Village, Hawaii, Howard Hughes continued its unprecedented sales pace, generating almost $900 million of sales proceeds. You put that all together, management provided an update on its internal NAV analysis, increasing its sum of the parts NAV to $170 per share versus today's price in the mid-80s.
That strong progress continued in Q1 this year, where it saw its MPCs grow sequential new home sales, but a decline in year-over-year levels, given it was lapping a very strong Q1 in 2021. In its operating assets, their multifamily and retail assets saw significant NOI increases was partially offset by a modest decline in its office NOI.
Despite increasing mortgage rates and inflationary pressures, Howard Hughes reiterated its guidance for full-year MPC EBIT and NOI targets. Howard Hughes also completed the sale of one of its last non-core assets, an office tower in Chicago, yielding net proceeds of $169 million on an initial investment of $13 million. Since announcing its transformation plan, Howard Hughes has now raised total proceeds of $570 million from its non-core asset sales. That extra cash, along with cash from operations, enabled Howard Hughes to buy back $280 million worth of stock year-to-date, or 5% of its outstanding share count.
I thought we'd also comment on the current environment and its potential future impact on Howard Hughes, and it's important to note that its MPCs are located in Houston, Las Vegas, Phoenix, Maryland, and Hawaii, all in growing and supply-constrained markets that have seen continued in-migration. Given that these residents are migrating to these communities from mostly higher cost states, rising mortgage rates and home prices have had less of an impact on demand in these communities.
Actually, I would say we've seen no impact on demand in these communities.
Yeah. They've done incredibly well. They're also differentiated from developers and home builders since they own a huge land bank, and they are not dependent on outside equity to fund development. Cash flow generation from its operating assets, MPCs and condo sales will serve to self-fund development opportunities on a case-by-case basis. As a result, Howard Hughes is never more than half a building ahead of demand, eliminating the potential to get caught in an economic downturn. That ability to be patient and control supply provides further insulation throughout economic cycles. Lastly, Howard Hughes has limited near-term debt maturities, with a substantial portion of its debt maturing in 2026 or later.
With 82% of its debt fixed or swapped to fixed rate and $688 million of cash on hand at the end of Q1, its balance sheet is really well-positioned. You put all these factors together, we believe Howard Hughes is constructed to withstand potential downturn and continue to thrive over the long- term.
I mean, if people get rich in real estate in inflationary periods, and the reason for that is they generally borrow money on a fixed rate basis, and they own hard assets. If you own hard assets in markets where there's increasing demand because people are moving to Texas or they're moving to Las Vegas or they're moving to Hawaii, you know, it's really good business. Now, this is a perennially cheap stock, and despite management having a fantastic year last year. What you've seen, at least in the first quarter of this year, I would say other than Lowe's, what percentage of the company did Lowe's buy back in Q1?
I think 8% share count reduction.
8% in Q1? Versus the end of the year or versus year-on-year?
Year-over-year.
Okay. Versus the end of the year. In three months, Howard Hughes bought back 5% of the company, right? This is, this wins as the most aggressive share repurchase program, at least in the Pershing Square portfolio.
They still have $124 million left to continue to buy back.
I think when you think about this company, I think their business plan at this point, our business plan at this point as a share of the company, is to grow the value of the company, generate a ton of cash, and to cancel the outstanding shares. Our goal is to own that last golden share, and we'll see. We'll see what it's worth. With that, Canadian Pacific, Manning, who has been on a call but not really presented in a call, this is her first opportunity to do so. But Manning actually wins the title for first work position she worked on is our best performer for the year. She deserves a lot of credit for that. Again, we're not trying to generate results over three months.
Tell us about Canadian Pacific. What's going on in the business? What's the status of the Kansas City Southern acquisition?
Sure. Thanks, Bill. We recently introduced Canadian Pacific in our latest annual letter. For the benefit of everyone, I'll give a quick summary of our thesis and why we like the business before touching on recent results. Beginning in late 2021, we reinitiated an investment in CP. As those of you who have been long-term PSH investors may remember, we first invested in CP back in 2011 and recruited industry veteran Hunter Harrison to lead a turnaround of the company. Under Hunter and his successor Keith Creel's exceptional leadership, CP became the best performing railroad in North America, more than doubling its operating margins over the last decade and growing organic revenue at an average rate of 6% over the last five years.
Since exiting our original investment in 2016, we've actually continued to closely follow the company, and we're excited to reestablish a position late last year during a pivotal time in CP's history. First, stepping back a little bit, we've always liked CP, and we believe it's an attractive business because it operates in an oligopolistic industry where the barriers to entry are very high due to considerable capital requirements, regulation, and network effects. CP provides a mission-critical freight transportation service that is often the cheapest or only viable method of transporting heavy freight over long distances, which gives the company significant pricing power.
We also believe that several secular trends will lead to accelerated freight volume growth in the future, including the share shift from trucking to rails, as well as the increased probability of significant investment in North American onshoring and energy production due to the current geopolitical environment and the resulting unwind of globalization. In addition to these attractive industry dynamics, what makes us even more excited about CP is its transformational acquisition of Kansas City Southern, which closed in December of last year. This combination actually creates the only transcontinental railroad with a direct connection from Canada through the U.S. all the way to Mexico, connecting six of the seven largest metro regions in North America in one direct route. This will obviously provide unparalleled service to shippers, and also lead to significant revenue and cost synergies.
Given the CP management team's track record of best-in-class execution, we also believe that they will make significant operational improvements at KCS. As a technical matter, CP currently owns KCS through a voting trust, which entitles CP to full economic ownership, but does not permit full operational consolidation until the merger receives regulatory approval, which management expects to happen in early 2023. Despite our belief in, you know, CP's high-quality business model and our belief that CP's already industry-leading growth profile will be greatly enhanced by the revenue and cost synergies from the KCS acquisition, CP's shares have recently traded at a discounted valuation to both historical and peer levels. Some short-term investors are likely standing on the sidelines waiting for the KCS transaction to receive regulatory approval before investing.
This actually created an attractive entry point for our investment, which we took advantage of given our long-term investment horizon. Moving on to recent results. Q1 was very challenging for CP, with revenue down 6% year-over-year due to a perfect storm of extremely cold weather in Canada, Omicron-induced staffing shortages, and a labor strike at the end of the quarter. However, we were actually encouraged by many data points from the results that continue to reinforce our thesis. Firstly, pricing remains robust at CP, with the company renewing contracts at an average rate of over 6%. Rails are actually good assets to own during an inflationary environment, because in addition to the strong pricing power, rails are able to pass on increases in fuel and other expenses directly to customers via fuel surcharges and CPI escalators built directly into contracts.
High fuel prices also disproportionately increase the cost of trucking, which is a main competitor to rails, as trucks are three times less fuel efficient than rails and should help rails gain share. Secondly, the geopolitical environment has actually created new business opportunities for CP and should help the railroad return to positive volume growth this year. For example, Canada is the world's largest producer of potash, which is a key component of fertilizers, and produces nearly 40% of the world's supply, while Russia and Belarus combine to produce another 40%. With supplies from Russia and Belarus disrupted, Canada is stepping up to fill the supply gap, and CP is the Canadian potash industry's most important transportation method.
Lastly, the KCS acquisition remains on track to receive regulatory approval by early 2023, and management is actually proactively planning for synergies by running proof of concept trains and actively engaging with potential customers. In summary, we're excited to reintroduce CP as a core position and see line of sight to double-digit free cash flow growth and share price appreciation closer to our estimate of fair value as the company integrates and realizes synergies from the KCS acquisition.
Great. That was a great presentation. Just to update you on position size, it's from 6% in the private funds to 10% for our public entity. In our 13F, this position is reflected as a smaller position because we still own the stock, bulk of our position through a forward contract, which we intend to exercise. With that, I'm gonna turn it over to Feroz. Domino's Pizza looked great. It was one point up 50%-60% from our purchase price, and now we're right back to, you know, made a round trip. What's going on?
Round trip is, unfortunately and painfully, a good way to put it. Domino's share price is actually now-
Maybe we should become a short-term trader.
For this one, we probably should have. Domino's is actually down 40% for the year, and the company actually now trades at just about where we actually began accumulating our position, and obviously the business has grown in value since. We find it quite compelling here. Why is the stock down? The decline year- to- date is driven by, one, both the market-wide sell off in high growth and high multiple stocks like Domino's and issues specific to Domino's as well, specifically a slowdown in same-store sales due to driver shortages and lapping stimulus payments that we've all been speaking about. Two, a hit to the company's profit margins due to inflation and rising costs in its commissary business.
The good news, Bill, is that Domino's has a very long history of defying skeptics and outperforming following very brief periods of weakness, and we think this time is gonna be no different. On driver shortages, the company is conducting a full assessment of the driver labor market and looking for ways to change the job to make it more appealing and flexible to get that labor back. The company actually saw sequential improvement in its delivery service metrics each month this year, and nearly half of the store base actually have better metrics now than it did at the same point last year. Management feels confident enough in their ability to return to acceptable staffing levels that they're actually gonna run their famous Boost Week campaign this summer, which the company actually hasn't run since Q1 of 2020.
It's important to note that Domino's has a supply problem, and it's not a demand problem, the latter of which is much, much more difficult to solve. Carryout same-store sales are still up 24% prior to pre-COVID levels, while delivery sales are only up 6%, which highlights where the issue is, and that's really due to driver shortages. Elsewhere, they're also working on increasing sales and franchisee profits by optimizing their pricing structure. The company recently refreshed its core national Mix & Match offering, and took the delivery offer price from $5.99 - $6.99, and also added a couple new products to that offer. This should be a several percentage point tailwind to same-store sales for the rest of the year.
Given other fast food peers have taken substantially even more pricing, we believe there's ample room for Domino's to increase prices across the menu. The company is also working with third-party call center providers to facilitate outsourced phone ordering and lower the burden on its in-store staff. Lastly, now that Omicron is slightly behind us, the company is mandating a return to core operating hours for all its franchisees. Like Restaurant Brands, the vast majority of Domino's profits are from franchisees. While it's feeling some impact of inflation in its commissary business, most of its P&L is actually relatively protected, and in fact benefits from inflation as the company's franchisees raise prices.
At the same time, as a franchisor, you need to ensure profitable growth for your franchisees or the business arrangement doesn't make sense, which is exactly what the company is doing. Franchisee health among Domino's franchises in the U.S. is still excellent, with average EBITDA per store of $174,000 last year, which is up 22% from pre-COVID levels. We think they're much, much better positioned than other systems to handle this cost inflation.
On the management side, Russell Weiner took over as CEO officially at the beginning of the month, and we are very optimistic about his abilities to reinvigorate growth, given that he was actually one of the chief architects of the pizza turnaround campaign back in 2008, and is a big part of the reason the company has been able to average basically 7% same-store sales for the subsequent 12 years. With all that being said, Domino's now trades at just under 24x our estimate of forward earnings, which is a significant discount to its historical multiple and actually pretty compelling given its historical strong track record of execution. In the meantime, the company continues to repurchase shares consistent with its very long-standing policy of returning all the excess cash flow to shareholders.
Great. Thanks so much, Feroz. Why don't I just briefly cover Fannie and Freddie? I think the important thing to think about with Fannie and Freddie is that the principally common stockholders of the company, we are the residual claimants. While nothing of note has taken place in the last few months in terms of the prospects of Fannie and Freddie reemerging as true public companies, the residual claimants, the stockholders, you know, these are two of the most profitable businesses in the world. I mean, combined, they're one of the most profitable businesses in the world. As a result, they're rebuilding capital very, very rapidly. At end of quarter, we're up to $85 billion, Anthony?
Yeah, $83.5 billion combined, yeah.
$83.5 billion of capital on a path to get to the minimum capital thresholds that were set, you know, during the Trump administration. We patiently you know, think of this as the, it's a lottery ticket in the drawer, but it's one that's enormously profitable, and just with the passage of time, will get to a level where they can. It won't be a lot of controversy on distributing them back to shareholders. Pershing Square Tontine Holdings. We are now about 60 or so days away from the two-year clock on Pershing Square Tontine Holdings. When we look at what we set out to accomplish when we launched Pershing Square Tontine, you know, we took this entity public in July of 2020.
That was as a result of a process we started in April of 2020 to take this business public. Our thesis at the time was, COVID is gonna disrupt the capital markets. You know, the SPAC idea is a good idea. The structure is, you know, fairly horrendous and creates all kinds of negative costs and consequences for their owners. We can design a better mousetrap, and we'll have a uniquely attractive entity. We're gonna use it to find a business that meets our very high standards, and we'll be, if you will, the only game in town by virtue of the scale of the entity if someone wants to go public by merging with an acquisition company. We worked hard to identify a target.
We came on to the Universal Music situation, which was controlled by Vivendi, and we spent eight months working on a transaction that had lots of twists and turns, principally driven. We started out with the, you know, goal of doing a merger, a more conventional SPAC transaction, but a series of tax and other legal complexities at Vivendi caused us to have to restructure the transaction in a less traditional, but we believed completely permissible fashion. We went down the process to get the transaction approved both by our shareholders, which I'm quite confident we would have gotten nearly 100% vote, and also by, of course, our principal regulator, the SEC. Unfortunately, the SEC, if you will, held us up.
They did not like the structure of the transaction not being a conventional merger. They had concerns about the Investment Company Act and other issues which we felt we had adequately addressed. In light of the requirement that we close the transaction in a relatively short period of time and the fact that it was basically a certainty we were not gonna get through the SEC process during that period of time, the board of Tontine elected to abandon the transaction. We at Pershing Square agreed to assume the transaction costs and an indemnification liability to Vivendi. We were, you know, happy for Pershing Square to acquire a stake in Universal for all the reasons we talked about today. Obviously, quite disappointed on behalf of the shareholders of Tontine.
Way we structured the assumption of the contract, we did it in a way to put Tontine in a position to do a transaction as promptly as practicable. We've had some hurdles along the way, since that the failure, if you will, of the Universal transaction. Among them, kind of litigation brought by a group of, I would say opportunistic plaintiffs, which is not great for our ability to do a transaction. Then really, I would say the demise of the SPAC industry, sort of generally where the word SPAC became, if you will, a dirty word, and the performance of every SPAC that did or nearly every SPAC that did a transaction. Actually, I had Feroz do some analysis. Why don't you tell us what the results have been?
Sure. Not great, to be short. If you look at all the SPAC mergers that have closed since the beginning of 2021, over $100 million SPACs, there's about just over 200, and more than 95% of them trade below their SPAC IPO price. You can count on two hands the ones that actually trade above $10, so created value for shareholders.
Buy below, it's not just, you know, 10%.
Yeah. The median is, you know, they've destroyed 50% of value.
Right. I would say the typical, in a way, as we predicted, you know, the nature of a structure with bad incentives and high frictional costs lead to bad outcomes, for investors. You know, what we committed to our investors in Tontine was we would only do a great deal, and we continue to want to only do a great deal. We've seen lots of mediocre transactions. We've seen transactions of good companies at the wrong price. We've seen some really interesting situations, but where there isn't a sufficient amount of time to consummate a transaction by the time of our date. We are still working, you know, until we run out of time to see if we can complete a transaction.
What I can assure you is if we do a transaction, it will be a great one. If we don't do a transaction, we're simply gonna send people's money back. We've received a number of questions from shareholders. Do you intend to extend the clock or seek shareholder approval to do so? The answer is only if we are able to close a high-quality transaction within that timeframe, as evidenced by our signing a transaction sometime over the next 60 days. Any investment banks who are listening, what I would say has happened in a fairly dramatic fashion in the last few months versus when we started. What we didn't anticipate when we launched Tontine is how strong the capital markets, the equity capital markets would be.
Our competition, for a SPAC of our size, you know, for Airbnb and all the various companies that we, sort of engaged with, was the traditional IPO market. In a hot IPO market, we were not gonna be competitive on price. What I would say right now is we have the opposite of a hot IPO market. It's an ideal environment for us to have an entity like this one with the amount of capital it has. Again, we're still looking for a very, very high quality, super durable, long-term growth company. Most of those companies have the flexibility to pick their moment, when they want to go public. This environment is one where many of those businesses, and perhaps most, would say, "You know what?
We'd rather wait for sort of a better market environment. If we do a transaction, we make some progress over the next 60 days, it's going to be a company in a special situation where it's important for them to get a transaction done with certainty in a short period of time. The one thing I can, just to clarify, while really no other SPAC can give certainty, we can. We can give certainty on going public, and if every other shareholder redeems, you have Pershing Square's minimum commitment of $1 billion and flexibility to go larger. That's still, even at $1 billion, a pretty decent sized IPO, certainly in this environment.
Now beyond that, as most of you know, we developed a sort of better mousetrap, if you will, for a SPAC, with Tontine, but there were still some negative elements. One of them which we're experiencing today is the fact that we have a two-year clock in which to identify a transaction. The other problem is we're holding on to people's money, and this is certainly the opportunity cost of people's capital has gone up significantly. Obviously, we can't get a deal done, we're gonna send people their money back. For a number of investors not having that capital invested up until now, that money can be put to work on very attractive terms.
Our SPARC entity, which we are pushing forward with, gives us basically we're gonna distribute subscription warrants, so-called SPARS, to our existing Pershing Square Tontine Holdings shareholders. If we wind up Pershing Square Tontine Holdings, we will take that shareholder list, and we'll distribute. Once this entity gets its registration statement approved, we will distribute SPARS to those shareholders. They will have a 10-year term. They'll have flexibility in the strike price. They won't have underwriting costs. There won't be any shareholder warrants. Each of these are things that make the entity, even our current entity, less attractive. We did, as you know, our first approach was to get the SPARS listed on the New York Stock Exchange.
Unfortunately, the SEC, we needed an approval of a modification or of a new rule for subscription warrants to be listed. The New York Stock Exchange loved the structure, came up with a rule to satisfy the SEC's concerns. In the midst of that process, the SEC launched its own revision of the SPAC rules, a several 100-page rule modification. Our sense is they're in that environment of working on fixing SPAC rules, they didn't wanna create a new rule for a new form of acquisition company.
Our alternative approach is to go to the OTC markets, where Fannie Mae and Freddie Mac trade, to list our subscription warrants, and we are in the process of revising the registration statement to reflect that change, plus some other improvements, and we're gonna expect to refile that prospectus with the SEC, hopefully in the next couple of weeks. That really speaks to the equity portion of the portfolio. Now, in light of the fact that our interest rate swaptions have become more material, I thought it'd be useful for us to go into a little more depth on a mark-to-market basis now that our equities have declined in value and our best performer for the yield are our swaption contracts. They now represent between 8.4% and 11% of the funds.
With that, I'm gonna turn it over to Bharath just to give an update. Go ahead, Bharath.
As Bill had previously mentioned, we have a large notional short position on primarily shorter-term treasuries in the form of payer swaptions. Taking a step back and echoing what everyone on our team has already addressed, we believe current economic conditions are in unprecedented territory with regards to both inflation and the tightness of the labor market. Starting with inflation, overall CPI is up 8% year-over-year, and on a core basis, excluding the impact of food and energy, is up 6% year-over-year. Both of those figures are running at 40-year highs and are continuing to run rate at a mid- to high-single-digit rate on a month-over-month basis. If you look under the surface of those headline figures, there are a number of noteworthy trends that suggest to us that inflation will continue to remain elevated.
One, inflation is increasingly being driven by services consumption, which accounts for 70% of the core index. This is in contrast to what we saw in the middle of last year when we first started seeing elevated signs of inflation. Back then, the most significant contributor was from the goods category, and it was much more concentrated in items like used car prices, where you could argue which were impacted by, you know, idiosyncratic supply chain issues. Fast-forward to today, inflation is much more broad-based, and you're seeing it play out across a broad swath of services consumption categories, where price increases tend to be more persistent and less volatile. Secondly, we believe one of the largest components of the CPI, shelter inflation, which accounts for a third of the index, overall index, is significantly understated.
The CPI report registers shelter costs increasing 5% year-over-year. Compare that to most market-based measures of home values and rental prices that are published by Zillow and Redfin, which show a high teens, +20% year-over-year. Because of the lagged nature of how rising housing costs get reflected in official inflation measures, we believe shelter inflation will continue to be a key contributor to overall inflation in the coming months. Finally, and perhaps most importantly, we're starting to see the widespread nature of price increases start to take root in the form of consumer inflation expectations increasing.
Two of the most widely followed studies on future inflation expectations, which is the University of Michigan Consumer Sentiment Index and the Philadelphia Fed Survey of Professional Forecasters, both of those studies have consumers' outlook for the next 5 years of inflation rising to over 3%, and that's risen dramatically over the last few months. All these data points suggest to us that, you know, inflation is unlikely to moderate in the near term, at least not without a significant monetary policy response. You turn to the employment picture, and we believe we're in an extremely tight labor market today. Our unemployment rate is at 3.6%, which is only ten basis points over its 50-year low of around 3.5%.
There are twice the number of job openings as there are the level of unemployed persons, which is the highest the ratio has ever been since the data on job openings was first collected. That significant supply-demand imbalance in the labor market has effectively translated into mid-single-digit-plus wage inflation across almost every single sector of the economy. Right? Despite this economic backdrop on both inflation and the labor market, the current Fed funds rate is still at 83 bps today, which is well below what the neutral rate is. The neutral rate is effectively the theoretical Fed funds rate where monetary policy is neither accommodative or restrictive, which the Fed currently estimates to be around 2.5%. Interestingly, when you
Which could be low.
Yeah, exactly. It's a theoretical estimate, so it's you know, until we see.
Which is likely low.
Yeah
I would say.
Yeah. What's interesting is when you compare the current economic context to prior tightening cycles, since the end of the Volcker era and since the '70s, inflation has never been this high, both on an absolute and on a core basis. The unemployment rate has never been this low, and the starting point of the Fed funds rate and monetary policy has never been this accommodative. In his recent commentary, Jerome Powell has fully acknowledged the sense of urgency of doing whatever it takes to control inflation, which he views as getting to the neutral rate as expeditiously as possible, beginning quantitative tightening, and then considering going well beyond the neutral rate until inflation moderates in a convincing manner over a several-month period.
The market has priced in some of the Fed's forward guidance, but we don't believe that current forward rates fully reflect the extent of tightening that'll be required to moderate inflation over the long- term. As the market continues to reprice its expectations, we believe our swaption position could still materially increase in value from here.
Great explanation. Good summary of economics. Just briefly, obviously, we sold Netflix during the quarter and, you know, wrote you a letter about that. I think the most important points to emphasize here are, we're not perfect. We make mistakes. The key in our business when you make a mistake is to recognize it as early as possible. We did, I think, save a fair bit of money for Pershing Square by exiting Netflix early.
You know, I think we've summarized in a little more depth, and actually kind of running out of time in the call, but the high level here is, after our investment, we learned new information that was, I would say, inconsistent with the original thesis that led to the band of outcomes for Netflix being much wider than we kind of had originally underwritten. That made it something not appropriate for a Pershing Square core investment, and that led to the sale. Wish the company well. We hope and expect ultimately they'll be successful. We like to own things where we have a very high certainty factor, and hopefully you've heard today about those businesses. Let me just go to the questions, and we're past our normal time. Obviously, feel free to hang up.
We won't be offended, but you know, in light of the last few months, it's certainly. We want to get to the questions. On Netflix, a couple questions on Netflix. I really make reference to the letter that we sent about the company. Chipotle, at the $1,800 price range, why were you still hanging on to Chipotle? Why you sold at like $800 and other levels before? The case with Chipotle, we sold pieces of the investment over time, not because we didn't have confidence in the business's success, but rather really for portfolio management reasons, which means the business stock did so well, it became a disproportionate part of the portfolio. We sold when it got to be excessively large, which is why we took.
It wasn't so much taking profits as really just reducing the relative size of that investment to others. We didn't sell at $1,800 because the position size at that time we thought was appropriate. At $1,800 a share, let alone at today's price, we envisioned over a long-term basis earning a high rate of return. How do you see the inflationary environment impacting profitability of the portfolio? I think we covered that. Can you explain the investment thesis for CP? I think Manning did an excellent job with that.
Fannie Mae, Freddie Mac on the takings claim, you know, I think we're not going to speculate on, you know, I would say in my view, I don't know if it's the firm's view, but certainly my view, if what happened at Fannie Mae and Freddie Mac, if that's not a taking, then every business in America should be afraid, right? What happened here was the government after the fact, outside the original contract, stepped in and changed the terms of their preferred stock in a manner which expropriated 100% of the profits of the business going forward. That to me is a regulatory taking. If the government gets off on a technicality, it's unfortunate, but we're not betting on that in our investment here.
Again, we think the passage of time ultimately will yield the right outcome. Interestingly, however, when the Administrative Procedure Act case was in front of the Supreme Court, a number of the justices said, "Why isn't this a takings claim?" I agree. We'll see what happens there. How are you thinking about holding your interest rate hedges because they've appreciated substantially? You could lose significant amounts if the market thinks the Fed may reverse course on interest rates. We do not see a scenario in which the Federal Reserve reverses, i.e., starts lowering rates from where they are now.
We think that I think it's highly near certainty probability the Federal Reserve is going to raise rates at a pretty aggressive clip over the next, you know, between now and the end of the year. If interest rates are raised less than we expect, we could lose some money in the hedge, not a ton. If they're raised more, which is what we think the most likely outcome is, we can make an attractive return, and we still think the investment is sufficiently the risk of the downside case versus the reward, if you will, of the upside case is sufficiently tilted in our favor that we maintain the investment.
We think there is a meaningful chance the Federal Reserve has gotten it wrong, is not as aggressive as they should be, and we find ourselves in a frightening inflation scenario, where they need to raise rates much, much higher than people expect. That, we think, has a pretty negative impact on markets. You should think about this, in some form it's an investment, but in some form, as with, you know, it's really a hedge. The benefit of protecting ourselves from that really adverse outcome, plus the inherent investment elements, make it a hold here. Despite the legal problems with Tontine Holdings, given the asset values have declined substantially, theoretically, the cash pile of Pershing must be extremely attractive here.
The answer is yes, but it has to be a great business at a price that makes sense, and they have to be willing to do a transaction in this environment. Are you concerned at all that you may have a very exposed flank in the case of a U.S. recession, given you would likely take a hit in your swap position if the Fed rows back on rate hikes in addition to your heavy consumer exposure in equities? Again, I think we spent a fair bit of time talking about why we feel very comfortable with the inherent consumer exposure in our equities. Just a couple thoughts on that. You know, the value of a business is the present value of the cash the business generates over its life.
Over the next 25, 30, 40, 50 years of Chipotle, for example, there are gonna be, you know, a number, probably a recession every seven, eight, nine, 10 years, maybe more often. That affects the cash flow for the next year, and that affects the, I guess, the multiple that you're paying for that, the cash flow one year before. That's sort of a simple rule of thumb for people thinking about the value of the business. Absent a highly levered company that's at risk of going bankrupt, if you've got a well-financed business that can endure a period of lesser profitability, a recession, if it were to happen at the end of this year or sometime next year, is not actually going to materially affect the value of the companies that we own.
We're not trying to trade around, you know, when people think there's gonna be a recession. We are very thoughtful about and spend a lot of time thinking about the interest rate hedge. Our goal here is not to maximize the value of the interest rate hedge. It's to maximize the value of the portfolio. If we thought it made sense to sell the hedge because we found a better place to put that capital, probably in an equity, we would do so. We think the risk reward really tilts strongly in direction of the Fed having to raise rates much more aggressively than the market anticipates, and we think that will be very good for that hedge. What risk do you see of stagflation? How would it impact your portfolio? I think there's real risk of stagflation.
I think it may be the more likely case where the Federal Reserve has to raise rates aggressively, even as the economy is kind of weakening, and that's the sort of stagflation type environment. That's why you wanna own great businesses. You know, we still think people listen to a lot of music. We still think people listen to a lot of music. Again, it's the value that if. It's sort of like people expect the market to trade on the basis of your prediction of next year. If you get the prediction of next year right, you make money. If you get the prediction of next year wrong, you lose money. Think about us as, you know, the model we use, like an investment holding company.
We're gonna own these businesses as long as if we continue to believe that over their life, the present value of those cash flows is a lot more than where the stocks are trading, and we haven't found a better place to put the money. Stocks are gonna go up and down based on people's fears and concerns about inflation, wars, pandemics, but we're not gonna be the best performing fund in every three, six, nine-month, year, two-year, three-year period. We think they'll do pretty darn well over a longer term period, and we have the privilege of being able to think that way, which is a huge advantage. Some comments on short exposure. How has that performed?
The only real short exposure is we're short, you know, fixed income instruments that's performed really well. Restaurant portfolios declined substantially. I think we really covered that well. I have to pass on that question because that particular question we can't answer on this call for regulatory reasons, but we can respond to that shareholder directly. With that, we're probably 20 minutes past our normal schedule, but certainly a time to make sure we answer all your questions, and we appreciate your loyalty and persistence as we continue the battle. Talk to you soon. Thank you.
Thank you, everyone. This concludes your conference call for today. You may now disconnect.