FAF Advisors Portfolio Manager Outlines Her Long Term Investment Strategy: Anticipate Increasing Dividend Streams From Selected Regional Banks As They Emerge From Credit Crisis
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Cori B. Johnson is a Senior Equity Portfolio Manager at FAF Advisors, Inc. She is the manager of Equity (Value) Income. She also manages institutional portfolios. Cori began working in the financial industry in 1981, joined the firm in 1985, and became a portfolio manager in 1992.
She was previously a securities analyst at American Express Financial Advisors. Cori received a BA degree from Concordia College and an MBA degree in finance from the University of Minnesota Carlson School of Management. She also holds the Chartered Financial Analyst designation and is a member of the CFA Institute and the CFA Society of Minnesota.
TWST: Would you be able to tell us about some of the holdings that you have that you feel are representative of your investment approach and the reasons why you found them attractive?
Ms. Johnson: I mentioned that we build our portfolio around what we call our core holdings. Here, we look for companies with businesses that grow above average over time with above-average profitability. Our core holdings have leading or growing market share positions with sustainable competitive advantages and therefore their future earnings and cash flow are expected to grow above average, and the balance sheet strength is expected to be maintained. And of course, they have dividend policies that produce growth in their dividends. Those characteristics tend to describe our core holdings.
A good example of that would be Praxair (PX), which is an industrial gas company with about 9 billion in revenues. It's a leader in the United States, has substantial market share in Europe, and is growing rapidly in Asia. It's a somewhat cyclical business, but in the global growth environment of the past several years, Praxair has been a leader in pursuing opportunities globally, especially in emerging markets. We look at it as a cyclical growth business, with strong underlying secular growth trends.
Praxair's management team has a strong cohesive strategy for continuing its competitive advantage and as a result -- profitable market share growth -- as it pursues opportunities around the world. The end markets grow mid- to high-single digits, and management has an excellent track record with attention to both growth and profitability, as well as maintaining balance sheet strength. During 2008, management was rigorous in controlling expense ratios, which allowed them to manage through volume declines last year very well, and they are now rebounding strongly. This is the kind of company we consider core to our strategy -- above average growth rate both top and bottom line, strong balance sheet, healthy cash flow with the ability to self fund their growth or support appropriate additional financial leverage. And, of course, they also have a corporate dividend policy that supports a growing dividend.
PX was one of the few companies that actually grew their dividend in 2009, and they raised it this year as well. We have owned Praxair for more than 10 years, although we did take profits during 2008 for more timely opportunities as the market was bottoming. But we still kept a base position in Praxair. Right now, we are more inclined to add because it's looking attractive on a relative basis, on a two- to three-year time horizon, as investors return to companies that can sustain above average growth.
TWST: What about one of the regional financial companies that you had mentioned earlier?
Ms. Johnson: Because we take a risk-averse approach, we actually added a basket of the regional banks that we were willing to hold for the next two to three years. It's still quite a risky environment for banks, so we decided to manage the risk through diversification in a few of the banks that we felt were among the least risky of a risky bunch. We bought banks that were valued attractively on price-to-book, with recovering credit metrics and attractive normalized earnings potential.
We added Regions Financial (RF), Fifth Third (FTB), SunTrust (STI), Key Bank (KEY). Our industry analyst met with the managements to understand their strategies for managing through the balance sheet issues during the next couple of years and to assess the adequacy of loan charge-offs and potential for loan reserve releases into earnings. We worked with our analyst team to determine the opportunity for investors to increase the valuation assigned to the asset books of each bank, as well as expectations for normalized earnings levels and earnings multiples. With that background, a good example is Regions Financial.
At the time that we bought it, it was selling at a substantial discount on a price-to-book basis, 60% to 70% of book value. We also looked at the tangible book, but we focused primarily on stated book value. After meeting with management, we became convinced they had the opportunity to improve earnings by releasing reserves into earnings at a level and pace not appreciated by investors. We considered their current loan book, but we also looked beyond the current book to the trajectory towards normalized earnings, based on their business mix and geographic footprint. Entering at a decent price-to-book, normalizing earnings at a run rate of about 1.6, looking out two to three years, and then assigning a P/E of 10 times earnings resulted in a price target that produced at least a double over that time period, with less than 10% downside risk -- an attractive risk-reward ratio.
However, at the time that we purchased these banks, they had cut their dividends drastically. So, we also had to be confident that dividends would rebound at an above-average rate in the next couple years, with dividend payout ratios increasing steadily. So, we expect a significant growth in the dividend income stream from our bank positions during the next couple years. At the time we added these banks, they met both our risk/reward metrics as well as our criteria for future dividend growth.
TWST: The other sector that you increased your exposure is consumer discretionary, which is still a little contrarian in your approach. Would you tell us about some consumer discretionary stocks?
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