Ryan Leggio: Hi, I'm Ryan Leggio, I am a mutual fund analyst here at Morningstar and with me today is Meggan Walsh, Manager of AIM Diversified Dividend. Thank you Meggan for joining us.
Meggan Walsh: Thank you for having me.
Ryan: Last time we talked, the government was just finishing the stress test results, you own a couple of banks which went through those stress tests, SunTrust and Fifth Third, and you are running a dividend fund and a couple of those have had to cut their dividends, can you talk a little about your thinking now on the financial companies you own and if anything has changed since the last time we talked?
Meggan: Sure. So I think again the last time we talked, we talked about that we are sticking with a handful of those companies that did cut their dividends, because we thought given the dramatic precipitous fall that we have seen, it was the right thing to preserve capital at that time.
I think as an investor we are all breathing a little easier now that the stress tests are done and we have adjusted our models to reflect the dilution impact from those stress tests. In most cases but not all cases, our normalized earnings power has come down as a result of the dilution and our timeframe has probably moved out 18 months or so in terms of when we expect to realize the upside.
We still feel very good about the names. From here, we think we have moved from the overhang of the capital adequacy and the capital viability and the uncertainty around dilution to sort of traditional blocking and tackling of the credit cycle.
And what we are seeing there looks pretty typical and that is that we are seeing some moderation in the deterioration of the early cycle buckets like residential construction lands and are starting to see a pickup in the later cycle on the areas like commercial real estate, which is in the early stages as well as C&I loans. So those are trends that we are watching very closely.
On the good news side for the banks, we do think that lending capacity will be much more restrained coming out of this cycle mainly because the leverage securitization markets are shut down and that should definitely result in better pricing for loans going forward.
Ryan: With those banks, any idea when you think they may be able to increase their dividends substantially?
Meggan: Well certainly paying back the TARP funds is everyone's priority and we will see when they release their plans to the government, their finalized plans when they will be allowed to pay back TARP. So we are not expecting anything over the near term, meaning the next six to nine months, for many of our holdings.
Ryan: OK. Another thing that has changed since the last time we talked is the market is well off its bottoms in March and a lot of your holdings have appreciated significantly. Like Limited and others, are you finding now that some of them are kind of approaching your fair value and you are recycling some of that money into more attractive opportunities?
Meggan: We are. We are taking advantage certainly of these very depressed areas and we are seeing good value across some of the sectors and certainly a lot of our names as you mentioned have had huge moves off the bottom of March nine as well as the broad market has.
So we are looking at the names and we are looking at names where we maybe not have as much confidence in our growth rates as we originally did and we are moving those to better upside parts of the market.
Ryan: Any particular that you have in mind right now that are the most attractive to you?
Meggan: Well, as you know we have had a barbell approach going into 2008 where we were overweight in both consumer staples and consumer discretionary with more than 2.5 times overweight in consumer discretionary. So the retail sector has largely realized in our view much of the value.
But away from retail within consumer discretionary, we still see very good upside on a normalized earnings basis which we focus on, mainly in the leisure areas, some of the gaming areas as well as select financials. And then even in energy we are starting to see some areas that have attractive risk reward profiles even though we still think there is real capacity in that area and we will maintain underweight for some time.
Ryan: Great. And lastly, the economy has been trying not only for the businesses that you own but also for money managers, is there anything in particular you are working on right now to take into account kind of the difficulties of investing in this type of market?
Meggan: Sure. As you know we spend a lot of time not to stress on the fact that things look cheap but gaining confidence around our entry point as well as our position sizes by going through a sensitivity analysis of our upside and our downside by really testing our models, testing the margins.
And one of the greatest challenges that I feel coming out of this cycle that feels very different to previous cycles that I have witnessed is that corporate margins sit at 30 to 40 or highs for many of the sectors. So what that implies is that we are really more dependent on topline growth coming back to witness operating leverage.
So we are hopeful for that and we are watchful for that, but given that the market has seen more than a 40% PE expansion mainly on the heels of better cost cutting. We are asking as a team what are we willing to pay for restructuring if we want to see topline growth and so the bulk of our time is around gaining confidence on that.
Ryan: Well, great Meggan, thank you so much for joining us.
Meggan: Thanks for having me.
Ryan: Thank you for joining us. This is Ryan Leggio for Morningstar.
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