Wall Street Transcript Interview with Arild Holm and Jeffrey A. Schwarte, Portfolio Managers at Principal Global Investors: Finding Value in Large-Cap Names by Taking Advantage of Market Dislocations

Wall Street Transcript

67 WALL STREET, New York - October 11, 2012 - The Wall Street Transcript has just published its Large-Cap Value Investing Report offering a timely review of the sector to serious investors and industry executives. This special feature contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Large Cap Investing - Value Investing - Long-Term Investing

Companies include: CF Industries Holdings, Inc. (CF), Pulte Homes Inc. (PHM), Lowe's Companies Inc. (LOW), Wells Fargo & Company (WFC) and many others.

In the following excerpt from the Large-Cap Value Investing Report, expert portfolio managers discuss the outlook and top picks for investors:

TWST: Would you introduce our readers to Principal's Large Cap Value Fund with a history and overview of the fund?

Mr. Schwarte: Principal's Large Cap Value Fund has been around since 1995. Since 2002, Arild and I have been involved in the fund. We have a very compelling story to tell in the sense that the fund has done very well versus the competition, as well as the objective benchmark, the Russell 1000 Value. We have a long tradition of being fundamentally oriented to our investment philosophy and process driven by stock picking. We pride ourselves on our proven ability to identify companies with characteristics the lead to that will outperformance. The strategy of the portfolio is to rely on stock selection as the key driver of excess returns.

Mr. Holm: What we're looking for is identifying companies that have positive and sustainable fundamental change. We verify these improvements by studying companies exhibiting rising earnings and cash flow and not overpaying for those attributes. Specifically, we look for companies that either have improving revenues, improving margins, either through better prices and improved mix or they're able to lower their costs, translating into higher earnings and higher cash flows.

We also analyze industry earnings trends. We do confirm with companies by visiting management teams to determine sustainability of these trends and catalyst to higher valuation. Finally, we look at valuation to not overpay for these characteristics. We use various valuation metrics that are industry specific. For example, financials have different valuation metrics than energy, versus tech, and so on.

TWST: Would you say, in general, there are ample opportunities in today's market for identifying good large-cap value investments?

Mr. Holm: Yes, we believe so. We believe the market is reasonably valued based on companies' earnings and cash flow. With easy monetary policy and low discount rate, stocks are very attractive. Alternative asset classes are less attractive, in our opinion, than equity markets. When you look at the composition of the Russell 1000 Value index, financials, energy and health care are about 50% of the index weight. Many of these stocks are trading at single-digit p/e multiples, therefore, from a valuation perspective, we do see opportunities.

Mr. Schwarte: There's certainly a lot to be worried about in the marketplace right now. We think the European debt issues are troubling investors. We seem to have made some progress lately on this front. With the upcoming election uncertainty and the fiscal cliff in the U.S., with potential sequestration, tax increases, dividend uncertainty, and slowing growth out of emerging markets, specifically China - there's an awful lot to be worried about right now. But we are finding very attractive opportunities that take advantage of some dislocations in the marketplace that warrant investments. Therefore, if you're a longer-term oriented investor, you can have handsome payoffs down the road.

TWST: What are some of your top investment picks or favorite investment ideas right now, and why?

Mr. Holm: I will start with Marathon Petroleum (MPC). This is a U.S. refiner that's benefiting in three ways. Currently, refining margins are high, and Marathon Petroleum has an extensive logistics system that provides the company access to a large variety of discounted crudes. Specifically, right now, the U.S. benchmark, WTI, is selling at a $20 discount to the world benchmark, Brent. So if you think about a refining margin being $15 per barrel using Brent; when you add a $20 discount, if you can source and get the inland U.S. crude, such as West Texas Intermediate, you can add $20 to your margin. All of a sudden your margin goes from $15 per barrel to $35 per barrel. They're benefiting from this trend.

On top of this, they have done a couple of investments. First, on the U.S. Gulf Coast, they added capacity to their refinery in Louisiana so they can export distillates/diesel to Latin America. Also, a refinery in Venezuela had a fire causing disruptions to supplies to that region. Margins for their exports have improved.

Lastly, they just completed a refinery upgrade in Detroit. They can source much cheaper Canadian crude, running it through their Detroit refinery, again significantly improving the margins. So they're really benefiting three ways.

Another one, and this is partly because we are here in the Midwest, is CF Industries (CF). The U.S. imports roughly half of its nitrogen needs used for fertilizers. The U.S. currently has low natural gas prices and this makes the U.S. and North America the second-lowest-cost producer in the world. Only the Middle East has a lower cost due to the subsidization of the industry. The U.S. can back out some of the imports, and CF Industries has been able to expand their nitrogen production here in the U.S. and improve margins at the same time.

For more from this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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