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New Manager Off to Good Start at Popular Dividend Fund

John Linehan, manager of the Bronze-rated  T. Rowe Price Equity Income, has generated fine results since taking over for the retiring Brian Rogers in late 2015. 

Katie Rushkewicz Reichart, CFA, 05/20/2017

The following is our latest Fund Analyst Report for T. Rowe Price Equity Income PRFDX

T. Rowe Price Equity Income manager John Linehan has gotten off to a good start since taking over for the retiring Brian Rogers in late 2015. Despite changes on the margins, he's kept the fund's longtime strategy intact, providing consistency for shareholders. Below-average fees and strong analytical support contribute to a Morningstar Analyst Rating of Bronze.

Linehan has stayed true to the fund's mandate, investing in undervalued dividend payers. But unlike some equity-income funds, absolute yield is not the driver here: The potential for price appreciation and the quality of company management also matter. Indeed, Linehan sold longtime holding AT&T T (previously a top-20 position under Rogers), showing he won't simply hold a name for its dividend.

That said, the fund's yield has ticked up a bit since Linehan took over. Some recent additions, such as Ford Motor F, sport healthy yields. The fund owns those alongside more-cyclical plays with more-anemic payouts, including Applied Materials AMAT, a top contributor thus far during his short tenure. In balancing the objectives of income and capital appreciation, the fund's yield won't look exceptionally high relative to some equity-income funds, but it will likely be above the S&P 500 over time.

Portfolio turnover has remained moderate (20% to 30%). Sector weightings haven't wildly changed, but Linehan upped the fund's stake in healthcare stocks, a lack of which had weighed heavily on performance during the past five years. (Rogers stayed light on healthcare because of regulatory concerns.) Meanwhile, he plans to keep cash below 4% of assets; an above-average stake had been a headwind in the post-2008 bull market under Rogers.

Linehan stress tests dividend stability, particularly in capital-intensive sectors such as energy. Cash flows and balance-sheet strength are even more important here than at former charge T. Rowe Price Value TRVLX, where he turned in solid results from 2003-09. His experience at that fund helps provide confidence here.

Process Pillar: Positive | Katie Rushkewicz Reichart, CFA 05/17/2017

This fund has not changed its stripes under new manager John Linehan. Like his predecessor, Linehan looks for companies trading cheaply relative to the market, industry, or historic norms. The portfolio consists of firms that offer at least a modest yield and the potential for price appreciation, which he seeks by buying out-of-favor names in a variety of sectors. Nearly all of the fund's holdings pay a dividend, but absolute yield is not the main objective; the fund's yield hasn't been notably high relative to equity-income large-value funds, but it's likely to be above the S&P 500's over time. The fund continues to look a bit lower quality than many equity-income peers, sporting a higher debt/capital ratio and lower returns on equity, assets, and invested capital. It remains diversified, with 100-120 holdings. But while Rogers occasionally held some cash if bargains were scarce (which weighed on performance in the post-2008 bull market), Linehan will likely keep cash below 4%.

Linehan's process at T. Rowe Price Value from 2003 to 2009 didn't emphasize dividends as much as this fund, and it didn't hold up quite as well in market declines (though it did fare better than the Russell 1000 Value Index in both up and down markets). However, since taking over here in 2015, he has maintained the same approach that fund investors have come to expect, earning a Process Pillar upgrade to Positive from Neutral.

John Linehan was announced as Rogers' successor in 2014 and started weighing in on the portfolio a few months before the official October 2015 transition. Turnover, which was under 15% in Rogers' final years, picked up to 27% in 2015 as Linehan made changes, but was down to 19% in 2016; below-average turnover will likely remain the norm.

Overall, under Linehan the fund decreased its consumer discretionary exposure and increased its healthcare and utilities stakes, though these were modest moves overall, and the fund's sector weightings aren't wildly different from the Russell 1000 Value Index. From a stock-specific standpoint, big sales included dividend mainstay and longtime holding AT&T as well as IBM IBMDuke Energy DUKEntergy ETR, and Corning GLW. New purchases have included Morgan Stanley MS and Citigroup C --he thinks financials are now better positioned to return capital to shareholders--and Ameriprise Financial AMP. He added Anthem ANTM in 2015 when it was trading at a lower valuation than competitors because of uncertainty about its potential deal with Cigna CI. He also added Ford when it traded down last year.

The fund's cash stake has dropped to 2% of assets from nearly 7% in December 2014; cash had been a headwind in recent years, and Linehan doesn't plan to hold more than 4%. The fund occasionally owns some convertible bonds or preferred shares.

Performance Pillar: Neutral | Katie Rushkewicz Reichart, CFA 05/17/2017 

When 30-year manager Brian Rogers stepped down from the fund in October 2015, its Performance rating was reset to Neutral. Successor John Linehan doesn't have much of a track record here yet, but he's done well out of the gate. Since taking over through April 2017, the fund's 13.4% gain beats the Russell 1000 Value Index's 12.2% and the large-value Morningstar Category's 10.5%. It has maintained an edge on a risk-adjusted basis.

Linehan posted good results at his previous charge, T. Rowe Price Value. He led that fund to an 8.3% annualized gain from April 2003 to December 2009 versus the Russell 1000 Value Index's 6.9% and this fund's 7.2%. T. Rowe Price Value did better in rising markets than this fund on his watch but not as well in pullbacks, and it was more volatile (based on standard deviation) than its average large-value peer and the S&P 500 and Russell 1000 Value indexes. However, with this fund's stated equity-income objective, he should be able to adjust to a more muted risk profile as he places greater emphasis on company balance sheets, cash flows, and dividends.

Linehan is also one of three managers on T. Rowe Price Institutional Large-Cap Value TILCX; since his 2004 start, that fund has edged the Russell 1000 Value Index and has more meaningfully beaten the large-value category average.

People Pillar: Positive | Katie Rushkewicz Reichart, CFA 05/17/2017

Katie Rushkewicz Reichart is a senior mutual fund analyst with Morningstar.

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