Harry Milling: Lastly, you mentioned cyclical companies, and you've done well with cyclical companies, Weyerhaeuser is a good example. It's still one of your top holdings, if not your top holding. What is it about cyclical companies that you like so much? What is maybe the best way to value them? I'm sure that depends on what sector it's in, but is there any sort of common theme when you value a cyclical company? Would you use P/E or would you use something else?
David Wallack: Well I think there are a whole host of valuations techniques that you can use and probably should use when you look at any asset or any stock. We are omnivorous; we will use anything we can to try and understand what an asset might be worth.
In the case of Weyerhaeuser, you have a particularly complex company in the sense that they're in a host of different businesses, each of which is unique. We're attracted often to old companies that have accumulated assets over the years. Here you have a company that's been in business for 100 years. It's the biggest private owner of timber in the United States. It's asset rich.
Over the years, they've acquired and accumulated assets in other businesses. They have one of the biggest lumber operations in the country. They have a fluff pulp business that manufactures pulp that goes into making diapers. They have one of the largest homebuilders in the country buried in Weyerhaeuser that few people know about. There are other assets as well.
So we value each of those separately. We'll value the timber operation based on a DCF-type of analysis, a discounted cash flow analysis. In addition, at some point in time Weyerhaeuser is likely to convert that part of the business into a real estate investment trust, so we've used a REIT type of framework to analyze it.
The lumber operations we value based upon replacement value, private market value, P/E based on future earnings potential of the company.
The fluff pulp business we will use replacement value analysis, and we could also use cash flow or earnings in that perspective.
Milling: And you would do that because they're probably going to sell that business? You're talking about the replacement value?
Wallack: It's possible that any of these assets could be sold, but we find replacement value a useful framework because it tells us, it indicates to us the price that is necessary for competitors to add new capacity to the industry. In other words, if we go back to the power producers for a moment, electric power prices likely need to more than double in price before a new power plant will be built. It's that value that determines the attractiveness of the asset. So replacement value is one of the valuation approaches we use most frequently with cyclicals.
Milling: Right. But you tend to gravitate, or I should say some of your biggest wins have been in cyclical companies. Is there anything about your process and about you as an investment manager that explains that?
Wallack: You know we both grew up as analysts in periods of adversity, honestly. I was a natural resource analyst in the 1990s. The resources area has been a hot area in the last decade. But when I grew up working as an analyst on the New Era Fund of T. Rowe Price, the natural resources fund, and other funds as well, the industries I looked at were in bear markets most of the time. So you had to kind of scrimp and scrape to make a living. You had to find a unique angle. I think you had to be creative and imaginative and flexible. You couldn't just let the tide sort of bring you to shore, so to speak. So I think that I've always had an affinity for companies that are out of favor, and I think a willingness to invest in businesses where the results are poor when we're making the investments.
You asked earlier is there something in the way of temperament that investing in cyclicals require, and I think it does require an ability to have a longer-term time horizon, a strong stomach, and a thick skin because a lot of people are going to disagree with you.
Heather has a similar background. She worked as a utility analyst in the early 2000s when the world was coming to an end, when Enron imploded and many electric utilities had tried to emulate Enron, built up merchant generation businesses and levered their balance sheets. So she was instrumental in getting the Mid Cap Value Fund invested in quite a number of distressed electric utilities in which we did very well.
Milling: Good, good. Well, I mean, it's returned 10% annualized since you started, so whatever it is that you're doing with cyclical companies, it's working. We'll leave it there. Thanks very much.
Wallack: Thank you.