Harry Milling: I'm Harry Milling, mutual fund analyst with Morningstar. I'm here with Heather McPherson, associate portfolio manager with T. Rowe Price Mid-Cap Value and David Wallack, the lead manager of that fund. Welcome to both of you.
2008, bad year, 2009 huge rally. Now we're in 2010. I gather you're not seeing the same compelling values, or at least the number of compelling values that you saw in 2009. But there must be value nevertheless somewhere. So, where is it?
David Wallack: Well, you're right. The average mid-cap stock is up over 100% since the market bottomed. A year ago or more, we were finding a lot of opportunities throughout the market and a broad variety of industries. Today, we have to be a little bit more selective, dig a little bit deeper. The market is always offering us opportunities among mid-cap stocks.
We're finding things to buy among the independent power producers, grocers, energy, and one or two industry groups as well.
Milling: You mentioned the power producers. I know that or at least it seems that you increased your stake in the utilities markedly in the past year. Recently you added Calpine and Allegheny Energy, increased your stake in Mirant. I know you're a bottom-up guy, but what are the themes in that sector that you like, and how are those themes playing out in the names that I mentioned?
Wallack: You're right, we are bottom-up, stock-picking-type folks, but often we will find areas of the market where capital has been exiting a preponderance of opportunities. What I mean by that is areas where they may have been an overbuilding of capacity, prices have come down in the industry, competitors are in distress, the industry's consolidating, it's difficult to get financing, and so on and so forth. So that theme is applicable in the independent power producer industry right now.
Last year, electric power demand in the U.S. was down by 3%, that's the steepest decline since the Great Depression. It happened that the big building boom in power plants that occurred in the mid-2000s resulted in an additional capacity being delivered into a very soft market last year and the previous year.
So prices for electric power are very low. The earnings for the IPPs are low. But inefficient power plants are shutting down. The industry is beginning to consolidate. You referred to Allegheny Energy. Allegheny Energy is going to be acquired by First Energy. Mirant, another one of our portfolio holdings, announced yesterday that it was going to merge with a competitor, RRI Energy.
What this means is, over the long run, you're going to have a group of well capitalized, well positioned, low-cost producers who are going to be the incumbents in the industry that, over time, should get better.
Milling: Heather, anything to add about utilities? I know that's a specialty of yours.
Heather McPherson: I think that--
Milling: Do you disagree with anything that David Wallack says?
McPherson: No, I agree with everything that David said. I think on the electric utilities, we don't see as much value as we do in the deregulated merchant companies or the pure merchant companies, where they're trading at compelling valuations on things like enterprise value to kilowatt, potential peak earnings power. We think that the companies we're in have some pretty astute management teams running them and have done a good job over the last five years allocating cash.
Milling: So when you say deregulated, you mean like Calpine and Mirant, those are deregulated, right? I'm getting that right?
McPherson: Those are merchant generators. They don't have any regulated operations. There are some quasi-regulated merchants. That would be companies like Allegheny and First Energy. So those we see value in versus say, some of the pure electric utilities; there's not as much value there.