Canadian Equity Strategies

Pembroke’s Canadian equity portfolios have been navigating through a challenging economic environment in the past twelve months, with the first half of 2022 proving particularly difficult. Inflationary pressures have percolated through the global economy, fuelled by aggressive monetary and fiscal countermeasures against the pandemic, supply chain bottlenecks, and the Russian invasion of Ukraine. While the first signs of inflation were largely viewed as transient, growing realization of its persistency has spurred swift increases in both short-term and long-term interest rates.

Equity markets have corrected sharply in this rising rate environment, with a contraction in valuation multiples driving the bulk of the losses. Growth-oriented stocks have sharply underperformed value and cyclical stocks in this downturn, as higher discount rates pressure longer duration assets.

Canadian Growth Fund

While Pembroke’s Canadian holdings are in robust financial health and continue to mark fundamental progress with per share growth and cash flow generation, returns on an absolute and relative basis have been pressured meaningfully.

From an industry group standpoint, Pembroke’s Canadian equity portfolios have significant weightings in the technology and consumer discretionary sectors, which underperformed in the prevailing economic environment. Additionally, the portfolios have limited exposure to the energy and mining sectors, which have performed relatively well, corresponding with strong underlying commodity prices. Finally, the Fund’s financial holdings are focused on specialty lenders, insurance underwriters and asset managers, which tend to trail the performance of large, diversified banks in times of economic turmoil.

Two stocks that made positive contributions to returns of the Fund over the past 12 months

Points.com (“PTS”) was a long-term holding in the Pembroke Canadian strategies. The company has relationships with many of the leading loyalty programs around the world. Its mission is to help the travel and leisure industry use loyalty to enhance customer satisfaction and grow revenues. Although the company was significantly affected by the pandemic, the recent results have been excellent, as the travel industry reopened. In May, a strategic buyer offered to purchase the shares at US$25, a 52% premium to the trading price at the time. While we were disappointed to see the company go private, the purchase price was near our four-year target, which is a satisfactory outcome.

Shares in Calian Group (“CGY”), a provider of technology solutions to the healthcare, training, cybersecurity, and satellite communications markets, performed well in the past year. The company delivered solid financial results, buoyed by robust organic growth and opportunistic strategic acquisitions. Calian shares also benefited from higher investor recognition of the fact that it is likely to benefit from increased spending in the realms of defence, space, healthcare, and digital security. The team at Calian has done a strong job of generating free cash flow and redeploying capital into acquisitions that are accretive to growth and profits. While shares have performed relatively well in the past year, they remain attractively priced and offer a balanced profile of growth and value.

Two stocks that made negative contributions to returns of the Fund over the past 12 months

Airboss of America (“BOS”) is a manufacturer of rubber-based products, with end markets that include applications for the automotive, industrial and defence sectors. During the past two years, the company leveraged its expertise as a manufacturer to provide personal protective equipment to various agencies within the US government. Our expectation was that, while such contracts may be lumpy and difficult to predict, they are not “one-off” events. The company is in front of a bid pipeline that is very substantial and yet to be awarded. The credibility Airboss built by delivering on large contracts in the past two years positions them well to be awarded some of these contracts. Shares initially benefited from a higher recognition when the company won the first large contract in 2020 and took off following the second contract. However, after roughly nine months with no additional large contract win, investors that bought into the idea that these large contracts were forthcoming appear to have run out of patience. The base business is now very reasonably valued, and investors are not paying anything for the optionality of the large request for proposal pipeline the company has outlined. Situations where the risk vs. reward balance tilts to such extremes attract our attention, and the potential upside is important. We continue to be shareholders in the business.

Sangoma (“STC”) has seen its shares pressured along with many of its peers in the unified communications-as-service space. Through a series of acquisitions, Sangoma has positioned itself as a credible alternative to leaders such as Ring Central (“RNG”). While its 2021 acquisition of Star2Star was executed at a premium valuation given Star2Star’s persistent revenue and high margins, Sangoma has followed that transaction with another acquisition at an attractive multiple, in line with its historical strategy. Furthermore, management continues to deliver reasonable organic growth and to maintain attractive profit margins. With over 70% visibility into annual revenue, strong free cash flow expected this year and the next, and a low valuation, Pembroke has taken advantage of market weakness to build its position over the past year. Management recently announced a share buyback, taking advantage of the low price to shrink its price base.

Dividend Growth Fund

The Pembroke dividend Growth Fund is a Pooled fund. This is a prospectus-exempt product that is only available to investors who meet the definition of an “accredited investor” under securities legislation. This strategy also forms a significant component of the Canadian Balanced Fund.

The Pembroke Dividend Growth Fund posted modest losses on an absolute basis in the past twelve months. Equity market headwinds were prevalent through the period, which pressured equity market valuations, driving down stock prices despite solid fundamental progress in the portfolio in terms of per share earnings growth, cash flow generation and dividends paid to shareholders.

The Fund’s returns slightly trailed large cap benchmarks in the past year, but are comfortably ahead of smaller capitalization indices. Most industry groups were in negative territory during the period, reflecting the difficult prevailing environment. While the Fund’s underweight positions in energy and mining companies were meaningful detractors to relative performance, its balanced approach of weighing growth and dividends provided reasonable ballast in turbulent times for equity investors.

Two stocks that made positive contributions to returns of the Fund over the past 12 months

Shares in Hammond Power (“HPS”), a leading manufacturer of dry-type transformers supplying the North American markets, performed well in the past twelve months. The company posted strong operating results that reflected a significant rebound of activity following pandemic induced project delays. Moreover, the company successfully defended its margin profile in a challenging environment of rapidly increasing input costs, highlighting its strong market position and operational agility. While Hammond’s recovery from the pandemic slowdown has been heartening, its longer-term prospects are particularly encouraging in light of the trend towards an increasing electrification of the economy. Despite very strong share price performance in 2021 and thus far in 2022, we continue to view Hammond as having an attractive risk/reward profile for our dividend-oriented strategies.

Fairfax Financial Holdings (“FFH”) is a leading global insurance company. The shares were very undervalued in 2020 and 2021, due to mediocre investment results and some volatility in the insurance results. In recent quarters, all aspects of the business have been doing well, including some significant portfolio gains, which accrued to book value. The company also made a very astute move by selling a small minority interest in one of its insurance companies to finance a significant stock buy back at a very favourable price. Despite the recent rally, the shares remain attractive.

Two stocks that made negative contributions to returns of the Fund over the past 12 months

Shares in Information Services Corp. (“ISV”), a leading provider to the private sector as well as governments of registry and information management services involving public data and records, have been weak in the past twelve months after reaching all-time highs in the middle of 2021. The company continues to execute well fundamentally, delivering robust revenue growth, significant free cash flow generation, a dividend increase, and opportunistic mergers and acquisitions. However, shares sold off on concerns that a slowdown in real estate activity could negatively impact the company’s transaction volumes, and on disappointment that a large registry outsourcing opportunity that was thought to be a potential source of growth is not coming to fruition in the near-term. Despite the setback in ISV shares in the past year, we continue to believe the company is well-positioned to deliver per share growth over the long term and that current valuation levels are attractive.

Canadian All-Cap Fund

The Pembroke Canadian All-Cap Fund is a Pooled Fund. This is a prospectus-exempt product that is only available to investors who meet the definition of an “accredited investor” under securities legislation.

The Pembroke Canadian All-Cap Fund declined on an absolute basis in the past twelve months. The lack of exposure to the energy sector, which posted very strong returns in concert with surging commodity prices, drove the portfolio’s relative underperformance.

However, the Fund gained ground in the second quarter of 2022 on its large cap benchmark, the S&P/TSX Composite. The improving relative performance can be partly attributed to a sizable exposure to the defensive consumer staples sector, where companies are able to pass on cost inflation without significant customer pushback. Furthermore, rising interest rates have benefitted the portfolio’s positions in two high-quality insurance companies.

The portfolio remains well positioned to weather the current difficult economic environment, as its holdings’ robust balance sheets, strong competitive positions and long runways for growth should allow them to deliver superior revenue and earnings growth in the coming years. 

Two stocks that made positive contributions to returns of the Fund over the past 12 months

Shares in Metro (“MRU”) have climbed higher over the last year as investors have sought security in sectors less exposed to a potential economic slowdown.  The business has also been a good hedge against inflation in the past.  With the relative concentration of the supermarket industry in Canada, Metro is in a strong negotiating posture with its suppliers and can pass on cost increases to consumers. It can also count on its low-cost concepts, Food Basics and Super C, to address any trade-down in consumer spending patterns. Finally, its pharmacy banners Jean Coutu and Brunet will benefit from growth in prescription counts as people consult their physicians more frequently post-pandemic.

Fairfax Financial Holdings (“FFH”) is a leading global insurance company. The shares were very undervalued in 2020 and 2021, due to mediocre investment results and some volatility in the insurance results. In recent quarters, all aspects of the business have been doing well, including some significant portfolio gains, which accrued to book value. The company also made a very astute move by selling a small minority interest in one of its insurance companies to finance a significant stock buy back at a very favourable price. Despite the recent rally, the shares remain attractive.

Two stocks that made negative contributions to returns of the Fund over the past 12 months

Auto collision repair shop operator Boyd Group (“BYD”) is navigating through the industry-wide shortage of qualified technicians and the resulting wage pressures. Demand remains strong as the number of accidents is growing, along with miles driven. The ability to meet demand is limited by available capacity. As such, Boyd is receiving price concessions from insurance carriers who wish to have their clients’ cars serviced first. Margins are starting to normalize as the price increases will soon approach the wage increases. With a healthy balance sheet, the company is in great position to continue its industry consolidation strategy going forward.

Cargojet (“CJT”) is a provider of air freight services within Canada, and from points that either begin or end in Canadian cities. The company has a monopolistic-type market share in the Canadian overnight air freight market, with a market share above 90%. The volatility of the share price is owed to a host of concerns. These include freight pricing rates, charter activity volumes, international cargo capacity, e-commerce demand and growth CAPEX investments. These concerns are legitimate considerations for investors to scrutinize, as we have. However, we do not believe the market fully appreciates the company’s business model. Much of the company’s business is under long-term contracts, which gives the company visibility on both pricing and volumes. We continue to remain shareholders and are optimistic that the operational expertise the company has displayed garnering such a high market share domestically will translate into a competitive advantage as they aim to expand internationally. We continue to remain shareholders in the company.

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