US Growth Equity Strategy – Q1 Portfolio Commentary
Pembroke’s US portfolios delivered a solid start to 2021 after posting strong absolute and relative returns in 2020. While the firm’s portfolios trailed their benchmark over the past three months, the jump in low-quality, indebted, and cyclical companies made the Russell 2000 a difficult benchmark during this period. The firm has no exposure to energy and limited exposure to financials, sectors which surged in the first quarter of the year. The Russell 2000 energy sector, for example, gained over 41% in the first quarter after dropping almost 37% in 2020. Few energy companies meet the firm’s parameters for sustainable growth and clear competitive advantages. Within information technology, the stock prices of most of our software services companies were pressured despite strong underlying fundamentals. The investment team reduced its exposure to some positions with extended valuations and allocated capital to secular growth companies that will benefit from the impending economic re-opening.
Two stocks that made positive contributions during the quarter included:
Pembroke’s position in TTEC Holdings (“TTEC”) responded to the company’s strong fourth quarter 2020 results and 2021 guidance. TTEC offers large companies and governments call center, customer engagement, and connectivity services. Pembroke initiated a position in 2020 when the stock declined after the equity offering. The team has known the 60% founder/owner for twenty years and watched him evolve TTEC into a persistent, highly cash generative leader in its markets. The COVID-19 pandemic has led institutions around the world to invest in their customer service protocols, and management turning this global disaster into a prolonged, powerful opportunity to win new business. Consumers want to interact with their service providers using myriad platforms, including voice, text, online chat, and social media. TTEC is well-positioned to help its large customers meet the challenges of a world going increasingly digital. TTEC is growing, profitable, and reasonably valued and is now the largest holding in the firm’s US funds.
Charles River Associates (“CRAI”) is finally being recognized by investors for its combination of per share revenue and earnings growth. The company has a long record of steadily growing its business through new client wins and the hiring of expert consultants to broaden its offerings. Management has used the company’s free cash flow to steadily reduce the number of shares outstanding, demonstrating conviction in its underlying business and the undervaluation of its shares. In fact, even after the recent share price rise, the company announced another buyback.
Two stocks that made negative contributions during the quarter included:
Shares in Paycom (“PAYC”) declined 18% during the first three months of 2021. Despite posting solid fourth quarter 2020 financial results that beat consensus expectations for both revenue and earnings, PAYC fell victim to the pronounced stock market rotation away from quality growth businesses. The company continues to execute well and take share in its fast-growing, multi-billion-dollar human capital management software end market. Its solutions represent a purpose-built, easy-to-use alternative to legacy providers. While we remain excited about the multi-year opportunity, we materially trimmed our position as the valuation rose above our long-term target.
Alteryx’s (“AYX”) shares declined in the first quarter of this year as the company’s recurring revenue growth guidance for 2021 fell short of consensus expectations. Furthermore, AYX terminated their relatively new chief revenue officer in the quarter following an inappropriate social media post, which resulted in an additional sell-off in the shares. Despite these developments, we remain confident in the long-term opportunity, and AYX’s differentiation within the data analytics software market. The company has compelling software which makes data analytics more accessible and understandable for a broader segment of employees.
The Pembroke Concentrated Fund (“PCF”) made modest gains during the first quarter but lagged behind its benchmark the Russell 2000. The Concentrated Fund’s strategy incorporates strict discipline and focuses on high-quality growth companies.
The main source of underperformance during the quarter was the market’s dramatic pivot to lower quality, value-oriented sectors and companies, which had underperformed for much of the last twelve–month period. Specifically, energy, materials, and financials stocks, and stocks with lower margins and more levered balance sheets broadly outperformed the market and PCF. While the market will periodically shift its attention to these characteristics, we maintain our approach of investing in high-quality growth companies over the long-term. At quarter-end, the portfolio consisted of 20 stocks, with approximately 92% of the fund invested in the US and 8% in Canada.
Two stocks that made positive contributions during the quarter included:
Bio-Techne (“TECH”), a leading provider of consumables and analytical instruments used by researchers in all aspects of life science research, saw its stock price increase in the first quarter of 2021 due to better-than-expected earnings results and 2021 guidance. Organic growth continues to accelerate and was broad-based across all segments and geographies, while operating margin expansion remains on track and importantly ahead of schedule. The company also completed its first sizeable acquisition in over two years by acquiring Asuragen, a manufacturer of diagnostic products providing identification of genetic abnormalities associated with oncology and genetic disease. The acquisition is complimentary to TECH’s existing portfolio of products and customers and expands its addressable market. The company remains well positioned to benefit over the next few years from the secular trends in proteomics, liquid biopsy diagnostics, and cell and gene therapies, three of the fastest growing areas in health care.
Shares in A.O. Smith (“AOS”), a leading global manufacturer of water heaters and water purification products, increased in Q1 2021 following stronger than expected earnings results and forward guidance. The company is benefiting from a strong US housing market, the consistent replacement cycle for old water heaters, a resurgence in the domestic Chinese market, and faster than expected global water filtration demand. Despite the strong recent move, we view AOS as a multi-year growth story with a combination of compelling secular and cyclical drivers, and a steady and shareholder-aligned management team at the helm.
Two stocks that made negative contributions during the quarter included:
Alteryx’s (“AYX”) shares declined in the first quarter of this year as the company’s recurring revenue growth guidance for 2021 fell short of consensus expectations. Furthermore, AYX terminated their relatively new chief revenue officer in the quarter following an inappropriate social media post, which resulted in an additional sell-off in the shares. Despite these developments, we remain confident in the long-term opportunity, and AYX’s differentiation within the data analytics software market. The company has compelling software which makes data analytics more accessible and understandable for a broader segment of employees.
Shares in Tecsys (“TCS”), a provider of supply chain software, services, and solutions for the healthcare, retail, and complex distribution sectors, declined in the first quarter of 2021 after gaining in 2020. Fundamentally, the company continues to perform well, with most recent quarterly results highlighting revenue growth, healthy bookings activity, and backlog visibility. While the COVID-19 pandemic has disrupted sales cycles with some of Tecsys’ customers, it has also highlighted the importance of supply chain infrastructure and the deficiencies of antiquated legacy systems. Tecsys is emerging as a leader in efforts to modernize these critical systems.
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Disclaimer
This report is for the purpose of providing some insight into Pembroke and the Pembroke funds. Past performance is not indicative of future returns. Any securities listed herein, are for informational purposes only and are not intended and should not be construed as investment advice nor is it a recommendation to buy or sell any particular security. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Pembroke seeks to ensure that the content of this document is correct and up to date but does not guarantee that the content is accurate and complete and does not assume any responsibility for this. Pembroke is not responsible for decisions or actions taken or made on the basis of information contained in this document.
