Pembroke’s Canadian equity portfolios posted strong gains in the third quarter of 2021, outpacing broader Canadian equity markets which posted flat returns. Canadian equity indices reached all-time highs in early September but declined late in the quarter as uncertainty created by the fourth wave of the COVID pandemic, evolving monetary and fiscal responses to the outbreak, emerging signs of inflation, and global supply chain disruptions dampened investor sentiment.
The Canadian portfolio’s positive absolute and relative performance in the quarter was driven by investments in the technology, financial, and consumer discretionary sectors, as markets reacted favourably to positive operational updates from several substantial holdings. Moreover, relative performance was buoyed by the portfolio’s underweight position in the precious metals sector, which suffered from declines amidst weaker underlying commodity prices.
Canadian Growth Fund
Two stocks made significant additive contributions to returns of the Canadian Growth Fund in the third quarter
Shares in Tecsys (“TCS”), a provider of supply chain software, services, and solutions for the healthcare, retail, and complex distribution sectors, rebounded after declining earlier in the year, a selloff we viewed at the time as inconsistent with the company’s strong underlying fundamentals. The company reported operating results that demonstrated sales momentum with new and existing clients. The transition to a software-as-a-service (SaaS) model is also progressing well. While the COVID-19 outbreak has lengthened the sales process with some potential customers, it has also highlighted the critical nature of supply chain infrastructure and the shortcomings of legacy systems. Tecsys is emerging as a leader in these modernization efforts.
Shares in goeasy (“GSY”), a provider of non-prime consumer leasing and lending products through its easyfinancial, easyhome and Lendcare brands, performed well in the third quarter as investors reacted positively to quarterly results and the issuance of positive three-year operational guidance. The company has a record of delivering attractive loan growth while maintaining credit underwriting discipline and winning share in profitable lending niches overlooked by larger financial players.
Two stocks posted declines that weighed on performance in the third quarter
Shares in Real Matters (“REAL”), a provider of technology-enabled appraisal and title services to the mortgage lending and insurance industries, were weak during the period as investors digested interim financial results that trailed expectations. The company is in the process of positioning its title operations to bring onboard and service larger, more sophisticated customers. A fallout of this process was that volumes from smaller customers were curtailed in the reporting period. Moreover, investors are concerned that rising interest rates could be a headwind for mortgage refinancing volumes, which would negatively impact appraisal demand. While near-term operational metrics have disappointed investors, we believe that Real Matters has ample opportunity to gain share in an industry ripe for disruption.
Shares in Westport Fuel Systems (“WPRT”) a designer and manufacturer of clean fuel components and engines servicing the commercial truck, transit and passenger vehicle markets declined in the third quarter, as investors weighed a strong demand environment for low-emission vehicles against uncertainties regarding the company’s joint venture with Cummins, potential supply chain disruptions in the automotive industry and continued overhang from the company’s equity issuance in June. We believe that Westport is poised to capitalize upon regulatory-driven adoption of its high-pressure direct injection (“HDPI”) technology by European and Chinese heavy-duty truck manufacturers, notwithstanding near-term industry and company-specific headwinds.
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 modestly positive returns in the third quarter of 2021, building upon a strong first half of the year. The Fund’s returns were in-line with those of the S&P/TSX Composite Index during the quarter.
Two positions were significant contributors to performance in the third quarter of 2021
Shares of Tricon Residential (“TCN”), a real estate investment and advisory company which owns and operates over 33,000 single-family and multi-family rental properties across 21 markets in North America, performed well in the third quarter, as the company reported quarterly results that reflected strong conditions in residential rental markets. Tricon enjoyed improvements in both occupancy and rental rates, which translated into increased profitability and cash flow generation. Moreover, the company has secured additional third-party capital commitments that will be deployed into new rental property investments and bolster fee income. Tricon is positioned to benefit from evolving real estate trends brought about by the COVID-19 pandemic and, yet remains attractively valued relative to its US-listed peers.
Shares in Sleep Country Canada (“ZZZ”), a mattress and bedding retailer servicing customers through 265 stores across the country as well as an e-commerce presence, appreciated in the third quarter lifted by operating results that exceeded expectations by a wide margin. The company’s impressive growth is being driven by strong same store sales, new store openings and growing e-commerce penetration. Moreover, we feel that continued progress will be driven by developing new channels of distribution, broadening the product offering to encompass “all things sleep”, and investing in marketing and analytics to drive additional market share gains.
Two stocks were significant detractors to performance in the third quarter of 2021
Shares in Sylogist (“SYZ”), a provider of software solutions for the education, not-for-profit and government segments, declined in the third quarter, as interim results lagged market expectations. Specifically, revenues during the period were negatively impacted by currency movements and lengthened sales cycles due to COVID-19 disruptions. While progress on new customer wins was slow in the quarter, retention of existing client relationships remained very sticky. We expect that management’s efforts to invest cash flows from a strong base business into product development, sales and M&A activity will ultimately translate into a more dynamically growing enterprise. Meanwhile, the company’s dividend remains well funded, its balance sheet is strong, and its valuation is attractive.
Shares in Absolute Software (“ABST”), an enterprise security software company empowering IT professionals to monitor and remediate security breaches of corporate devices and data, were weak in the third quarter, as the company released financial guidance that was conservative relative to market expectations. The guidance incorporated financial contributions from the sizable acquisition of NetMotion, a complimentary security software business which closed in July.
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 Canadian All Cap Fund delivered positive absolute and relative performance during the quarter, continuing to build on the solid results of the first six months of the year. Strong corporate earnings from key holdings in the technology, financials and consumer sectors contributed to the solid performance.
Two positions were significant contributors to performance in the third quarter of 2021
BRP’s (DOO) results continue to impress as the company is rapidly increasing manufacturing capacity to meet heightened demand for its side-by-side vehicles, personal watercraft, snowmobiles, and other power sports vehicles. Although consumer demand is difficult to forecast in the short term, the company’s sales visibility is high, with a great need to restock dealers’ low inventory levels. During the quarter, BRP launched with great dealer acceptance the Switch, a highly versatile pontoon that could prove to be another leg of growth for the Company. BRP has a strong record of product innovation in the industry, and we believe it should continue to gain market share over time.
Telus International (“TIXT”), which was spun out of Canadian telephony company Telus Corp in early 2021, provides digital information technology consulting services to customers around the world. TIXT is well positioned, with specific expertise in gaming, e-commerce, and financial technology. Telus is capitalizing on the fact that businesses everywhere wish to become more online-enabled, and to meet evolving customer demands. Second-quarter revenue growth of 36% topped investor expectations and helped drive the stock to new highs. TIXT is investing in artificial intelligence and data annotation expertise, which should help fuel its long-term progress. The company remains reasonably valued given its growth trajectory and has strong free cash flow. It is a top-ten holding in Pembroke’s Canadian All-Cap Fund.
Two stocks were significant detractors to performance in the third quarter of 2021
Shares in Franco-Nevada, a gold-focused provider of royalty and streaming financing solutions, with a diversified portfolio of producing, development, and exploration assets, were weak in the third quarter of 2021. While the company announced operating results that showed growth in underlying production, revenues, EBITDA and cash flow, fundamental progress was overshadowed by a weakening gold price environment, which sent shares lower. Although gold price weakness has a negative impact on operating results in the short-term, Franco-Nevada has a long history of flourishing in a variety of commodity price environments. In challenging gold markets, Franco leverages its clean balance sheet, project evaluation expertise and reputation as a trusted financial partner to participate in royalty and streaming deals where debt and equity financing are less available.
The shares of Cogeco (“CGO”) declined in the third quarter, despite solid fundamentals. There are a few reasons for this current situation. First, the company recently completed an additional acquisition in its U.S. business. There is some concern that the newly acquired assets are in competitive markets, where there is more than one video service provider. However, Cogeco’s success in Miami augurs well for the growth of these assets. Secondly, investors are worried about the company’s plans for Canadian wireless, where recent spectrum purchases are a sign of an imminent entry into the market. This also has large value creating possibilities, but there will be up front costs. Lastly, investors seem worried about the rate of cord-cutting in the U.S. Nonetheless, cable operators are very well positioned in the highly profitable Internet service business, which continues to grow and is more than offsetting any declines in the less profitable video business. Cogeco has one of the most conservative balance sheets in the industry and we believe the company should continue to grow.
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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.
