After posting gains in the first three quarters of 2021, Pembroke’s Canadian equity portfolios declined in the fourth quarter, trailing broader Canadian equity markets, which ended the period in positive territory.
Markets were volatile through the quarter, as the emergence of the Omicron variant of COVID-19 added to ongoing challenges with supply chain disruptions, emerging inflationary pressures, and ever evolving monetary and fiscal policies. Moreover, market breadth was narrow, with returns tilted towards larger, liquid stocks, and more cyclical businesses.
Canadian Growth Fund
The Pembroke Canadian Growth Fund’s performance in the quarter was held back by declines in its technology and industrial holdings, which suffered from a combination of general sector weakness as well as declines in specific stocks. Moreover, modest exposure to cyclicals and larger weightings in less liquid stocks proved to be significant headwinds to relative performance.
Two stocks that made positive contributions to returns of the Fund in the fourth quarter
Shares in Colliers International (“CIGI”), a global provider of commercial real estate-oriented services and investment management offerings, performed well as the company reported better than expected interim financial results and raised its outlook for the remainder of the year. Colliers has seen business activity rebound significantly from pandemic-induced lulls. Moreover, the company is driving organic growth through geographic expansion, market share gains, broadening of its product portfolio, and general industry growth, as corporations increasingly outsource their real estate activities.
Shares in Airboss of America (“BOS”), a developer, manufacturer, and marketer of rubber-based products serving a diverse set of end markets, finished 2021 on a strong note as the company delivered significant volumes of personal protective equipment to government agencies, which bolstered financial results. Moreover, the company’s demonstrated ability to deliver large orders in a timely manner is leading to additional business, evidenced by significant announcements of new contracts. The COVID-19 pandemic has highlighted critical shortages of healthcare essentials throughout the medical supply chain, and governments are building stockpiles to address this issue.
Two stocks that made negative contributions to returns in the fourth quarter
Shares in MDA (“MDA”), a technology and service provider to the commercial and government space industry, were weak as supply chain disruptions pushed back the delivery timeline for one of the company’s significant projects, shifting a modest amount of revenue and profits from 2022 to 2023. The delay was outside of MDA’s control and has no impact on the ultimate value of the project to the company, but the slight reduction in guidance weighed disproportionately on MDA’s shares. Despite this short-term setback, the outlook for space-related spending remains strong. The commercialization of space continues to accelerate with declining launch costs, and geopolitical dynamics have major powers worldwide allocating resources to stake their positions in a new “space race”.
Shares in Goodfood (“FOOD”), a Canadian provider of meal kits and online groceries, declined as waning pandemic-driven demand coincided with cost pressures from labour shortages, food cost inflation, and operating expenses, all of which resulted in negative cash flow for the period. Moreover, management announced its decision to adjust the company’s business model to devote more resources to its online grocery business, thereby deemphasizing its traditional meal kit business. While online groceries represent a massive and fast-growing market, we believe that it is less attractive than the meal kit business given an intense competitive environment, structurally lower margins, and heavy capital investment requirements. Considering the heightened operational and financial risk that accompanied the shift in business strategy, we exited our position in the company.
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 fourth quarter of 2021, augmenting the strong results in the first nine months of the year. The Fund’s returns trailed those of the S&P/TSX Composite Index during the quarter. Holdings in the industrial, consumer, and financial sectors were the most significant contributors to performance in the period, whereas investments in the communication services, technology, and materials services were the largest detractors to performance.
The Fund’s underweight positions in the energy and materials sectors were also headwinds to relative performance, as investors favoured companies with greater cyclical exposure amidst optimism for widespread economic growth.
Three stocks that made positive contributions to returns of the Fund in the fourth quarter
Shares of Stantec (“STN”), an international professional services company in the design and engineering industry, performed well as the company issued solid financial results and reported backlog levels, which are indicative of encouraging momentum going into 2022. The company entered 2021 with balance sheet flexibility and a focused strategy. This led to the completion of six acquisitions, including the $620MM purchase of Cardno’s US and Australian assets. Moreover, the company’s organic growth prospects will be bolstered by President Biden’s $US 1.2 trillion infrastructure spending package. We remain optimistic about Stantec’s ability to pay a conservatively financed dividend to shareholders, while executing its organic and acquisition-driven growth initiatives.
Shares of Fairfax Financial (“FFH”), a holding company which, through its subsidiaries, is engaged in property and casualty insurance, reinsurance, and associated investment management activities, rallied as the company announced strong operating results driven by policy growth, solid underwriting performance, and gains in the investment portfolio. Moreover, the company is undertaking shareholder-friendly capital allocation actions, engaging in a major share buyback program, while partially divesting some of its insurance assets at attractive valuations.
Shares of PFB Corporation (“PFB”), a manufacturer of polystyrene-based insulation products used in commercial and residential building structures, rose as the company agreed to be acquired by The Riverside Company at a reasonable premium to the pre-deal closing price. While we were enthusiastic shareholders of PFB and optimistic about the company’s prospects to expand geographically, win market share, make strategic acquisitions, and grow its public company profile, we felt the acquisition offer was fair and a superior offer was not likely to surface. For these reasons, we sold our position in the company and reinvested the proceeds into other investment opportunities.
Two stocks that made negative contributions to performance in the fourth quarter
Shares of James River Group Holdings (“JRVR”), an insurance underwriter focused on specialty insurance, casualty reinsurance, and excess and surplus lines, were weak as the company announced adverse claims developments in its casualty reinsurance segment. These charges negatively impacted the company’s profitability and balance sheet flexibility.
Shares of Lifeworks (“LWRK”), a provider of human resource consulting and outsourcing services, were weak as the company reported quarterly results that disappointed the market. The company wrestled with a challenging sales environment. This external headwind coincided with increased usage of its counselling services, which increased costs and depressed margins. While short-term results were clearly a setback, we believe that demand for Lifework’s offerings will reaccelerate given an incredibly tight labour market, and an increasing focus on employee well-being and mental health. Moreover, the company’s dividend is well financed, and its shares are attractively priced at multiples well below its historical averages.
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 reported positive returns in the fourth quarter of 2021, building on the returns of the first three quarters of the year. Investments in the consumer and real estate sectors contributed positively to returns, while holdings in the industrials and communications services were detractors.
Canadian equity markets were up strongly during the quarter, on the back of accelerating economic growth. However, much of the strength was concentrated in a limited number of value stocks. Portfolio returns underperformed those of the S&P/TSX Composite Index, as investor liquidity moved into more cyclical value stocks, companies whose characteristics are typically not favoured by Pembroke managers.
Two stocks that made positive contributions to returns of the Fund in the fourth quarter
Shares of Aritzia (“ATZ”), a Canadian women’s apparel retailer, continued to perform well. Despite headwinds affecting store operations and the company’s ability to source and receive goods, Aritzia continues to post earnings above expectations. The company is experiencing strong sales momentum across both its online and bricks-and-mortar channels, reflecting a fashion-right merchandise offering, as well as growing brand appeal, particularly in the US where the company continues to be underpenetrated. With approximately 100 stores across North America, the company has an opportunity to grow for several more years. The stock performed very well in the fourth quarter and over the last eighteen months, reflecting fundamental progress in the business, and an expansion of its earnings multiple.
Shares in Constellation Software (“CSU”) continued their multi-year ascent. The proven software consolidator continues to effectively deploy its high free cash flow on acquisitions around the world, totalling approximately $1.3Bn in 2021. Furthermore, the company’s successful offering of shares in Topicus (“TCS”), one of its European segments, highlighted the opportunity for management to surface more value from within its portfolio in the coming years. Given the size of the acquisition pipeline and the company’s impressive free cash flow profile, there is little reason to believe that growth cannot continue at an impressive pace for the next several years.
Two stocks that made negative contributions toperformance in the fourth quarter
Shares of SNC-Lavalin Group (“SNC”), a company that operates as an integrated professional services and project manager, declined. Under a new management team, SNC-Lavalin continues to make progress in its transformation from an engineering and construction company to a lower risk, pure play, engineering, and design practice with strong ethical standards. Several steps were taken in 2021, including the exit from several geographic markets, the sale of the energy division and the early lifting of sanctions by the World Bank. However, SNC still needs to execute three lingering fixed price rail construction projects. As the company reported during the fourth quarter, these projects are facing cost overruns and delays due to the COVID-19 pandemic. SNC management has taken a conservative stance by fully recognizing these additional costs, despite potential contractual recoveries. The core engineering business continues to progress.
Shares of Cargoget (“CJT”), a company that provides time sensitive overnight air cargo services in Canada, were weak. The risk when we first added Cargojet to the portfolio was an optical/headline risk: that the anomalously strong 2020 results would not be repeated, and earnings would decline. We accepted that scenario on the basis of the multi-year supply/demand fundamentals that were looking increasingly favourable, i.e., a monopolistic position in Canada supplying overnight freight, increasing usage of air cargo as consumers shifted further their mix of purchases to online retailers, and international supply cratering as a result of commercial passenger traffic going away (which carries roughly half of global international air cargo). The thesis remains unchanged.
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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.
