During the second quarter of 2021, Pembroke’s Canadian equity portfolios built upon the gains generated earlier in the year. Investors reacted favourably to progress regarding the reopening of the global economy from COVID-19 lockdown measures, despite challenges with new variants and a third wave of infections.
While debates regarding emerging inflationary pressures, monetary policy and fiscal stimulus continued, market participants ultimately continued to embrace risk assets in the quarter.
Canadian Growth Fund
In the quarter that just ended, the Pembroke Canadian Growth Fund posted positive absolute returns. However, returns trailed the S&P/TSX Composite and Completion indices. Underweight positions in the energy and mining sectors were headwinds to relative performance, as were lagging returns in the fund’s technological and industrial holdings.
From an investment style standpoint, value stocks also garnered greater interest from investors than growth stocks. Moreover, several Pembroke investments that were strong drivers of performance in 2020 and in the first quarter of 2021 declined in the second quarter, negatively impacting returns.
Two stocks that made positive contributions to returns in the second quarter
Shares in Converge Technology Solutions (“CTS”) performed well in the second quarter as the company delivered interim results and forward-looking guidance that were well received by investors. The company, a reseller of technology solutions spanning the disciplines of cybersecurity, digital infrastructure, managed services, talent solutions, analytics and cloud computing, has been successfully implementing a consolidation strategy in the IT reseller market and outlined a five-year plan to expand the business. Moreover, the company is focused on growing higher-value-added offerings, which sport attractive margins and generate recurring revenues.
Shares in Trisura Group (“TSU”), a specialty insurance provider operating in surety, risk solutions, corporate insurance, and reinsurance markets, increased in the second quarter as investors digested outstanding interim financial results. The company’s Canadian specialty insurance business was strong, while its fast-growing US business is reaching critical mass and showing rising profitability. Trisura has a long runway for growth given its modest share in the sizable US market.
Two stocks that made negative contributions to returns in the second quarter
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 second quarter. Demand for Westport’s natural gas engine components is growing and expected to remain strong in the coming years, driven by continued regulatory-driven adoption of its high-pressure direct injection (“HPDI”) technology by European and Chinese heavy-duty truck makers. While the company has adequate capacity to meet demand in the near-term, the magnitude of the growth opportunity necessitated a capital increase to invest in additional capacity for the medium to long-term.
Shares in Sangoma Technologies (“STC”) declined in the second quarter as investors digested the company’s acquisition of Florida-based competitor Star2Star. Sangoma provides unified communications-as-a-service to its business customers, including telephony, collaboration software, and network connectivity. Prior to this deal, Sangoma management had an impressive record of acquiring niche competitors and technologies. Further, the company grew at a reasonable pace and operated at healthy profit margins. The acquisition of Star2Star was a step-out in terms of its size and valuation parameters. Investors, including Pembroke, now wait to see if the combined company can deliver accelerating growth and sufficient profitability to justify the acquisition price. Certainly, with recurring revenue representing over 70% of total sales and a larger sales force, the opportunity for growth is real.
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 positive absolute returns in the second quarter of 2021, continuing the positive performance that started in April 2020 following the rapid selloff at the onset of the COVID-19 outbreak. Investors are increasingly anticipating a normalization of economic activity following more than a year of lockdown measures as vaccination efforts are proving effective.
While new variants still loom as threats, market participants are turning their attention to the interplay between accelerating economic growth, monetary and fiscal stimulus, inflationary pressures, and interest rates in determining risk premiums.
On a relative performance basis, the fund trailed the S&P/TSX Composite and the S&P/TSX Dividend Aristocrats indices during the quarter after a period of outperformance in the year prior. The portfolio’s underweight positions in the energy and materials sectors weighed on performance, as did lagging returns from holdings in the information technology sector.
Two stocks that made positive contributions to returns in the second quarter
Shares of Information Services Corporation (“ISV”), a leading provider of registry and information services for public data and records, performed well in the second quarter as financial results and forward-looking guidance reflected strong demand in its registry operations. Furthermore, this strength was augmented by contributions from acquired service and technology solutions businesses, demonstrating management’s ability to harvest free cash flow from its core registry business and to redeploy the capital into adjacent opportunities.
Shares in CI Financial (“CIX”), a provider of wealth management, asset management and advisory services, delivered gains in the second quarter as investors digested strong financial results that validated management’s strategy of acquiring and integrating registered independent advisors in the US market. Expansion south of the border is allowing CI to extend its runway for growth beyond its mature Canadian roots. Moreover, the growth strategy is being executed without compromising other capital allocation priorities, including share buybacks, debt reduction and dividends.
Two stocks that made negative contributions to returns in the second quarter
Shares in Richards Packaging (“RPI-U”), a distributor of plastic and glass packaging, healthcare, and cosmetic products, declined in the second quarter as investors contemplated potential disruptions from a third COVID wave to the operations of certain cosmetic clinic customers, negative impacts of a stronger Canadian dollar on financial results, and a fall-off in COVID-related demand for sanitization and disinfection products from 2020 levels. Despite the modest decline in revenue levels expected in 2021, Richards remains in an excellent position to implement its strategy of acquiring high-quality businesses in the packaging, healthcare, and cosmetics distribution segments and integrating them in its platform. The company’s balance sheet has been bolstered by positive cash flow generation, giving it increased flexibility.
Shares in James River Group Holdings (“JRVR”), a specialty insurance underwriter focusing on excess and surplus policies, underperformed in the second quarter after raising equity to cover adverse claim developments in a discontinued commercial auto portfolio. Investors were disappointed with the negative impact to earnings and the resultant dilution to equity holders that was undertaken to address the charge and strengthen the balance sheet. We believe that there will be no further financial impact from the discontinued commercial auto portfolio, and that the company is well positioned to grow within the attractive excess and surplus niche.
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 posted strong absolute performance during the quarter, building on the solid results of the last twelve months. On a relative basis, the Fund underperformed the S&P/TSX Composite Index due to its underweight positions in the energy and mining sectors.
Two stocks that made positive contributions during the second quarter
Shopify (“SHOP”) was a beneficiary of the pandemic, as retailers around the world set up online stores using the company’s cloud-based software tools. Shopify’s content management, domain registrar, fulfillment services and other tools allow its 1.7M merchant customers to compete successfully against Amazon. Many investors feared a slowdown in the company’s growth trends in a post-pandemic world, as consumers returned to brick-and-mortar shopping centres. Shopify reported strong results during the quarter and cleared up the investor uncertainty regarding its growth trends, driving its share price to new highs. Shopify’s shares appear expensive, but the company continues to perform well.
Despite facing continued COVID-19 lockdown restrictions impacting store openings, operating hours and capacity, women’s apparel retailer Aritzia (“ATZ”) reported much better than expected sales and earnings during the quarter. The company pivoted quickly to enhance its online capability. As a result, Aritzia is emerging from this difficult operating environment in a stronger position than most of its peers. Building on its strength, Aritzia announced an accelerated expansion into men’s wear, with the acquisition of Reigning Champion, a designer and manufacturer of premium athletic wear. In the future, Aritzia will benefit not only from renewed consumer spending on apparel, but also from an increasing number of attractive real estate opportunities.
Two stocks that made negative contributions during the second quarter
Stella Jones (“SJ-T”), a manufacturer of pressure-treated wood products, reported solid results during the quarter, benefitting from strong demand and pricing for its residential lumber division, as well as robust customer orders for its utility pole and railroad tie products. The company also provided a favourable outlook for the rest of the year. Despite the positive news, Stella Jones stock trailed the rest of the portfolio during the quarter. We expect residential lumber prices to moderate over the next several quarters, and for the financial windfall of the current situation to be temporary. However, Stella Jones is building its resources for further acquisitions, and we are carefully watching to understand the implications of the railroad tie segment from CN’s purchase of Kansas City Southern.
The pandemic has driven demand for BRP’s (“DOO”) snowmobiles, personal watercraft and side by side vehicles. During the quarter, the company announced record sales and earnings. It also reported that keeping up with the strong demand was proving difficult. Despite this, many investors fear the current environment cannot get any better for the company. Perhaps reflecting these concerns, BRP’s stock declined 11% over the three-month period ending in June. However, management does not believe that peak demand has been reached, a view supported by the fact that dealer inventory restocking will only begin next year and that the company’s products continue to gain market share. On the back of this positive outlook and following the stock’s decline, BRP announced a $350M substantial issuer bid.
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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.
