Canadian Growth Equity Strategy – Q4 Portfolio Commentary
During the fourth quarter of 2020, Pembroke’s Canadian equity portfolios rallied, building on the gains that followed the market trough in March. News of the efficacy of several COVID-19 vaccines, combined with the continuation of stimulative policies adopted by monetary and fiscal authorities, stoked investor appetite for risk assets. While the course and duration of the pandemic remains uncertain and disruption of day-to-day life remains severe, markets are clearly looking beyond the current crisis and anticipating some “new normal” that will emerge.
The performance of Pembroke’s Canadian mandates was strong on both an absolute and a relative basis in the fourth quarter. Returns outpaced the S&P/TSX Composite and Completion indices. From an industry group perspective, the portfolio benefited from gains generated by consumer discretionary, technology, industrial, and financial holdings. Investments in the consumer staples and materials sectors posted modestly negative returns in the quarter, after having performed strongly earlier in the year.
On an individual holding basis, two stocks made significant additive contributions to returns in the fourth 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, rallied more than 210% in the fourth quarter. The company reported financial results that exceeded market expectations, buoyed by a recovery in volumes from COVID-induced slowdowns and an acceleration of deployment activity with a key partner, Volvo. Moreover, Westport is on the cusp of making inroads in the sizable Chinese markets, as efforts to commercialize its technology with engine manufacturer Weichai continue to progress. Finally, Westport is enjoying growing recognition that its technology is well positioned to play an important role in efforts to decarbonize the economy. We remain optimistic about Westport’s ability to capitalize on strengthening secular tailwinds driven by increasingly stringent vehicle emissions standards worldwide.
Shares in Tecsys (“TCS”), a provider of supply chain software, services, and solutions for the healthcare, retail, and complex distribution sectors, performed well in the fourth quarter as interim financial results highlighted accelerating trends in the company’s bookings, backlogs, and revenues. While the COVID-19 pandemic has been disruptive to some aspects of Tecsys’ operations, it has also underscored the vulnerability and fragility of the supply chain infrastructure and systems of many organizations. Tecsys is proving itself to be an industry leader and appears to be widening its lead over the competition in an environment of growing demand.
Two stocks posted declines that weighed on performance.
Shares in software consolidator Enghouse Systems (“ENGH”) declined in the fourth quarter of 2020 but remained up 28% for the year. Investors were disappointed that the company’s strong organic growth in the third fiscal quarter of the year, driven by videoconferencing and work-from-home products, was not repeated in the fourth quarter. Hopes for sustainably higher levels of organic growth led to a modest re-rating of the company’s valuation. Enghouse’s long-term success, however, has never been driven by organic growth. Rather, the company has proven adept at acquiring software businesses at attractive prices and significantly raising their profit margins. Critically, these acquisitions are funded from the company’s free cash flow and strong balance sheet. On December 31st, Enghouse announced a deal to acquire a Portuguese software company with $30M in revenue, demonstrating continued opportunities for additional tuck-ins. Further, management opted to pay out some of its excess cash in the form of a $1.50 per share special dividend.
Shares in Richards Packaging (“RPI-U”), a distributor of plastic and glass packaging, healthcare, and cosmetic products, pulled back in the fourth quarter after strong returns in the second and third quarters of the year. The company has been a significant beneficiary of COVID-related spending on sanitization and disinfection products in 2020 but anticipates some normalization of demand trends in 2021 as the pandemic runs its course. Despite the modest pullback in revenue levels expected in 2021, Richards remains in an excellent position to execute its strategy of acquiring quality businesses in the packaging, healthcare, and cosmetics distribution verticals and integrating them onto its platform. The company’s balance sheet has been bolstered by robust cash flow generation in 2020, giving it ample flexibility to pursue inorganic growth.
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.
The Pembroke Dividend Growth Fund posted gains in the fourth quarter of 2020, continuing the momentum since market lows in March. The emergence of effective vaccines against the COVID-19 virus buoyed equity market sentiment and lifted expectations for a gradual normalization of economic activity in 2021. Furthermore, stimulative policies implemented by fiscal and monetary authorities are being viewed by the market as sufficient to bridge the economy to a post-COVID world.
On a relative performance basis, the fund outperformed the S&P/TSX Composite Index, performed in-line with the S&P/TSX Dividend Aristocrats Index, and trailed the smaller-company oriented S&P/TSX Completion and Small Cap Indices during the quarter. Investments in the consumer discretionary, financial, technology, and industrial indices were the fund’s most significant positive contributors to performance in the fourth quarter, while holdings in the materials, communications services, and consumer staples sectors were in negative territory for the period.
Two stocks were significant contributors to performance in the third quarter of 2020.
Shares in Tecsys (“TCS”), a provider of supply chain software, services, and solutions for the healthcare, retail, and complex distribution sectors, performed well in the fourth quarter as interim financial results highlighted accelerating trends in the company’s bookings, backlogs, and revenues. While the COVID-19 pandemic has been disruptive to some aspects of Tecsys’ operations, it has also underscored the vulnerability and fragility of the supply chain infrastructure and systems of many organizations. Tecsys is proving itself to be an industry leader and appears to be widening its lead over the competition in an environment of growing demand.
Shares of Collectors Universe (“CLCT”), a leading provider of third-party authentication and grading services for high-value collectibles such as coins and trading cards, rallied to all-time highs in the fourth quarter after delivering strong financial results and subsequently receiving an all-cash bid to acquire the company. Collectors has recorded unprecedented demand for its services from consumers, who have engaged in the collecting hobby enthusiastically during the pandemic. While this surge in demand has been beneficial to short-term results, we remain convinced that the company has the longer-term opportunity to grow into attractive adjacent markets beyond authentication and grading, including transaction-oriented aspects of the collecting industry. We do not view the acquisition offer as sufficient and have publicly articulated our rationale for opposing the transaction. Click here to learn more.
Two stocks were significant detractors to performance in the fourth quarter of 2020.
Shares in software consolidator Enghouse Systems (“ENGH”) declined in the fourth quarter of 2020 but remained up 28% for the year. Investors were disappointed that the company’s strong organic growth in the third fiscal quarter of the year, driven by videoconferencing and work-from-home products, was not repeated in the fourth quarter. Hopes for sustainably higher levels of organic growth led to a modest re-rating of the company’s valuation. Enghouse’s long-term success, however, has never been driven by organic growth. Rather, the company has proven adept at acquiring software businesses at attractive prices and significantly raising their profit margins. Critically, these acquisitions are funded from the company’s free cash flow and strong balance sheet. On December 31st, Enghouse announced a deal to acquire a Portuguese software company with $30M in revenue, demonstrating continued opportunities for additional tuck-ins. Further, management opted to pay out some of its excess cash in the form of a $1.50 per share special dividend.
Shares in Richards Packaging (“RPI-U”), a distributor of plastic and glass packaging, healthcare, and cosmetic products, pulled back in the fourth quarter after strong returns in the second and third quarters of the year. The company has been a significant beneficiary of COVID-related spending on sanitization and disinfection products in 2020 but anticipates some normalization of demand trends in 2021 as the pandemic runs its course. Despite the modest pullback in revenue levels expected in 2021, Richards remains in an excellent position to execute its strategy of acquiring quality businesses in the packaging, healthcare, and cosmetics distribution verticals and integrating them onto its platform. The company’s balance sheet has been bolstered by robust cash flow generation in 2020, giving it ample flexibility to pursue inorganic growth.
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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.
