Altus Group (“AIF CN”) provides software, data solutions, consulting and advisory services to commercial real estate (CRE) owners and investors. Its Argus software solution provides mission-critical tools to analyze and manage CRE assets and is the global standard in the industry, benefitting from the institutionalization of the real estate sector. In recent years, Altus has successfully transitioned its Argus software business from a license model to a more valuable subscription-based model with very high retention rates and subscription growth. Importantly, it is also expanding the reach of Argus from equity to credit, and capturing more of the value it creates. Its consulting and advisory services business is very profitable and continues to win more market share due to their superior data and expertise. Their aligned CEO views capital allocation like many in Pembroke’s wall of fame, and has a compelling plan and the execution skills necessary to drive growth for the long-term.
Castle Biosciences (“CSTL”) is the market leader in diagnostic testing for dermatological cancers, a dramatically underserved market with no well-established commercial genetic tests. It operates in an attractive industry as similar tests for indications like thyroid and breast cancer have reached very high penetration rates over the years and retained a dominant market share even after competitors entered the market. We see a long runway for growth as CSTL is less than 5% penetrated in its $2B addressable market, which we expect to more than double overtime as current pipeline projects mature. CSTL’s revenue is expected to grow at a 30% CAGR over the next five years with 2021 showing a significant revenue acceleration as dermatology clinic volumes rebound and the expanded coverage from Medicare increases ASP by 30%. The company has already embraced operational discipline even as an early commercial-stage company leading to best-in-class gross margins and positive returns on capital. A strong financial position with over $500M in net cash limits the need to access capital markets and de-risks our investment thesis. Pembroke believes that CSTL represents an attractive way to gain exposure to secular growth trends in cancer diagnostics with realistic take-out optionality.
Chart Industries (“GTLS”) is a global manufacturer of highly engineered products for the natural gas, clean energy and industrial gas markets. A leader in its segments, Chart utilizes proprietary technology for most of its products and as a result generates peer-leading margins and returns. The company is benefitting from numerous secular and structural advantages. Clean energy has moved from cottage industry to global mandate, and Chart’s broad portfolio positions it better than any other global manufacturer. The company is run by an aligned management team that is growing its recurring revenue streams, expanding margins, and smartly allocating capital for sustainable growth.
Danimer Scientific (“DNMR”) is the leading global producer of biodegradable, compostable plastic films, derived from renewable sources. DNMR employs proprietary technology licensed from Procter & Gamble Despite its leadership position, this is still a nascent industry measured in 10’s of millions of pounds as compared to the oil-derived hydrocarbon plastics market measures in 100’s of billions of pounds. DNMR is partnering with leading global consumer brands like Pepsi, Bacardi, and Mars/Wrigley who have committed to utilizing biodegradable, compostable materials by 2025-2030. Demand is outstripping supply by orders of magnitude. As such, Danimer can lock in pricing and volume commitments prior to production ramping. Furthermore, their feedstock costs are either passed through to customers or hedged thereby effectively eliminating commodity price fluctuation. The management team is well aligned and has done an impressive job of developing and commercializing the technology and engineering a production growth strategy.
Ollie’s Bargain Basement (“OLLI”) is one of the largest retailers of close-out merchandise and excess inventory in the United States. Through its long-standing relationships with consumer product companies, it purchases at bargain prices large volumes of brand-name goods no longer wanted because of product design or packaging changes, misestimation of demand, order cancellations or disruptions in supply chain. As a result, the Company offers these goods at up to 70% off other store prices. The in-store assortment frequently changes, providing a treasure hunt shopping experience. When customers see something they like, they buy it because when it is gone, it’s unlikely to come back! With only 400 stores, Ollie’s has significant white space ahead, particularly in the Southern and West Coast portions of the United States. The stores are highly profitable with estimated paybacks under two years. With a growing supply of low-cost second-generation locations and increased scale providing an even greater access to brand name merchandise, we believe unit economics and growth can be sustained for an extended period.
Sangoma Technologies (“STC”) offers unified communication systems to small and medium-sized businesses. Basically, the company provides services such as voice, data, videoconferencing, allowing end users to deal with one supplier rather than sellers of multiple points solutions. The communications infrastructure at many companies needs updating, offering significant greenfield for Sangoma. After steadily growing through organic means and measured acquisitions, the company announced the acquisition of Star2Star for over $400M in early 2021. Star2Star will dramatically expand the company’s sales force, indirect sales channel, and product suite, putting the company on a good footing to compete against larger players. Sangoma expects to increase its revenue growth while maintain profit discipline. As an underfollowed Canadian company, Sangoma trades at a significant discount to its U.S. peers. With a U.S. listing expected and growth acceleration likely post-merger integration, Pembroke believes Sangoma offers investors a chance to benefit from both operating progress and valuation expansion.
Tecsys (“TCS CN”) provides supply chain management software to the healthcare, distribution, and retail industries. The company has invested significantly in its technology base to build specific expertise in each of these verticals, leading to growing momentum in win rates and market share gains. Increasing supply chain complexities are driving companies in these sectors to replace antiquated legacy systems with cloud-enabled platforms; this is a thematic trend we expect to drive growth for several years at a minimum. Moreover, once installed, Tecsys’ platform becomes deeply integrated within the day-to-day operations of its customers, leading to strong revenue persistency and low churn. The company is led by its founders who retain a significant ownership in the business and are thus well aligned with other shareholders.
While seven names exited the portfolio this quarter, there were essentially two decisions. The first was to sell our high-valued, high-growth software names that benefited from significant valuation expansions in 2020 (Alteryx, Avalara, Descartes, Kinaxis, MongoDB and Paycom). As interest rates dropped to zero (and negative levels on an inflation-adjusted basis), these companies – our fastest-growing, longest-duration growth businesses – benefited the most.
That said, this was not a macro call. If the bottom-up, multi-year valuation work that we conduct on all our stocks pointed to additional upside, we would have held them all. The opposite was true. When we appropriately raised our discount rates and lowered our implied valuation multiples to levels more in line with likely interest rate environment, we could no longer justify inclusion in PCF. To be clear, these businesses remain high quality Pembroke stocks, they just fall below our top 20 best ideas.
We also sold Dolby Labs (“DLB”) to make room for another consumer retail exposed name, Ollie’s (as described above).
Other Articles Of Interest
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.