Canadian Equity Strategies

Pembroke’s Canadian equity portfolios have experienced challenging conditions in the trailing twelve months, and particularly in the past two quarters. While broader equity markets experienced continued momentum from the trough of the COVID-19 selloff in April 2020, growth-oriented stocks have sharply underperformed their peers since the third quarter of 2021.  

However, Pembroke’s portfolios continue to show fundamental progress measured by revenue and earnings per share growth, but recent returns have been held back dramatically by a contraction in valuation multiples in growth equities. 

While many cross –currents are buffeting the markets at present, fears of ratcheting inflationary pressures have been the primary culprit in the decline in multiples of growth stocks. Higher long-term interest rates have put pressure on the value of longer-duration assets, including Pembroke’s growth-oriented equities. 

Canadian Growth Fund 

The Pembroke’s Canadian Growth Fund faced a challenging market during the last twelve-month period and, particularly, in the past two quarters.* From an industry group standpoint, the Fund held significant weightings in the technology and consumer discretionary sectors, which underperformed in the prevailing economic environment. Moreover, the portfolios had only slight exposure to the energy and mining sectors, which posted very strong returns in the past twelve months, in tandem with surging commodity prices. 

Two stocks that made positive contributions to returns of the Fund over the past 12 months

Converge (“CTS”) is a North American and European IT reseller. It has proven to be a very adept consolidator in a fragmented industry. Over the course of 2021, the company made several accretive acquisitions, while building a solid beachhead in Europe.  The company has a disciplined acquisition model and can secure better working capital terms for its targets after acquisition. The company is also building a hybrid offering between the core hardware distribution and a fast-growing cloud software reseller that helps smaller companies access the IT talent needed for the implementation of core software offerings. The growth of this division is enhancing the overall financial profile of the company. Despite uncertainties around the supply chain and the economy, Converge is debt free and generating significant free cash flow, which can fund its ongoing acquisition program.

Women’s apparel retail Aritzia’s (“ATZ CN”) stock price posted solid returns in the last year, on the back of good results and an expanding stock multiple. Strong sales south of the border in both the online and bricks-and-mortar channels have increased investors’ confidence in ATZ’s ability to capitalize on the large opportunity in the US. With only 40 stores and a small e-commerce penetration, we believe the company should be able to grow for several years in that market. The Aritzia brand is gaining momentum, while the number of attractive real estate opportunities has grown due to a combination of competitors’ store closures, and Aritzia becoming a desired tenant due to its sales productivity.

Two stocks that made negative contributions to returns of the Fund over the past 12 months

Shares in Pollard Banknote (“PBL CN”), a leading supplier of instant scratch tickets and iLottery services to North American lotteries, were affected over the last twelve months by the combination of a slowdown of iLottery sales, and reduced profitability from supply chain-driven capacity constraints and inflationary price pressures in their key inputs, namely paper and ink. The iLottery segment has now stabilized and is growing again in 2022, with several state lotteries expected to adopt iLottery solutions over the next few years. However, the long-term fixed-price nature of their instant ticket contracts, which has historically offered investors visibility into a stable revenue stream, is limiting Pollard’s ability to pass on cost pressures to its customers and capitalize on a strong North American retail demand for lottery products. While the current inflationary environment remains an overhang over the near-term, the stock’s current valuation is far from demanding for the quality of the business.

We sold our position in Westport Fuel Systems (“WPRT”) in the first quarter following a difficult set of quarterly earnings and significantly reduced visibility on forward results. WPRT has suffered because of spiking energy prices. In general, their products become less economic as natural gas prices increase relative to diesel prices. This dynamic has hurt their European business and slowed the launch of a key growth platform in China. While we maintain confidence in WPRT’s long-term market opportunity and competitive advantage, we recognize that this commodity backdrop could persist and represents a challenging fundamental headwind. Furthermore, the termination of the company’s joint venture with Cummins compounds the risk potential.

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  gains in the trailing twelve months. The Fund’s performance was largely driven by capital appreciation, though dividend and trust income also contributed. The Fund’s returns, however, trailed those of the broader Canadian equity market indices. Holdings in the financial, real estate, industrial, energy and material sectors all delivered significant gains for the Fund, while investments in the information technology and communication sectors declined for the period.

The Fund’s underweight positions in energy and mining stocks were also significant drivers of relative underperformance, given the commodity-price fuelled rallies in those industries.

Two stocks that made positive contributions to returns of the Fund over the past 12 months

Tricon Residential (“TCN CN”) is a real estate company focused on single-family rental homes in the US. Over the past twelve months, a confluence of factors occurred, including growth in earnings which supported a strong stock price. The company also cross-listed its shares in the US markets and raised some capital at the same time, to increase its presence in front of US investors. The fundamental operating story powering earnings is based on the management’s strategy of identifying not only the attractive markets in which to buy homes but adding further scrutiny to establish which homes within those attractive markets are the most compelling. The technology and process that Tricon has built internally are a competitive advantage. This is manifesting itself in the form of higher rental growth rates when compared to the national average and the market averages to which they are exposed. Supply and demand dynamics also support future growth in rental rates and earnings. Migration from higher-cost cities (such as New York and Los Angeles), millennials reaching family formation age, and the inability to grow supply due to slow permitting and inflation on construction, support a favourable outlook for the business.

Shares in Topaz Energy (“TPZ”), a royalty and energy infrastructure company with a diverse portfolio of assets across Western Canada, performed well in the past year as the company benefited from buoyant underlying commodity prices, which bolstered its cash flow significantly. The company executed a series of opportunistic and timely acquisitions during the period. These acquisitions were completed at attractive financial metrics and allowed for several dividend increases, which were well received by the market. Moreover, Topaz has exposure to the Clearwater play in Alberta, an area that is emerging as one of Canada’s lowest cost and most prolific hydrocarbon basins. Topaz is in a strong financial position, with ample flexibility to fund dividend payments, while selectively deploying capital into additional growth opportunities.

Two stocks that made negative contributions to returns of the Fund over the past 12 months

Lifeworks (“LWRK”) has been a long-time holding for Pembroke. It is a leading North American pension benefits consultant, and a provider of employee assistance programs (EAP). After a strong start to 2021, the company reported two consecutive disappointing quarters in the second half of 2021. The reasons were related, in part, to a slight slowdown of the business, but more importantly to the rising costs associated with strong usage of the company’s mental health programs (Covid stimulated demand as people were under great stress).

Shares of Sylogist (“SYZ”), a provider of enterprise software solutions to the not-for-profit, education and government end markets, were weak in the past year in the context of a difficult equity environment for technology stocks. The company recruited a new CEO in late 2020, who has embarked on a campaign to bolster the company’s sales and marketing efforts in order to drive accelerating organic growth. While progress has been made in recruiting talent, solidifying relationships with customers, and closing on opportunistic acquisitions, organic growth has remained muted as pandemic disruptions have lengthened sales cycles.

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 showed positive results  on a trailing twelve-month basis but declined during the first quarter of 2022. The results can be attributed to solid contributions from several consumer staples and discretionary holdings, as well as good returns from securities in the financial sector. However, despite promising fundamental progress in our information technology holdings, money flows have moved away from high-growth stocks, causing their share prices to decline and their valuations to contract.

Two stocks that made positive contributions to returns of the Fund over the past 12 months

Women’s apparel retail Aritzia’s (“ATZ CN”) stock price posted solid returns in the last year, on the back of good results and an expanding stock multiple. Strong sales south of the border in both the online and bricks-and-mortar channels have increased investors’ confidence in ATZ’s ability to capitalize on the large opportunity in the US. With only 40 stores and a small e-commerce penetration, we believe the company should be able to grow for several years in that market. The Aritzia brand is gaining momentum, while the number of attractive real estate opportunities has grown due to a combination of competitors’ store closures, and Aritzia becoming a desired tenant due to its sales productivity.

Despite an operating environment muddled by pandemic operating restrictions, supply chain constraints and rising container costs, Dollarama (“DOL CN”) management continued their streak of exemplary execution. Over the last year, DOL posted sector-leading same-store-sales growth, and good margin performance, while applying excess free cash flow to share repurchases. The company also increased its potential store target in Canada to 2000, extending the runway for growth for the next ten years. The company also proceeded with the introduction of a new pricing tier with items priced at up to $5. All these elements contributed to strong stock price performance.

Two stocks that made negative contributions to returns of the Fund over the past 12 months

Shares in Shopify (“SHOP”), a digital platform that provides the infrastructure enabling e-commerce for over two million merchants around the world, declined over the last year amidst the market’s souring emotions on high-growth tech names, and the market’s growing concerns over inflation. Nevertheless, Shopify continued to perform well at an operating level. In 2021, Shopify added over 300,000 merchants and processed over $175 billion in commerce. The company continues to innovate in its product offering, launching products for point-of-sale (POS) payments, cross-border commerce, money management and global ERP programs. Shopify also continues to integrate with third parties, such as Walmart, TikTok, Facebook Shops and JD.com in China. These developments make it increasingly difficult for competitors to replicate and compete, further cementing Shopify as the leading platform. While the current inflationary environment may be a headwind for consumer spending, we believe the low level of e-commerce penetration globally, coupled with Shopify’s scale advantage, should allow the company to continue performing well in the long-term.

Shares in Telus International (“TIXT”) declined over the past year, despite the company’s strong revenue and profitability progress. Telus provides information technology consulting and services to companies around the world. The company’s customers are exposed to high-growth sectors, such as telecommunications and gaming, and are making significant investments in digital processes and automation. Despite Telus International’s expectations for strong organic revenue growth and EBITDA margins in 2022, investors appear concerned about rising wages and management’s ability to hire enough talent to meet demand. Thus far, TIXT has been up to the task. Furthermore, management’s decision to invest in sales and marketing is paying off with a funnel of opportunities. During the fourth quarter of 2021, it signed multi-year agreements with a US wireless carrier, an Australian software firm, a significant gaming company, and a leading American software developer. Given the compelling growth runway, a reasonable valuation, and a strong balance sheet, TIXT remains a large holding in the portfolio.

 

*Erratum: The originally published version of this sentence mistakenly mentioned that the fund “posted solid gains” during the trailing twelve months. The sentence was modified on May 9, 2022. 

 

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• See Our Products page for Pembroke’s range of funds.
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