US Equity Strategies

Pembroke’s focus on well-financed, profitable companies helped the US equity strategies navigate the difficult end to the last quarter as inflation and recession fears combined with a banking scare to drive markets lower.

The positive performance was driven by holdings in the industrial technology and consumer discretionary sectors, while the strategies’ modest exposure to two strong regional banks was a slight drag on performance.

Overall, the valuation set-up is compelling for investors taking a multi-year view. Many cyclical names are reflecting a recession, and secular growth companies have seen their valuations compress in conjunction with rising rates. Pembroke does not pretend to know where markets may head in the short term. However, we believe the growth characteristics, balance sheet strength and favourable valuations of many holdings bode well for the future.

US Growth Fund

The US portfolio rose in the first quarter of 2023 and outperformed the Russell 2000 index. Over the past twelve months, the portfolio is down, but has modestly outperformed its benchmark.

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

Shares of Monolithic Power Systems (“MPWR”), a leading designer of analog power management semiconductors, gained 42% in the first quarter of 2023, compared to the 3% gain in the Russell 2000 benchmark, and the 17% gain in the tech-heavy Nasdaq Composite Index. In the last quarter, MPWR benefited from a strong earnings and forward guidance report that reminded investors of the company’s tremendous secular growth potential. Furthermore, improving investor sentiment within the broader technology and semiconductor space buoyed shares after a particularly negative 2022 that saw the U.S. semiconductor index decline by 35%. Despite its strong move year-to-date, MPWR remains reasonably priced given its growth profile, quality characteristics and track record of execution. It remains a core U.S. holding for Pembroke.

Shares of Installed Building Products (“IBP”) gained 40% in the first quarter of 2023, compared to the 3% gain in the Russell 2000 benchmark. IBP is one of the largest installers of residential building insulation in the U.S. and, as such, is heavily dependent on new home construction. While 2022 was characterized by high levels of inflation, rising interest rates and fears of collapsing new home demand, 2023 has proved that years of pent-up demand, new household formation and favourable demographic trends trump higher mortgage rates. Demand for new homes is much better than feared and has led to solid investor interest in IBP shares. In the long term, our view is unchanged: IBP remains a high-quality compounder with significant multi-year upside potential.

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

Shares in Globus Medical (“GMED”) fell on news that the company would be acquiring Nuvasive (“NUVA”) in a transaction that would create the second-largest provider of spine surgery products. The market is skeptical due to struggles faced by other companies that have effected major mergers and acquisitions in surgical device markets. In Pembroke’s view, Globus is the best-run player in the spine surgery market, if not the entire medical device industry. It grows faster than its end market and operates at market-leading profit margins. The company has a long record of innovation, including the successful launch of a robot used in spine surgery. This robot has helped Globus steal market share from larger incumbents. The company is also launching new cutting-edge products and is pushing into new markets, such as trauma. Nuvasive has a proven sales force and unique go-to-market strategies that should complement Globus’ impressive record of innovation and engineering. The acquisition of Nuvasive offers several opportunities.

• Globus management believes it can raise the profit margins at Nuvasive from the mid-20s to mid-30s through cost cuts, manufacturing rationalization, superior raw material buying power and other synergies.
• Globus has a sales team focused on the east coast of the U.S., while Nuvasive is west coast centric. Therefore, the sales team overlap is minimal compared to prior deals in the spine surgery market.
• Globus will place its robot in the hands of the Nuvasive sales force, which should represent a large opportunity for Nuvasive to win market share with new and existing customers.
• Nuvasive is more established in the trauma sales market, but Globus has a more complete product suite; this combination of a strong sales force and superior product line-up should prove fruitful.
• Globus has also hinted that it expects sales force turnover to be minimal at Nuvasive, as Globus offers generous compensation packages to its successful sales executives.

While the short-term stock price action in a large holding such as GMED is disappointing, the combined company will be generating significant free cash flow and will have no net debt. With the drop in the share price, Globus is trading near the bottom end of the valuation range typically seen for profitable medical device companies. The upside versus downside equation is skewed in favour of long-term, patient investors. Pembroke has added to its position.

Shares in Seacoast Banking Corporation of Florida (“SBCF”) were weak in the first quarter of 2023 in the context of a widespread sell-off in the banking industry. SBCF is a provider of integrated financial services, which include commercial and consumer banking, wealth management and mortgage services. Its services are offered to customers through 50 full-service branches across Florida, as well as a digital platform. The banking sector was in turmoil in March with the failure of three American banks in rapid succession. While the failures of these institutions were driven by company-specific flaws that are not prevalent through the broader banking sector, they nonetheless triggered fears of financial contagion and of a potential outflow of deposits. Unlike the banks that failed in March, Seacoast has a well-diversified, granular deposit base, with no exposure to cryptocurrency. Moreover, Seacoast’s securities portfolio is predominately classified as available for sale, such that the company has been consistently marking to market the value of these investments and is not susceptible to a sudden erosion of its capital base should it need to liquidate them. While industry turbulence has compressed valuations and will pressure deposit costs in the near term, Seacoast remains well positioned to grow in tandem with a burgeoning Florida economy, while maintaining disciplined underwriting standards and conservative capital levels.

Concentrated Fund

Both the first quarter of 2023 and the trailing one-year period were favourable for the Pembroke Concentrated Fund, from an absolute and a relative perspective. The strong year-to-date performance was driven by our positions in the technology, industrials and communication services sectors, slightly offset by headwinds in several of our consumer discretionary and healthcare positions.

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

Shares of Monolithic Power Systems (“MPWR”), a leading designer of analog power management semiconductors, gained 42% in the first quarter of 2023, compared to the 3% gain in the Russell 2000 benchmark, and the 17% gain in the tech-heavy Nasdaq Composite Index. In the last quarter, MPWR benefited from a strong earnings and forward guidance report that reminded investors of the company’s tremendous secular growth potential. Furthermore, improving investor sentiment within the broader technology and semiconductor space buoyed shares after a particularly negative 2022 that saw the U.S. semiconductor index decline by 35%. Despite its strong move year-to-date, MPWR remains reasonably priced given its growth profile, quality characteristics and track record of execution. It remains a core U.S. holding for Pembroke.

Shares of Installed Building Products (“IBP”) gained 40% in the first quarter of 2023, compared to the 3% gain in the Russell 2000 benchmark. IBP is one of the largest installers of residential building insulation in the U.S. and, as such, is heavily dependent on new home construction. While 2022 was characterized by high levels of inflation, rising interest rates and fears of collapsing new home demand, 2023 has proved that years of pent-up demand, new household formation and favourable demographic trends trump higher mortgage rates. Demand for new homes is much better than feared and has led to solid investor interest in IBP shares. In the long term, our view is unchanged: IBP remains a high-quality compounder with significant multi-year upside potential.

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

Shares in Globus Medical (“GMED”) fell on news that the company would be acquiring Nuvasive (“NUVA”) in a transaction that would create the second-largest provider of spine surgery products. The market is skeptical due to struggles faced by other companies that have effected major mergers and acquisitions in surgical device markets. In Pembroke’s view, Globus is the best-run player in the spine surgery market, if not the entire medical device industry. It grows faster than its end market and operates at market-leading profit margins. The company has a long record of innovation, including the successful launch of a robot used in spine surgery. This robot has helped Globus steal market share from larger incumbents. The company is also launching new cutting-edge products and is pushing into new markets, such as trauma. Nuvasive has a proven sales force and unique go-to-market strategies that should complement Globus’ impressive record of innovation and engineering. The acquisition of Nuvasive offers several opportunities.

• Globus management believes it can raise the profit margins at Nuvasive from the mid-20s to mid-30s through cost cuts, manufacturing rationalization, superior raw material buying power and other synergies.
• Globus has a sales team focused on the east coast of the U.S., while Nuvasive is west coast centric. Therefore, the sales team overlap is minimal compared to prior deals in the spine surgery market.
• Globus will place its robot in the hands of the Nuvasive sales force, which should represent a large opportunity for Nuvasive to win market share with new and existing customers.
• Nuvasive is more established in the trauma sales market, but Globus has a more complete product suite; this combination of a strong sales force and superior product line-up should prove fruitful.
• Globus has also hinted that it expects sales force turnover to be minimal at Nuvasive, as Globus offers generous compensation packages to its successful sales executives.

While the short-term stock price action in a large holding such as GMED is disappointing, the combined company will be generating significant free cash flow and will have no net debt. With the drop in the share price, Globus is trading near the bottom end of the valuation range typically seen for profitable medical device companies. The upside versus downside equation is skewed in favour of long-term, patient investors. Pembroke has added to its position.

Shares of Stoneridge, Inc. (“SRI”), a producer of electronic components and control devices for global auto and truck makers, declined 13% in the first quarter of 2023, compared to a 3% gain in the Russell 2000 benchmark. Following a strong relative performance run in 2022 (SRI gained 9% compared to a 20% decline in the benchmark), the company re-encountered some of the supply chain management issues that it faced in 2021. Specifically, several of its key automaker customers in the U.S. and China temporarily ceased production in late December due to product or labour availability. While all customers had resumed production by the time of the earnings call, investors punished SRI in early March. Zooming out, SRI is poised to grow its production at two or three times the rate of the underlying market, with a robust incremental margin and return profile. We see compelling strategic value in this asset as its proprietary technology, strong market position, and favourable incremental margin structure point to significant earnings upside in the coming years.

 

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