US Equity Strategies

Pembroke’s US strategies, along with the broader financial markets, have come under significant stress in 2022. Multi-decade highs in inflation have led the Federal Reserve to quickly boost interest rates, engage in quantitative tightening and signal that additional restrictive policy is forthcoming.

Inflation is now the enemy, and the Fed is committed to bringing the currently elevated levels down in the near future, even if that causes a recession. It is this inflation, interest rates and recession dynamic that pressured markets and our funds in the second quarter of 2022.

This is not the first time Pembroke has experienced a macro-induced sell-off in its more than 50 years in business. Consistently timing the market or “calling the bottom” is nearly impossible.

Instead, we remain focused on bottom-up, fundamental research of high-quality, well-financed growth businesses. We intentionally pick stocks with fortress balance sheets, differentiated competitive positions, and superior growth outlooks that should enable strong returns over the long-term.

Furthermore, Pembroke is back on the road, literally and virtually, interviewing our portfolio holdings and prospect companies, and identifying areas of opportunity.

US Growth Fund

Following strong performance in 2020 and 2021, Pembroke’s US Growth Fund has declined year-to-date and underperformed its benchmark, the Russell 2000. However, the Fund gained ground on a relative basis versus the Russell 2000 in the second quarter of 2022 and similarly remains ahead of its benchmark over the past 12 months.

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

International Money Express (“IMXI”) is a leading participant in the international remittance industry. The company has built a successful business competing with the likes of Western Union and Moneygram. They have gained market share by focussing on a “neighbourhood” based marketing strategy, which targets agents in areas where there is a high concentration of foreign and immigrant workers who use their services. They have also adopted an omni-channel strategy to address the changes caused by the newer digital payment methods. The results over the past two years have been good, as the company continues to gain share in its core Latin American markets. Despite the rally in the share price, the shares remain inexpensive.

KBR (“KBR”) is a government services contractor with expertise in providing everything from training to space launch preparedness schedules and energy transition advisory solutions. KBR is another company that has been awarded a meaningful contract in the past year. They delivered as expected and have leveraged that credibility to further their reputation by winning a large contract to manage the relocation of US military personnel. This is a nine-year contract that adds substantially to the earnings profile and visibility of the company. Sentiment on the name has also held up well given the view that the government agencies KBR is exposed to have budgets that are increasing in the current environment. Finally, it is a business that is nearing the end of an exit from large contracts with construction exposure. As the last of these contracts substantially winds down in 2022, the company deservedly is worth a higher valuation given the absence of construction risk and a better visibility. We continue to be satisfied with this management’s execution and remain as shareholders.

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

Kornit Digital (“KRNT”) is an Israel-based manufacturer of digital printers for the textile industry. They also provide the ink consumables and have been at the leading edge of technology as the garment industry transitions from analog screen print to digital. The execution has been strong in the last few years: the company nearly tripled revenue since 2017. The management team also set aggressive sales targets going out to 2026. The valuation became expensive in the second half of 2021 and, on multiple occasions, Pembroke took the opportunity to reduce the weight. Despite the fundamental progress and the size of the eventual market opportunity, we determined that the near-term numbers did not fully justify the multiple ascribed to the shares. The first leg down on the stock came at the end of 2021 and into 2022, as the market took a harsh view on high-growth companies with high valuations and little near-term earnings support. This was further magnified by company guidance for the second quarter of 2022, which disappointed investors. While the long-term opportunity for the market continues to exist, we have hesitation concerning the competitive environment and have chosen to redeploy the weight into other holdings in which we have a higher degree of confidence.

Trex Company (“TREX”), a manufacturer of composite decking products, is a long-time Pembroke holding that had positive developments over the last year. Given strong demand for its products, the company announced the addition of a third production site, less than a year after the completion of a 70% capacity expansion project. Trex management wishes to stay ahead of demand and accelerate share gains after operating in a capacity constrained environment in the last 18 months. Industry demand for decking products remains strong as more and more consumers embrace outdoor living. Additionally, Trex has been gaining market share at the expense of wood alternatives. Despite these positive news, Trex’s stock has declined precipitously since December, along with other housing-related stocks. Part of the reason for this is that investors fear higher inflation and rising interest rates will hinder demand for home renovation products, such as those supplied by Trex.

 

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