Canadian Equity Strategies

October 2024

 

Canadian capital markets posted strong returns in the third quarter, as investors welcomed economic data that showed inflation moderating sufficiently to warrant a significant easing in central bank monetary policy.

While uncertainty about the strength of future economic growth, geopolitical tensions and the dynamics of the Canadian and US electoral cycles remain headwinds to sentiment, investors enthusiastically embraced the prospect of falling interest rates, pushing equity valuation multiples higher.

CANADIAN GROWTH STRATEGY

Pembroke’s Canadian Growth Strategy participated in the market rally in the third quarter. It delivered strong absolute returns over the period, driven by gains across all industry groups, with particular strength from holdings in the Consumer Discretionary, Real Estate, Industrials and Materials sectors.

The strategy benefited from the acquisitions of Sleep Country Canada and Hamilton Thorne at significant premiums, highlighting the continuing valuation gap between public and private markets, smaller and larger issuers, as well as Canadian and global companies.

On a relative basis, in the third quarter, the strategy underperformed large cap benchmarks, but outperformed small and mid cap indices. The portfolio’s underweight in interest-rate sensitive companies, such as banks or real estate investment trusts, and in precious metals, were headwinds to relative performance.

DIVIDEND GROWTH STRATEGY

Pembroke’s Dividend Growth Strategy also participated in the market rally in the third quarter, adding to a strong first half of the year. A falling interest rate environment was certainly constructive for yield-oriented equities, and the strategy saw significant positive moves in its Financial, Industrials and Consumer Discretionary holdings.

Similar to our Canadian Growth Strategy, our Dividend Growth Strategy benefited from the privatization of Sleep Country Canada at a healthy premium to prevailing public market valuations. This is the strategy’s third significant buyout in 2024. The investment team continues to look for new investment opportunities to redeploy capital into attractive companies that offer investors a balance of growth complemented by well-funded distributions.

CANADIAN ALL CAP STRATEGY

Pembroke’s All Cap Strategy posted strong absolute returns in the third quarter, continuing its 2024 trend. Gains over the quarter showed healthy breadth, with only the industrials sector posting modest declines. While the strategy’s Financials and other interest rate sensitive holdings rallied in a falling interest rate environment, relative performance lagged slightly due to the benchmark’s significant exposure to Banks and Utilities.

The Canadian All Cap Strategy focuses on entrepreneurial growth and this approach differentiates it from the broader Canadian indices.

POSITIVE CONTRIBUTION TO THE STRATEGIES

From a company-specific perspective, shares of Sleep Country Canada Holdings (ZZZ), Canada’s leading omnichannel specialty sleep retailer, were top performers in the third quarter, as the company agreed to be acquired by Fairfax Financial at a 28% premium to its pre-announcement closing price. We believed Sleep Country had plenty of runway to grow through market share gains, expansion into accessories, increasing online penetration and opportunistic acquisitions. However, we felt the offer price was reasonable given the near-term uncertainty in demand due to the negative impact of inflation and higher interest rates on consumer disposable income.

We exited our position in Sleep Country following the takeover announcement and redeployed the proceeds into other investment opportunities with a compelling risk/reward profile.

NEGATIVE CONTRIBUTION TO THE STRATEGIES

Boyd Group Services (BYD), one of the largest operators of company-owned collision repair centres in North America, underperformed in the third quarter. Volumes were negatively impacted by favourable weather conditions and conservative consumer behaviour, with customers postponing vehicle repairs. While these industry headwinds have resulted in challenging same store sales metrics throughout 2024, we believe they are temporary and that a normalization of repair volumes is on the horizon.

In the meantime, Boyd has continued to invest in growth, deploying capital in greenfield and brownfield expansions that should generate attractive returns on capital as they mature. In addition, the company remains well positioned to add repair centres through acquisition, a strategy that has been very productive over its history. With the shares trading at depressed valuation multiples, we believe the risk/reward equation is very attractive for Boyd investors. We are optimistic about the road ahead.

 

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