US Growth Equity Strategy – Q3 Portfolio Commentary
The Pembroke US Growth Fund is a Pooled Fund. This is a prospectus-exempt product that is only offered to investors who meet the definition of an “accredited investor” under securities legislation.
Pembroke’s US equity growth mandates rose in the third quarter of 2020, performing modestly better than the Russell 2000 benchmark. During the first nine months of the year, the portfolios remain well ahead of the Russell 2000. The investment team wants to deliver strong results while remaining true to its strategy of investing in high-quality, shareholder-oriented growth companies. Measuring the portfolio’s characteristics on a holistic basis is therefore critical. We try to build portfolios that have less debt, offer faster revenue and earnings growth, and have superior shareholder alignment than the set of stocks comprising the benchmark (see Just the Facts).
Stocks in the consumer discretionary, information technology, and industrial sectors led the way over the past three months. The financial holdings also contributed positively, largely as a result of the takeover of long-time holding National General Holdings (“NGHC”) at a significant premium to the stock’s trading price the day before the announcement. Pembroke has long considered NGHC, a speciality insurer operating in the automotive and high-end home markets, undervalued and was impressed with recent fundamental performance. The attractive acquisition price offered by a strategic player reflects the fact that the stock market did not fully appreciate NGHC’s track record or growth prospects.
Two stocks made positive contributions during the quarter.
Installed Building Products (“IBP”), which installs housing insulation, rallied over the course of the third quarter. The company reported strong financial results in early August, benefiting from robust demand in its core single-family housing market and benign labor and raw material pricing. Profit margins expanded significantly, which helped demonstrate IBP’s long-term earnings power as a consolidator of this highly fragmented industry. Pembroke has a positive view of the US home market, which has been underbuilt since the 2008/2009 financial crisis. Signs of its health and resilience are becoming increasingly clear. Further, IBP is responding to a COVID-19 related trend which has been the accelerating migration of people from cities to suburbs.
Shares in Charles River Laboratories International (“CRL”), a leading pre-clinical contract research organization (CRO) servicing pharmaceutical and biotechnology firms globally, continued to rebound in the third quarter of 2020, hitting new all-time highs as the company posted strong second quarter earnings results and raised guidance for 2020. Its clients remain well-financed and are taking advantage of exciting scientific breakthroughs to research and launch new products. CRL has successfully transitioned from a provider of “overflow” testing capacity to its clients to one of their most critical and strategic partners. Headwinds related to COVID-19 have been much less severe than originally feared, and two of the company’s three business segments outperformed expectations while the third segment delivered satisfactory results despite the pandemic. CRL announced another acquisition in the quarter which should serve as a nice tuck-in and offer cross-selling opportunities. With its strong market leadership globally, a solid management team, and growing end market, CRL is well positioned to continue to grow over the coming years.
Two stocks made negative contributions during the quarter.
The shares of Albany International (“AIN”), a diversified industrial company operating in the paper and aerospace sectors, declined by 15.7% from the end of June through September. Despite delivering better-than-expected second-quarter financial results, AIN is affected by challenged aerospace demand. Moreover, management issued cautious second-half guidance for its high-quality paper and packaging machine clothing business to reflect the uncertain macroeconomic backdrop. Clearly, 2020 is a historically challenging year for commercial aerospace businesses, particularly those with Boeing 737 MAX exposure. That backdrop does not, however, change the fact that AIN offers highly innovative, industry-leading products that will help lower the weight and resulting fuel consumption of commercial aircraft. Importantly, the 737 MAX should regain regulatory certifications in the coming months. Given the advanced age of the global narrow body fleet, this aircraft should enjoy solid multi-year delivery growth. On the machine clothing side, as the world emerges from this recession, increased consumer and industrial spending will drive demand.
Shares in healthcare technology company HMS Holdings (“HMSY”) declined after the company posted lower-than-expected revenue and earnings for the second quarter of 2020. The company also lowered guidance for 2020, as its state government and large insurance customers delayed purchasing decisions for HMSY’s new population health management products. While the company’s coordination of benefits offering, which help insurers and states save money on improperly paid medical bills, remains market leading and highly profitable, management’s forays into adjacent opportunities have been challenged. The onset of COVID-19 further extended sales cycles and rendered the rate of future growth less clear. Despite these challenges, HMS is highly profitable, cash generative, and well-positioned to win mindshare with its new products.
CONCENTRATED GROWTH EQUITY STRATEGY – Q3 PORTFOLIO COMMENTARY
The Pembroke Concentrated Fund gained by 3.33% during the quarter, outperforming its benchmark the Russell 2000 Index which gained by 2.71% during the quarter. At the end of the quarter, the fund held 19 of the firm’s highest conviction investments; 17 US holdings and two Canadian holdings. Since its inception on January 31, 2018, the fund has posted a 12.9% annualized return compared to the Russell 2000 Benchmark’s annualized return of 0.2%, an excess annualized return of 12.7%.
A significant source of excess returns during the quarter was the fund’s zero weight in financials. Most financials, including banks and insurers, do not meet the concentrated fund’s stock selection criteria. During the quarter, Russell 2000 financials declined by over 4%; in the year-to-date, financials have declined by more than 27%. Another source of excess return during the quarter was the fund’s security selection in the information technology (IT) sector where five of the fund’s eight IT holdings advanced, two by more than 10%, while the benchmark’s IT sector holdings gained less than 1%. The fund’s zero allocation to energy also contributed to positive relative performance. Although three of the fund’s four industrial holdings gained during the quarter, the fund’s industrial sector performance was held back by turbulence affecting one holding in the aerospace industry.
Two stocks made positive contributions during the quarter.
Installed Building Products (“IBP”), which installs housing insulation, rallied over the course of the third quarter. The company reported strong financial results in early August, benefiting from robust demand in its core single-family housing market and benign labor and raw material pricing. Profit margins expanded significantly, which helped demonstrate IBP’s long-term earnings power as a consolidator of this highly fragmented industry. Pembroke has a positive view of the US home market, which has been underbuilt since the 2008/2009 financial crisis. Signs of its health and resilience are becoming increasingly clear. Further, IBP is responding to a COVID-19 related trend which has been the accelerating migration of people from cities to suburbs.
Shares in Charles River Laboratories International (“CRL”), a leading pre-clinical contract research organization (CRO) servicing pharmaceutical and biotechnology firms globally, continued to rebound in the third quarter of 2020, hitting new all-time highs as the company posted strong second quarter earnings results and raised guidance for 2020. Its clients remain well-financed and are taking advantage of exciting scientific breakthroughs to research and launch new products. CRL has successfully transitioned from a provider of “overflow” testing capacity to its clients to one of their most critical and strategic partners. Headwinds related to COVID-19 have been much less severe than originally feared, and two of the company’s three business segments outperformed expectations while the third segment delivered satisfactory results despite the pandemic. CRL announced another acquisition in the quarter which should serve as a nice tuck-in and offer cross-selling opportunities. With its strong market leadership globally, a solid management team, and growing end market, CRL is well positioned to continue to grow over the coming years.
Two stocks made notable negative contributions to returns during the quarter:
The shares of Albany International (“AIN”), a diversified industrial company operating in the paper and aerospace sectors, declined by 15.7% from the end of June through September. Despite delivering better-than-expected second-quarter financial results, AIN is affected by challenged aerospace demand. Moreover, management issued cautious second-half guidance for its high-quality paper and packaging machine clothing business to reflect the uncertain macroeconomic backdrop. Clearly, 2020 is a historically challenging year for commercial aerospace businesses, particularly those with Boeing 737 MAX exposure. That backdrop does not, however, change the fact that AIN offers highly innovative, industry-leading products that will help lower the weight and resulting fuel consumption of commercial aircraft. Importantly, the 737 MAX should regain regulatory certifications in the coming months. Given the advanced age of the global narrow body fleet, this aircraft should enjoy solid multi-year delivery growth. On the machine clothing side, as the world emerges from this recession, increased consumer and industrial spending will drive demand.
Shares in healthcare technology company HMS Holdings (“HMSY”) declined after the company posted lower-than-expected revenue and earnings for the second quarter of 2020. The company also lowered guidance for 2020, as its state government and large insurance customers delayed purchasing decisions for HMSY’s new population health management products. While the company’s coordination of benefits offering, which help insurers and states save money on improperly paid medical bills, remains market leading and highly profitable, management’s forays into adjacent opportunities have been challenged. The onset of COVID-19 further extended sales cycles and rendered the rate of future growth less clear. Despite these challenges, HMS is highly profitable, cash generative, and well-positioned to win mindshare with its new products.
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Disclaimer
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.
