ON THE ROAD AGAIN Pembroke’s investment approach centers on backing skilled executives. Investing alongside accomplished management teams who understand their industries and have solid financial backing has been rewarding for the firm and its clients. The current portfolio includes holdings where Pembroke has followed a proven executive to a new company. The management team at Acadia Healthcare Company (“ACHC”), for example, helped build and sell Psychiatric Solutions before embarking on a new venture in the same industry. In our Canadian portfolios, the management team at Kelt Exploration (“KEL”) built and sold Celtic Exploration to Exxon Mobil, and now own almost 21% of KEL – which aligns their interests with those of outside shareholders.

In November of 2013, Pembroke visited with the management team of Sequential Brands Group (“SQBG”). The CEO, Yehuda Shmidman, had taken leadership of SQBG a year earlier at the behest of Bill Sweedler, the company’s Chairman and largest shareholder. Mr. Shmidman had an impressive track record, having been appointed as COO of Iconix Group at the age of 29.

Iconix is the “800 pound gorilla” in the brand management and licensing business with a market capitalization of US$1.6 billion. The company acquired the rights to established but underutilized brands (including Danskin, OP, Material Girl, and Starter) and built a highly profitable business that licenses those brands to manufacturers and retailers around the world. In many cases the brands have been revitalized, extended into new product categories, and taken to new geographies. In 2005, Iconix acquired the rights to Joe Boxer from Bill Sweedler’s investment firm, and Mr. Sweedler joined Iconix as an executive.

1 On the Road

3

The Biotechnology Investment Challenge

6 Just the “Facts”

7 Overview of the Quarter

16

Business Update

 

 

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Seeing the success of the business model, as well as the number of brands becoming available in a challenging retail environment, Mr. Sweedler decided to invest his capital into building a competitor to Iconix, which he called Sequential Brands Group. He selected Mr. Shmidman as well as SQBG’s CFO, Gary Klein, to lead this effort. Mr. Shmidman brought a powerful network of relationships to the new company. These relationships allowed him, along with his management team, to acquire established brands and quickly launch (or re-launch) them across new product categories, retailers, and geographies. Heelys, for example, is a global name in children’s footwear that incorporates a wheel in the sole of shoes. Under SQBG’s ownership, Heelys’ has grown into a lifestyle brand, expanding into categories such as wheeled bags, backpacks, and other back-to-school accessories.

Pembroke followed SQBG’s progress and was impressed by management’s record and encouraged by the high level of management and board ownership, which is in excess of 30%. In June 2014, the company acquired Galaxy Brand Holdings from Carlyle Group for approximately $260 million of cash and stock. Carlyle also obtained a board seat in the deal and has held on to its equity stake. The transaction gave Sequential the scale to better drive profitability and established the company as a major player in brand licensing. Through management’s contacts, Galaxy’s brands (such as Aviva and AND1) have moved into new product categories and secured important retail relationships.

Pembroke made an investment in SQBG after visiting management the company’s showroom in New York in November 2014. Subsequently, some investors became impatient with the pace of new product acquisitions and a downtick in the stock gave Pembroke a chance to add to its position. Share price volatility was not reflective of fundamentals but of investor skittishness and the lack of liquidity in this small-cap company. In April 2015, the company announced the acquisition of

a controlling interest in the fashion brand of pop star and celebrity Jessica Simpson. SQBG plans to take the Jessica Simpson brand global, to launch an e-commerce business, and take it into new categories. The share price of SQBG surged on the announcement.

 

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Management's goal is to grow existing brands at 8-10%, add new brands through acquisition, and drive profit growth at a high rate by leveraging the company's relatively fixed SG&A cost structure. The company does NOT control manufacturing or inventory, nor does it retail the products. It owns, manages, and licenses brands. Despite its current small size, EBITDA margins are expected to exceed 60% in the next twelve months.

Pembroke remains confident that management’s track record, combined with the backing of Mr. Sweedler and the Carlyle Group, gives Sequential Brands a long and potentially rewarding growth opportunity. Patience is required as good companies are not built overnight. By staying focused on the fundamentals and taking advantage of short-term volatility, Pembroke believes investing in SQBG is an example of how to generate superior long-term returns.

THE BIOTECHNOLOGY INVESTMENT

CHALLENGE Pembroke and many of its peers face an increasingly difficult dilemma as loss making companies represent a larger part of the market and have been outperforming profitable companies in recent years. Long-term oriented, fundamental analysis and portfolio management often guide experienced investors away from companies with little or no revenue or profit and a low probability of sustainable success. Yet the percentage of loss-making companies (by number of companies) makes up approximately one third of one of our benchmarks, the Russell 2000.1

A number of these loss-making companies are biotechnology companies that have materially out-performed the markets on an absolute and relative basis since 2008. During the past five years, the biotechnology stocks within the Russell 2000 have increased at an annual rate of 24.8% while the index has appreciated at a rate of 14.5%. This level of outperformance increased during the past twelve months, with the biotechnology sector increasing 40.1% while the index increased by 8.2% (all figures in US dollars as at March 31st, 2015). With this strong performance, the 143 biotechnology stocks in the Russell 2000 now represent 6.25% of the index, which is more than the Materials (4.34%), Energy (3.41%), Consumer Staples (3.17%), Utilities (3.51%) or Telecommunication Services (0.74%) sectors.

                                                            1 Furey Research Partners and FactSet Research

 

 

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Pembroke has chosen not to invest in the sector because the binary outcomes associated with pre-revenue biotechnology companies do not fit with our investment approach.

What is meant by a binary outcome? A biotechnology company will generally be valued on its most advanced or “lead” drug as that drug proceeds through successive stages of human clinical trials. At each of these three “Phases”, the drug may succeed (generally showing efficacy and safety) or fail (demonstrating some toxicity or fail to meet regulatory and scientific efficacy hurdles). There is no middle ground, thus the binary outcome. Over time it has been estimated that just over 1% of all drugs make it through all three phases, a process that can take over 10 years. The low rate of success and the long gestation period make this particularly risky for smaller companies. For large capitalization investors, the risk associated with binary outcomes can be partially offset by investing in companies that have a portfolio of drugs under development. Specialist biotech investors can own a large portfolio of binary risks. Neither is an option for Pembroke.

Biotechnology companies that succeed in the face of scientific and technical risks, are increasingly facing new headwinds from payers – both government and private – who ultimately pay for new drugs. Governments and insurance companies are increasingly contesting the price of novel drugs and their inclusion on formularies versus existing, and often less expensive generic drugs.

As the success of a drug trial is very difficult to predict, pre-revenue biotechnology stocks have a tendency of increasing in price very suddenly when there is good news. During 2014, there were 23 one day moves of 50% or more and 76 moves of 25% or more. Analysis by Furey Research Partners has shown that to successfully invest in the sector, one needs to own the biotechnology stocks that experience these unpredictable one day moves.

So, how do you catch the “pops”? Regardless of the analyst (Ph.Ds.’ and M.Ds. included), the knowledge of whether a drug will ever generate revenues is unknown until the U.S. Food and Drug Administration grants approval to market the drug. Understanding the strength of management or the potential demand is not nearly as important as it would be in other sectors. As the key is to know the outcome of the trials, which is virtually impossible, the best way to catch the “pops” is to invest in all the companies. This is an approach that works for passive index investors, but not for active managers such as Pembroke that make investment decisions based on fundamental research.

Pembroke is cognizant of the benefits (i.e., the final products) of the biotechnology industry as well as the potential reward for those who invest in

 

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successful biotechnology companies. However, many of the small to mid-cap companies in the sector do not meet our ownership criteria. They have little or no revenue or profit and very limited certainty of success. Even at Phase III only 54% of the drugs finally make it to market. We know of no meaningful way to analyze a drug’s ability to achieve success, in fact, even biotechnology company management teams have limited visibility into the final outcome.

Pembroke’s aversion to biotechnology has historically been additive to our returns as the sector outperformed only briefly during the early 1990s and again during the early 2000s. However, the most recent rally in biotechnology companies within the Russell 2000 has been in full force since 2008, and the funds managed by Pembroke have not participated in this rally.

While Pembroke is unable to identify attractive pre-revenue biotechnology companies, the firm has successfully focused on services and information technology related companies within the healthcare sector. In addition, Pembroke has recently invested in two companies focused on manufacturing and selling generic drugs. Pembroke believes that the risk profile in this area is lower than in pre-revenue biotechnology as the drugs are already approved, and the companies generally have many products in their stables.

In conclusion, Pembroke is not invested in pre-revenue biotechnology and is unlikely to change its approach.

 

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JUST THE “FACTS” Before providing qualitative comments on the quarter, we present some quantitative information regarding our top five Canadian and U.S. holdings which highlight what we believe are solid fundamentals.

Top Five Canadian Holdings March 31st, 2015

Company Q1 Price

Change

(CAD)

Revenue

Growth, Current

Fiscal Year

EBITDA

Growth, Current

Fiscal Year

Revenue

Growth, Next

Fiscal Year

EBITDA

Growth, Next

Fiscal Year

The Descartes 

Systems Group   11% 9% 16% 12%  15%

Stella‐Jones  22% 16% 29% 7%  12%

FirstService  38% 19% 38% 8%  11%

Performance Sports 

Group  17% 69% 141% 7%  12%

Gildan Activewear  14% 25% 25% 9%  22%

Average 20% 27%  50% 9%  14%

Source: Consensus and Pembroke estimates

Top Five U.S. Holdings March 31st, 2015

Company Q1 Price Change

(USD)

Revenue Growth,

Current Fiscal Year

EBITDA Growth,

Current Fiscal

Year

Revenue Growth,

Next Fiscal Year

EBITDA Growth,

Next Fiscal Year

BofI Holding  20% 44% n/a  33%  n/a

Virtusa   ‐1% 21% 26%  15%  21%

Actua*  ‐16% 62% 138%  25%  ‐14%

Gentherm  38% 12% 11%  13%  17%

WNS (Holdings)  18% 0% 16%  7%  1%

Average 12% 28% 48%  19%  6%

Source: Consensus and Pembroke estimates

*Formerly ICG Group, renamed in September 2014.

 

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OVERVIEW OF THE QUARTER North American small and mid cap equity indices increased in the first quarter. This is the second straight quarter in which small-caps have outperformed large-caps, after having underperformed in four straight quarters from the fourth quarter of 2013 to the third quarter of 2014. In the U.S., the strengthening currency acted as a headwind for many larger companies, leading investors to seek out investment in U.S.-focused businesses. Strong fourth quarter 2014 earnings reports and signs of an ongoing economic recovery helped fuel measured investor risk-taking. Canadian equities benefited from a falling dollar and the central bank's decision to lower rates. In particular, Canadian companies with U.S. revenues saw their stock prices rise. In the U.S. and Canada our companies continue to execute against their long-term objectives and are generally seeing per share improvement in revenue and earnings. Merger and acquisition activity continues apace as well-capitalized businesses take advantage of their financial strength and easy credit to make strategic progress. Type-font leader Monotype ("TYPE") added to its product suite by acquiring a company with strong emoticon technology. New holding GTT Communications ("GTT") added significant scale to its network through an accretive acquisition, sending its stock to new highs. Matador Resources ("MTDR") took advantage of its strong balance sheet to make a counter-cyclical acquisition of oil properties that will help de-lever the company's cost-structure by adding scale in a key geography. Finally, long-time holding Catamaran ("CTRX"), a pharmacy benefits manager, was acquired at a meaningful premium, helping highlight the value in Pembroke's portfolios - which is sometimes realized on a step-function (i.e., all of a sudden) rather than linear basis. Pembroke believes most valuations within its portfolios are reasonable relative to historical levels and, more importantly, relative to the growth rates of its holdings. A measure of volatility has also returned to equity markets, providing opportunities for long-term oriented investors. The team continues to find new investments across a range of industries through extensive travel and due diligence. Portfolio managers visited management teams in cities including Nashville, Los Angeles, New York, Washington, New Orleans, Chicago, Calgary, Toronto, and Vancouver in the first quarter. Pembroke remains positive on equity markets and on small/mid caps in particular, given that our holdings are delivering growth in per share metrics such as revenue and earnings, and given that we are still finding new investments that meet our criteria for growth, strong management, financial strength, and reasonable valuation.

 

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U.S. COMMENTARY

While generally pleased with the fundamental results of our holdings, we battled two undertows. The first was a market still driven upwards by sectors the firm avoids: biotechnology (this topic is discussed at length in this issue of Perspectives). Biopharma companies led the way again in the first quarter, accounting for 30% of the Russell 2000’s gain. In fact, leadership within the indices was generally very narrow, with only seven of the Russell 2000 index’s 24 sub-sectors outperforming the benchmark. The second was our holding in FXCM, a foreign exchange broker. When the Swiss Franc peg to the Euro was unexpectedly relinquished, FXCM suffered a loss that left it in violation of regulatory liquidity requirements. FXCM ("FXCM") is a New York-based foreign exchange broker that is led by one of its founders and until recent events, was led by a management team and Board that owned almost 50% of the outstanding equity. The company has a leading technology platform to facilitate foreign currency trading for individuals and institutions. It had a strong balance sheet, with over $300MM of cash and no debt, and was aggressively consolidating this fragmented industry. Currency volatility - which drives customer activity - was at a historically low ebb. Nevertheless, FXCM remained healthy and profitable. When currency volatility returned, the profit upside was judged to be significant. While the company extended overnight credit to its customers, FXCM management had guided the company through global crises including the Russian Ruble's collapse in 1998 and the 2008-2009 financial crisis without bearing any major losses. However, risk controls that worked for two decades of currency moves proved lacking in the case of the Swiss Franc. Customers were making highly leveraged trades with the Franc. When Switzerland’s Central Bank allowed its currency to free-float, the Franc soared and caused significant losses for some FXCM customers. The move was so fast that FXCM did not have an opportunity to hedge the risk. Though FXCM does not ultimately bear these losses, it stands behind its customers' trades on a short-term basis. Without the customer making immediate payments, the loss meant FXCM did not meet regulatory liquidity requirements and would be have to shut down. Forced to raise outside financing under extreme duress, Pembroke and other shareholders suffered massive dilution and the position was sold at a significant loss. Healthstream ("HSTM") shares fell after the company reported 2015 guidance that fell short of Wall Street's expectations. The disappointment was caused by accounting dynamics related to an acquisition rather than a fundamental shortfall. To put it in perspective, the company's revenue grew 29% in 2014

 

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and will grow at a faster rate in 2015. The inability of the market to see past the quarter took HSTM's share price down despite their impressive progress against long-term objectives. HSTM has established relationships with thousands of hospitals in the United States. The company employs a technology platform to deliver educational and testing material to its customers, allowing them to track whether they meet regulatory requirements and to benchmark their expertise against competition. HSTM continues to win new hospital customers and deliver new content within this core segment. The company is also taking its expertise to the long-term care facility market. This will require some near-term investments in technology and sales but expands its addressable market by approximately 30%. Finally, HSTM is beginning to bundle all the data it collects from customers into benchmarking and analytical tools which it can sell back into its customer base. The Founder/CEO of HSTM is not focused on meeting Wall Street's short-term metrics; instead, he is focused on leveraging his first-mover advantage, customer relationships, and technology platform to drive substantial shareholder value over the long-term. Two consumer discretionary stocks that suffered in the fourth quarter of 2014 for no fundamental reason bounced back in the first three months of 2015. Automotive parts supplier Gentherm ("THRM") rose within a few percent of its all-time high after delivering solid fourth quarter results and strong guidance for 2015. Sales of the company's climate controlled seats rose 22% in the fourth quarter indicating that customer demand for heated/cooled seats remains strong. Pembroke invested in THRM in 2006 and continues to see the company make strong inroads into new and higher volume automotive platforms. Shares in Carmike ("CKEC"), a U.S. theatre operator focused on smaller cities, have risen on the back of an improving film/attendance outlook after a difficult year for the industry in 2014. The company continues to drive per patron revenue higher, which should lead to improved profitability metrics, and management is confident that it can make accretive acquisitions. Shares in Carmike trade at a valuation discount to those of its peers, and Pembroke believes it is well-positioned to deliver good growth in 2015 and 2016. Shares in BOFI Holding, Inc. ("BOFI" - or "Bank of the Internet") rose to near all-time highs in the first quarter. BOFI operates without physical branches and therefore has a much lower cost structure relative to its traditional peers, while serving a nationwide audience. The company has successfully leveraged this cost advantage to generate significant loan and deposit growth, while maintaining a rigorous underwriting discipline. As a result, BOFI's return on capital and growth metrics are among the best in the industry. Pembroke has

 

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met BOFI's senior executives numerous times over the past several years. Insiders own 8.6% of BOFI shares, and as such are well aligned with other shareholders. We expect continued organic growth in 2015 and hope that BOFI will be allowed by regulators to consummate its acquisition of H&R Block's banking operations - a deal which is both accretive and strategically sound.

CANADIAN COMMENTARY

While many energy-related companies continued to suffer from low oil and natural gas prices, other Canadian companies are now seeing the benefits of a falling Canadian dollar. Outside of the energy sector and a small new holding in consumer staples, Pembroke’s portfolios saw positive contribution from all the major industry sectors in the first quarter. Information technology stocks led the way higher; however, the firm’s holdings in industrials, financials, and materials also provided a significant lift. The investment team continues to identify new ideas in the Canadian small cap universe. Once thought to be thinning out, the small/mid cap equity market - especially outside of natural resources - has seen a revival in new public offerings. The portfolio management team is closely monitoring its holdings in energy, with a view towards allocating weight within the portfolio to companies that are especially well-positioned to make strategic progress during this difficult part of the cycle. In information technology, two long-time holdings - Constellation Software ("CSU") and Descartes Systems ("DSG") - continue to make attractive acquisitions and deliver profitability growth. The runway for both remains significant and the management teams have proven to be adept at allocating shareholder capital. Within the industrial space, the firm's holding in DIRTT Environmental Solutions ("DIRTT") rose when the company reported much stronger than expected quarterly results. The technology driven company, which manufactures customized interiors for the non-residential construction market, saw revenues in the fourth quarter increase by 69% over those reported one year earlier. In addition to the office market, DIRTT is increasing its focus on the hospital market and will be launching a residential offering in June. Mr. Mogens Smed, the company’s Co-Founder and CEO is a dynamic entrepreneur, and the name of the firm stands for Doing It Right This Time. FirstService Corp ("FSV" in Canada and "FSRV" in the U.S.), a real estate services and commercial brokerage firm, announced that it would split the company into two separate businesses. The CEO, who founded the company

 

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and owns a significant amount of equity, determined that shareholder value would best be realized by allowing investors to value each segment separately and by giving each an unencumbered, independent currency with which to pursue strategic acquisitions. In combination with strong fundamental results, this decision sent FSV shares to new highs. Energy shares continued to struggle through the first quarter of 2015. Canyon Services Group ("FRC") and Canadian Energy Services ("CEU") saw their share prices fall as investors anticipated a slowdown in new drilling and exploration activity. Both companies provide fracturing services to oil and gas companies. Pembroke's energy experts continue to evaluate the services sector and are considering the risks associated with a prolonged downturn in activity. Shares in RMP Energy (“RMP”) fell after the company issued a year-end reserve report that was negatively interpreted by the market. Pembroke believes the reserve bookings were performed in a conservative manner and continues to back RMP as its strong balance sheet and well productivity will allow it to withstand the current difficult commodity price environment.

Shares in Diamond miner Lucara ("LUC") dropped as a result of a softening in diamond prices and in sympathy with the general malaise in the resource sector. LUC is extremely well-capitalized and has a history of extracting more and larger diamonds from its mines than most investors expect. Pembroke believes there is significant long-term upside yet to be realized, along with optionality from the possibility that LUC will extract large and extremely valuable diamonds on a periodic basis.

INTERNATIONAL EQUITY COMMENTARY

Pembroke’s international equity portfolio, the GBC International Growth Fund, posted a significant gain for the first quarter of 2015, in line with the Morgan Stanley Capital International (MSCI) All Country World ex-USA Small Cap Index. The Fund maintained its five-star rating from Morningstar.

Fund performance in the first quarter was broadly helped by markets hitting record highs. The European Central Bank unveiled its quantitative easing program which helped investor sentiment, major currencies continued to depreciate versus a soaring US dollar and growth stocks outperformed their value counterparts.

Strong stock selection was the driving force behind relative performance. Selection was generally positive across most sectors with Consumer Discretionary and Staples leading the way.

 

  12

Geographically, the Fund’s exposure to Japan was the most significant contributor (after hurting relative performance in 2014 due to low valuation style headwinds). Five of the top ten contributors for the quarter were from Japan, including Kose Corporation (“TYO: 4922”) and Pigeon Corporation (“TYO: 7956”).

Kose Corporation, Japan’s third largest cosmetic company, continues to see accelerated sales growth and beat earnings expectations. Pigeon Corporation, a baby care product manufacturer, reported strong operating profits as international sales continue to impress. Relative performance was also driven by stock selection and under-exposure to the Energy and Materials sectors.

Stock selection in Information Technology, Industrials and Emerging Market Asia detracted during the quarter. Underperformance in Information Technology was due to weakness in the Internet Software and Services industry while Building Product holdings caused Industrials to lag. Emerging Market Asia performance suffered as holdings in both China and India underperformed the market.

Exposures to the UK, Emerging Market Asia (Taiwan and Thailand) and Latin America (Mexico and Panama) were increased at the expense of Japan in the first quarter, largely reflecting company fundamentals and relative valuation opportunities. From a sector perspective, the Fund’s Consumer exposure and Industrials weightings were increased while Financials and Health Care holdings were reduced.

FIXED INCOME COMMENTARY

The investment grade GBC Canadian Bond Fund posted positive returns for the first quarter and underperformed the DEX Universe Bond index. The portfolio is defensively positioned from interest rate risk. The Bank of Canada’s surprise rate cut on January 21st lit a fire under the bond market. Yields fell across the board and bond prices rose. When it became apparent the Bank would “hold firm” at 0.75% as their target for the overnight rate in March, yields retraced a small portion of their January drop. Falling rates favor bond investors with longer durations and maturities. However, as rates approach zero, the greater interest rate risk appears to be on the upside. Long maturity Provincials and Infrastructure bonds were the market leaders. Shorter-term bonds with less interest rate sensitivity did reasonably well too.

 

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The portfolio’s foreign holdings were strong performers in the quarter; such as the Canadian dollar denominated bonds of Depfa ACS Bank, which rose on continued improvements in credit quality. Going forward the GBC Canadian Bond Fund has a yield in excess of the index and with bond yields at historical lows, the Fund is positioned with a shorter duration than its respective benchmark. This is a defensive position in the event rates rise. The investment grade portfolio ended the quarter with a yield to maturity of 2.1% and an adjusted duration of 4.6 years.

GROWTH AND INCOME COMMENTARY

The balanced GBC Growth and Income Fund, was flat in the first quarter and slightly underperformed its benchmark. No major changes were made to the asset mix, with equities representing approximately 66% of the portfolio. The fixed income component is primarily invested in securities rated “A+” that, on average, have a collective yield to maturity of 2.1% and adjusted portfolio duration of 4.6 years.

Income is generated from dividends and interest. The gross yield is currently an annualized 3.8%. The growth component of the portfolio stems primarily from the 35 dividend paying companies that are expected to appreciate in value over time. Sixteen names, representing 46% of the equity exposure, are also held in Pembroke’s standard growth portfolios. The holdings unique to this portfolio are generally less volatile, pay a substantial dividend, and are expected to grow their earnings at a more moderate rate. Companies are selected based on having an attractive well-funded, sustainable dividend as well as reasonable growth opportunities. Management quality and aligned interests with shareholders are also key investment considerations.

The Fund was negatively impacted by its exposure to the energy sector, which suffered from a drop in commodity prices. At the end of March, energy stocks accounted for 14.0% of the Fund, down from 16.3% at the beginning of the quarter. In addition, the lack of direct exposure to the healthcare sector, where Pembroke has not found reasonably valued small- to mid-capitalization holdings with stable to growing dividends, impacted relative performance in the quarter.

Three stocks made notable positive contributions in the quarter. New Look Eyewear (“BCI”), an optical retailer in Quebec and the Maritimes, performed

 

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strongly after it completed a sizeable acquisition. A combination of merger-related synergies, increased analyst coverage, and solid fourth quarter earnings resulted in a higher stock price.

Tricon Capital (“TCN”), a real estate asset manager and investor in North American residential real estate, rose following strong fourth quarter results and the purchase of a large portfolio of single-family homes in three U.S. states.

TECSYS (“TCS”), a supply chain management technology company with a focus on healthcare, reported strong results with record bookings and moved higher. This company, as well as others with U.S. revenues and Canadian dollar costs, has benefited from the weaker Canadian dollar.

Sylogist (“SYZ”), an underfollowed enterprise software vendor that operates in several vertical markets, saw its stock fall as costs associated with the acquisition of Serenic Software resulted in weaker than expected earnings. We expect many of these costs to be one-time in nature and are encouraged by the company’s longer-term prospects and disciplined management team.

AutoCanada (“ACQ”), an automotive retailer with significant exposure to Western Canada, saw its stock decline on weaker than expected guidance tied to sluggishness in the energy sector. While new car sales are expected to decline, the ongoing maintenance of the cars under warranty provides a solid base of revenue and profits for ACQ.

Pembroke continues to find attractive new opportunities for the GBC Growth and Income Fund, indentifying five new holdings during the first quarter. The new additions were broadly diversified and provide exposure to the financial, technology, industrials, and consumer discretionary sectors.

Our outlook for 2015 is constructive and supported by the results and guidance posted by many of the Fund’s holdings. The team continues to travel to monitor existing holdings and identify new opportunities. Valuations are not generally stretched within the Fund, and in the cases where they are, we are prudently trimming positions and recycling the proceeds into companies with a more attractive combination of yield and growth.

OUTLOOK AND CONCLUSION The past quarter and year has been frustrating for small/mid cap growth investors - Pembroke in particular. From a relative performance standpoint, our Canadian portfolios stand in stark contrast to our U.S. portfolios. In Canada we have benefited from our long-standing practice of sector diversification

 

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(relative to the heavily resource-weighted Canadian indices) and from our strong stock selection. In the U.S. both sector allocation and stock selection have worked against us, especially during the past two quarters. While this is a short timeframe for a firm that was founded in 1968, we still take the relative underperformance of our U.S. equity portfolios very seriously.

Pembroke avoids the biotechnology sector because it is subject to huge binary outcome risk (discussed at length in this Perspectives issue). Pembroke also generally avoids the semiconductor industry, as many small/mid cap companies in this space amount to product cycles masquerading as growth companies. Further, interest rate sensitive sectors including REITs and utilities, which do not meet our criteria for sustainable growth, performed well in the past 15 months. We might be forgiven for avoiding these sectors as it has been our announced long term practice. However, we are not pleased that several of our larger holdings marked time in 2014, or worse, announced poor fundamental results. Unfortunately, the collapse of FXCM during January masks excellent fundamental results in our U.S. equity portfolios and therefore generally improving stock selection and performance. Pembroke believes that the market-related and company-specific factors that have hurt our U.S. performance during the past two quarters have all held us back before at one time or another – but never all at the same time.

Our outlook for 2015 is constructive and supported by the results and guidance posted by the majority of companies in both our Canadian and U.S. portfolios. The first quarter of 2015 included many earnings reports that exceeded investor expectations by substantial margins. The team is travelling to monitor existing holdings and identify new opportunities. Valuations are not generally stretched within our portfolios, and in the cases where they are, we are prudently trimming positions and recycling the proceeds into companies with more upside potential. The growth rates of our top holdings are impressive, and we expect to be rewarded accordingly.

 

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BUSINESS UPDATE

RETIREMENT ANNOUNCEMENT

After twenty years at Pembroke, Michael Shannon has chosen to retire from the firm. He will be transitioning his responsibilities to other members of the team during the coming months and will then serve as an advisor. Mike has made a significant contribution to the firm as a Partner, Portfolio Manager, member of the Management Committee and friend. His sense of humour and intellect will be sorely missed.

Prior to working at Pembroke, Mr. Shannon was a small cap analyst at Burns Fry (now part of BMO Capital Markets). Mike joined Pembroke in January 1994 as a Portfolio Manager, focussed on both Canadian and U.S. growth stocks, and became a Partner in December of the following year. Mike also served as a Director of Pembroke Management Ltd. and Pembroke Private Wealth Management Ltd. Over the years he covered sectors including technology, healthcare and energy.

The Partners and employees of Pembroke wish Mike all the best in his future endeavours.

PAST EVENTS

William Thorndike: The Outsiders Pembroke recently hosted a second lunch with William Thorndike, a successful private equity investor and founder and Managing Partner of Boston based Housatonic Partners. Author of “The Outsiders", which discusses his insights regarding successful capital management, Mr. Thorndike examines eight companies that have created substantial shareholder value to understand the common characteristics of their unconventional CEOs, and what has allowed the companies that they lead to outperform the market and their peers by a wide margin. The most important characteristic he identified was the ability to allocate capital effectively over long periods of time. Knowing when to invest in the business, when to make an acquisition, when to pay a substantial dividend, or when to repurchase stock are critical. Patience combined with the willingness to take decisive action at the appropriate time were also key determinants of success. Pembroke believes that the messages contained in the book and conveyed during the lunch are important, so much so that we have sent a copy of the book to the CEOs of each of the companies held in our portfolios. Forbes magazine reviewed the book and a copy of that review can be accessed by clicking here.

 

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Jim Furey: U.S. Small Cap Market Strategist During March, Pembroke hosted a series of meetings with Jim Furey, Managing Partner and Chief Investment Strategist of Furey Research Partners, who provided an update on U.S. small-cap market trends and opportunities. Mr. Furey is a respected U.S. small-cap market strategist and this is the third time that Pembroke has invited him to speak since 2011. During previous presentations he highlighted why he believed that the U.S. market would move higher and why small cap stocks were attractive. In this most recent presentation, the core message remained unchanged. Rather than summarizing his presentation we will highlight just one of the many points he made.

In the past year the U.S. dollar strengthened significantly against most currencies and has appreciated by 14% to the Canadian dollar. This impacts the value of foreign revenues and profits of some companies and the competitive position of others. Mr. Furey made the point that smaller companies in the U.S. tend to outperform larger companies during periods of a rising U.S. dollar because they typically have less foreign sources of revenue. Looking at the past 40 years, Furey noted that smaller companies do particularly well as compared to large ones when the U.S. dollar is rising AND the economy is growing slowly. If the trend holds, Furey expects smaller companies to outperform larger ones in the year ahead.

Source: Furey Research Partners

While a strong U.S. dollar provides a relative boost for many smaller U.S. companies, the weak Canadian dollar helps smaller companies in Canada. This is because smaller companies in Canada often generate substantial revenues

 

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from international markets, including the U.S., while smaller companies in the U.S. tend to focus on the domestic market.

These comments apply to companies in general. Pembroke cautions that company specific analysis is required to determine whether a particular firm will benefit from currency changes.

If you are interested in a summary of Mr. Furey’s presentation, or a copy of slides, please contact your Pembroke representative.

UPCOMING EVENTS

Pembroke will be hosting a Manager Luncheon presentation discussing Fixed Income Opportunities in a Low Rate Environment on May 6th at the National Club in Toronto. Please contact us for additional details if you are interested in attending.

NEW ADDITION TO THE TEAM

Caroline Taylor joined the team in Toronto as a Client Services Associate. Caroline is a graduate of the University of Toronto with a Bachelor of Arts, Major in Economics and from Niagara University with a Bachelor of Professional Studies in Education. She is currently a CFA Level 1 candidate. Caroline has over 10 years of experience in the financial services industry and worked most recently at Scotiabank as a Senior Financial Advisor.

PEMBROKE IN THE COMMUNITY

Nicolas Chevalier, Partner and Portfolio Manager, was appointed to the Board of the Mental Illness Foundation in February. The Foundation offers outreach programs to schools to teach young people, parents and school staff to recognize the signs and symptoms of depression and to help refer someone in distress to appropriate resources. Since its establishment in 1998, their programs have touched close to one million teens across Quebec.

Candice Jay, Vice President & Branch Manager, and Stephen Hui, Partner &

Portfolio Manager, attended the Confederation of Greater Toronto Chinese

Business Association Gala on February 28th. This association is dedicated to

fostering a sustainable environment for Chinese businesses.

Sarah Cragg, Senior Client Relationship Manager, attended the Food Share: Recipe for Change Annual Fundraiser on February 26th, which raised $55,000. Food Share is a non-profit organization that works with communities and schools to provide food education and healthy food across Toronto.

 

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Pembroke is pleased to announce a new

acquisition to our art collection! The

landscape, entitled River Flow, was painted by Holly Friesen, a Montreal-

based artist.  

THE FIRM Pembroke Management Ltd. was founded in 1968 and is based in Montreal. Pembroke’s business and investment philosophy is rooted in the concept of ownership. Owners do what is in the long-term interests of their customers and stakeholders to maximize their own wealth. For this reason, Pembroke will more often than not back management teams that either own significant stakes in the companies they manage or whatever they own represents a significant part of their personal wealth. Furthermore, Pembroke tries to not take unnecessary risks in its investment portfolios because the Pembroke partners are large shareholders in the firm’s funds. The result is a powerful alignment of interests.

Pembroke is registered as an Investment Advisor in Quebec, Ontario, British Columbia, Alberta, Manitoba, the United States, Denmark and Ireland. The firm manages segregated portfolios for institutional and high net worth clients. Pembroke Private Wealth Management is a subsidiary of Pembroke Management and is a mutual fund Manager and Dealer for the GBC family of mutual funds and the Pembroke family of pooled funds.

PEMBROKE PRIVATE WEALTH CONTACT For additional information regarding Pembroke Private Wealth Management

please call us in Montreal at 514-848-0716 or 800-667-0716 or in Toronto at

416-366-2550 or 800-668-7383, or refer to our website www.pml.ca.

 

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DISCLAIMER The purpose of Pembroke Perspectives is to provide insight into our

investment philosophy, our current strategy, and how we manage our

portfolios. Pembroke Perspectives is not intended to provide specific

information about the firm and its activities. Any individual securities

mentioned in this report are for informational purposes only. Holdings are

subject to change at any time. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation

cannot be guaranteed. Information and opinions expressed are those of

Pembroke Management Ltd. Information is current as of the date appearing in

this material only and subject to change without notice. This information does

not constitute, and should not be construed as, investment advice or

recommendations with respect to the securities mentioned nor does it constitute an offering of securities or an offering of any kind. This version of

Pembroke Perspectives has been prepared for non-accredited investors.

Published on April 13th, 2015