Manager Says Canadian Small Businesses Are Due for a Comeback

To reduce risk in the cyclical world of small-caps, Jeffrey Tory takes a longer-term, multi-disciplined approach when managing the gold-rated Pembroke Canadian Growth mandate. Tory is chairman and portfolio manager at Pembroke Management Ltd. in Montreal.

“I have this saying,” says Tory, “that the asset classes have cycles for sure. Small-cap Canada was in a bear market for a decade basically but it looks like it’s reviving now. Growth on the other hand has had a pretty good run, and value has been out of favour.”

Established in 1968, Pembroke Management specializes in small-to-mid cap growth equities for institutional and high-net-worth investors. Aligned with their shareowners, the partners are all owners in the shares of the management company and have over $100 million invested. 

COVID Effects Categorized
Early on, the investment team anticipated the impact of COVID. The managers held a meeting and classified their companies into four buckets: secular growth companies that probably wouldn’t be disturbed by COVID, companies that were perversely beneficiaries, buoyed by lockdown measures, for example, companies that became more cyclical, then businesses that were adversely affected, such as the REITs and some of the retailers.

In terms of the stock-picking “fishing pond,” the market cap in the small-and-mid cap space is approximately $200 million and not much higher than $2 billion for a new idea. The fund, launched in November 1988, is co-managed by Nicolas Chevalier and Stephen Hui.

To counter cyclicality, the 13-member investment team focuses on companies that grow their earnings, dividends and cash flow. “Even if we get the valuation wrong in terms of the entry point.” says Tory, “you are going to benefit over time with the growth.” 

Good Old Ideas Still Great
“The world’s changed,” says Tory, “but the idea of investing in small-to-mid-sized growing companies that have a good return on capital, strong balance sheets, run by people who have large stakes - that is still valid no matter how much the world has changed.”

Strong balance sheets, management alignment, and a company’s sustainability are also considered key stock criteria. A choice was also made to hold almost no debt in the portfolio. To boost risk management, in 2016, the firm hired someone from outside the company to act as the independent chief risk officer. The role adds further quantitative analysis and unbiased objectivity.

A few years ago, the team decided to tighten up and only own the highest quality companies, concentrating on approximately 40 names. Differing from some of their peers, the portfolio turnover ranges between 25% to 30%.

In positioning the fund, the research process includes talking to a company’s competitors, industry analysis, discussions among peers, and “a ton of interviewing,” says Tory. “Since March, I’ve probably done 400 management interviews, sitting here in the basement. The CEOs are stuck in their basements too and they want to talk.”

Top Canadian Picks
The largest holding, BRP Inc. (DOO), a Montreal-based company, specializing in snowmobiles and recreational vehicles has actually benefited from the pandemic. “We bought it at the IPO,” says Tory, “it was a modest grower, but clearly it’s been a spectacular success.” 

An example of a holding with little research coverage is Tucows Inc. (TC), a Toronto-based technology company in domain services and network access. Recently, the company has been building high-speed interest networks in small cities in the U.S. “The CEO’s grown a company,” says Tory, “that’s very profitable and produces a ton of free cash flow. He is building in cities where the competition has not invested as much, so there is a 10-year runway in building these networks.” In addition, the company is favoured for its great track record of capital allocation and continued growth. 

The holding, Colliers International Group Inc. (CIGI), a Toronto-based real estate services and investment management business, reflects the firm’s long-term investment horizon. The company is favoured for its strong brand, free cash flows and long-term potential for growth. “And the opportunistic part,” says Tory, “is that the stock got quite cheap because of COVID. The shares have suffered of course in 2020. but the table is set to do very well in 2021 and 2022.”

Another holding is Tecsys Inc. (TCS), a Montreal-based software company serving the logistics and healthcare industry. “It fell under the radar for many years,” says Tory, “but when you looked under the hood, this was an amazing Canadian-based software company. It trades at a fraction of the valuation of U.S companies, so it’s been a great performer.” As well, it will still be a great performer because the company is almost in a monopoly position in their sector in the healthcare supply chain, adds Tory.