Q1'17 Micro Cap Value Strategy
The Pacific Ridge Capital Partners (“PRCP”) Micro Cap Value strategy rose 5.2%* in the first quarter of 2017, ahead of the -1.0% return for the Russell Microcap® Value Index (“Index”). Over the trailing one-, three-, and five-year periods, the strategy returned 46.6%*, 16.0%*, and 20.7%* (annualized), respectively, compared to the Index returns of 33.3%, 7.0%, and 13.6%. Since inception on April 1, 2007, the strategy has returned 11.9%* annually versus 5.0% for the Index.
The strong move in equity markets following the recent election has been attributed to several potential catalysts: lower taxes, fewer regulations, potential health care reform, and a stronger economy. The markets took a bit of a breather during the first quarter as investors struggled to reconcile ambitious campaign promises with the realities of governing, even with one party in control of both the White House and Congress. Recent meetings and discussions with various management teams have left us feeling optimistic about the direction of the economy. However, we recently came across research highlighting the growing gap between “soft” survey-based economic data compared to other indicators that are based on “hard” data such as industrial production and retail sales. This divergence has led to markedly different GDP growth forecasts, with the NY Fed estimating a solid 3% growth rate, while the Atlanta Fed is tracking closer to 1%. Whether it is divergent economic data, competing legislative priorities, or even whether the best picture winner was Moonlight or La La Land, the world appears to be awash in mixed signals.
As value focused investors with a bottom-up stock-picking approach, we are not dependent upon any specific macroeconomic outcome to outperform our benchmarks. Regardless of the pace of economic growth, whether it be a new economic boom, continued slow and steady growth, or a recession, we will continue to adhere to our proven value-oriented investment philosophy.
First Quarter 2017
For the quarter, the Micro Cap Value strategy delivered 620 basis points of excess return versus the Russell Microcap Value Index. We benefited from another quarter of size bias, given that smaller market cap segments outperformed larger ones. In the Russell Microcap Value, stocks with a market cap below $400 million returned 0.9%, while those with a market cap greater than $400 million fell 2.1%.
Within both the Index and our strategy, stocks with lower P/E ratios performed significantly better than those with higher P/Es. The strategy also benefited from being overweight in lower P/E stocks relative to the Index.
From a sector standpoint, the strategy’s strong performance in Information Technology contributed around 420 basis points of excess return versus the Index. However, poor performance in Consumer Discretionary detracted about 30 basis points versus the Index. The lack of exposure to the Real Estate, Telecommunications, and Utilities sectors within the strategy created a minor tailwind and resulted in 10 basis points of excess return during the quarter.
Industrials remained the highest weighted sector in the strategy at 29.9% and is the greatest overweight compared to the Index at 11.9%. The strategy’s holdings in the sector returned 0.6% in the period, compared to a 0.3% decline in the Index. The greatest contributor to performance in the sector was CAI International (“CAI”), with its shares returning 81.6% in the quarter. CAI, a shipping container lessor, rebounded in the first quarter following a difficult 2016, when its stock hit multi-year lows. Pricing in the industry began to firm following a long downward trend and excess capacity. Additionally, a rebound in general commodity prices and a slight uptick in trade activity contributed to strong performance. Despite the recent strength, we continue to find valuations in the container lessor space attractive.
P.A.M. Transportation Services (“PTSI”), a dry van truckload carrier, was the greatest detractor to returns in the Industrials sector, with its shares down 37.3% in the quarter. PTSI reported earnings that missed the lone estimate and forward estimates were subsequently lowered because higher costs are leading to lower margins. Overcapacity in the industry is making it difficult for PTSI to pass along rate increases to their customers. Despite the near-term headwinds, we will maintain our position as we look for industry fundamentals to improve and the company to benefit from the significant operating leverage in their business model.
Financials was the second highest weighted sector in the strategy at 26.7%, and had the greatest underweight compared to the Index at 40.7%. The strategy’s holdings in this sector increased 0.1% during the period, compared to a decline of 1.7% in the Index. Pacific Continental Bancorp (“PCBK”), a community bank operating in the Pacific Northwest, was the greatest contributor to returns in the sector, with shares up 15.6%. PCBK announced during the quarter that they agreed to be acquired by Columbia Banking System (“COLB”). While we consider the acquiring bank to be a high quality institution, we exited our position because the projected market cap of the combined institution exceeds our limits.
Bancorp (“TBBK”) was the greatest detractor to returns in the Financials sector, with its shares down 36.4% during the period. TBBK, a community bank headquartered in Delaware, is in the process of a slow earnings turnaround, but continues to battle credit issues with their legacy commercial loan book. We recently purchased the stock believing new management had a handle on their problem credits, but now that appears questionable after another sizable provision in the first quarter.
Information Technology was the third highest weighted sector at 26.0%, compared to 10.8% in the Index. The strategy’s holdings in this sector returned 20.9% during the period, compared to a 9.8% gain in the Index. Ultra Clean Holdings (“UCTT”) was the greatest contributor to returns in the sector, with the shares returning 73.9% in the quarter. UCTT, a developer and manufacturer of critical subsystems in the semiconductor capital equipment industry, has posted several quarters of strong results based on increased demand from their two largest customers. They are also on track to meet their 2017 guidance. Operating margins have rebounded from recent lows and appear to be headed towards the high single-digits.
Radisys Corporation (“RSYS”) was the greatest detractor to returns in the Information Technology sector, with the shares down 9.7% in the quarter. RSYS, a maker of hardware and software solutions for the wireless telecom industry, sold off during the quarter when they announced that 2017 guidance was below consensus. Management attributed the lower revenue guide to legacy business falling off more sharply than expected. On a positive note, the company continues to guide towards a strong year in their high-growth segments, though the market remains skeptical as to whether this will materialize over the second half of the year. At current levels, we feel the risk-reward is favorable.
As always, we continue to search for companies that demonstrate an ability to earn a fair return on capital. We welcome any questions or comments you may have, and thank you for your continued support.
Pacific Ridge Capital Partners
*Returns are preliminary
Note: Sector weights for the strategy and Index are the average for the period
Pacific Ridge Capital Partners, LLC (“Pacific Ridge”, “PRCP”, or “the Firm”) is a 100% employee owned investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940. The Firm was established in June 2010, and has one office located in Lake Oswego, Oregon. Pacific Ridge claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. PRCP has been independently verified for the periods June 10, 2010 through December 31, 2016. Verification assesses whether (1) the Firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the Firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The Micro Cap Value composite has been examined for the periods June 10, 2010 through December 31, 2016. The verification and performance examination reports are available upon request.
The Micro Cap Value composite was created on June 10, 2010. The Micro Cap Value composite comprises fully discretionary portfolios managed by the Firm invested primarily in a concentrated equity portfolio of smaller companies with market capitalizations similar to those found in the Russell Microcap® Index. The strategy ascribes to a disciplined bottom-up fundamental selection process with an emphasis given to the cash flow generating capabilities of a company. The strategy’s objective is to outperform the Russell Microcap® Value Index which is used as our benchmark. Eligible portfolios must be managed for a full calendar month prior to inclusion in the Micro Cap Value composite. Prior to June 10, 2010 the performance represents the track record established by the Portfolio Management Team while affiliated with prior firms. The portability of the prior track record has been reviewed by Ashland Partners & Company LLP. Composite dispersion is measured using an asset weighted standard deviation of returns of the portfolios. Returns and asset values are stated in US dollars.
The Russell Microcap® Value Index measures the performance of the microcap segment of the U.S. equity market. For comparison purposes, the index is fully invested, which includes the reinvestment of income. The return for the index does not include any transaction costs, management fees or other costs.
Sources: Pacific Ridge; FactSet Research Systems (“FactSet”); and Russell Investment Group (“Russell”) who is the source and owner of the Russell Index data.
Returns for the Micro Cap Value composite are presented gross and net of management fees and other expenses and includes realized and unrealized gains and losses, cash and cash equivalents and related interest income, and accrued based dividends. Net returns are calculated by deducting the highest annual management fee of 1.50% from the quarterly gross composite return. All returns are calculated after the deduction of the actual trading expenses incurred during the period.
The management fee is a flat rate of 1.50%.
The portfolio characteristics, sector weightings and attribution analysis for the Micro Cap Value composite are based on a representative account within the strategy. The representative account statistics are shown as supplemental information. The Firm maintains a complete list and description of composites, policies for valuing portfolios, calculating performance, and preparing compliant presentations which are available upon request by contacting Peter Trumbo, Chief Compliance Officer at (503) 886-8972 or Peter.Trumbo@PacificRidgeCapital.com.
Top 5 and Bottom 5 Performing Securities represent those security holdings that had the largest positive and negative total contribution to the portfolio return. Top 3 and Bottom 3 Economic Sectors represent those sectors that had the largest positive and negative total contribution to the portfolio return.
In order to maintain consistency when comparing the Micro Cap Value strategy to the Russell benchmark, the Firm utilizes FactSet’s outlier methodology calculations which provide a comparable portfolio characteristic calculation methodology as Russell applies to its indices.
The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in our strategy at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any of the holdings discussed herein were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Past performance is no guarantee of future results.
Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.