Q1'24 Micro Cap Value Strategy

Performance Review

The Pacific Ridge Capital Partners Micro Cap Value strategy (the “Strategy”) returned -0.8%* (-1.2* net of fees) during the first quarter ended March 31, 2024, underperforming the Russell Microcap® Value Index (the “Index”) return of 3.6%. For the twelve months ended March 31, 2024, the Strategy returned 19.1%* (17.4%* net of fees) versus the Index return of 19.0%.

The Strategy’s portfolio characteristics can be significantly different from the Index because we primarily invest in smaller, undervalued stocks and adopt a sector-agnostic approach. You can see these distinctions in the charts below.

Size Analysis

During the quarter, the Strategy received a moderate size tailwind where smaller companies in the Index outperformed larger ones. Stocks with a market capitalization below the $265 million Index median saw a return of 7.0%, versus a 3.0% return for stocks with a market capitalization above the breakpoint level. The Index had 16.5% of its weight below the median market capitalization level, while the Strategy had a comparatively higher 51.3% weight.

Style Analysis

The Strategy faced a moderate style bias headwind from unprofitable companies (stocks with a PE ratio less than 0x) that posted the best return in the Index of 11.4%. The Index had a 29.1% weight versus the Strategy at 13.1%. Additionally, suboptimal stock selection scores, particularly in unprofitable companies and profitable stocks with a PE ratio below 15x, further contributed to the overall headwind.

*P/E ratios are based on analyst estimates for the current fiscal year, including both completed and estimated quarterly results. Companies that have no earnings estimates have been excluded, and thus the bars may not add up to 100%.

Top Contributors

Top Detractors

Top Contributors

Heritage Insurance Holdings (“HRTG”) is a property and casualty insurer primarily based in the Southeast. The company reported another strong quarter following minimal weather losses. Results have improved significantly since insurance reform legislation in Florida was signed into law last year. The stock continues to trade at a modest multiple on earnings, though estimates have been steadily moving higher.

BuildABear Workshop (“BBW”) is a specialty retailer that offers an interactive “make your own stuffed animals” experience. BBW experienced a fourth quarter pullback in the shares related to concerns over weakening consumer demand going into the year-end holidays. Since then, the stock resumed what has been a strong upward trajectory over the past few years after a strong earnings report in March. BBW is simply a different animal (pun intended) than it was pre-pandemic, as evidenced by consistent higher profit margins and less seasonality. The shares remain attractively valued at less than 6x trailing operating income.

CRA International (“CRAI”), aka Charles River Associates, is a specialty consulting company that offers litigation, regulatory, financial, and management consulting services. This well-run company has posted consistent, mostly organic revenue growth over the Strategy’s nine-year holding period, with nice margin expansion and a more than sevenfold share price increase over that period. CRAI’s M&A practice group is currently benefiting from increased scrutiny of antitrust deals. Overall strong results are now garnering more attention and a fairer valuation from investors. Consequently, we have been trimming our position on strength.

AXT, Inc (“AXTI”) is a key maker of silicon-alternative semiconductor substrates, notably indium phosphide (InP) and gallium arsenide (GaAs). AXTI faced disappointing results for most of the past two years tied to working off elevated customer inventories following the pandemic, general industry slowness, and some impacts from US/China trade tensions. Recent and forward outlook results exceeded expectations due to InP demand from increased optical networking capacity driven by AI applications, the large potential demand for GaAs coming from power amplifiers, and micro-LED applications.

Hamilton Beach Brands (“HBB”) is a marketer of commercial and residential kitchen appliances, in addition to a growing business in the home medical appliance business. Like many consumer product companies, HBB shares experienced a decline over the past two years as government stimulus measures were gradually phased out and work from home mandates eased. However, its business is showing gradual improvement, including growth in sales and margin expansion. HBB shares are reflecting these positive trends.

Top Detractors

Metropolitan Bank Holding (“MCB”) is a business bank based in Manhattan, New York. The company has been the subject of controversy over the last year. Hedge funds and short sellers have tried to link MCB to the issues faced by other banks that have undergone turmoil. The recent stress experienced by New York Community Bancorp (“NYCB”) was the latest example of this unrest. MCB trades at only 6x ’24 estimates, has plenty of capital, and remains highly profitable.

Red Robin Gourmet Burgers (“RRGB”) is a family-friendly hamburger restaurant chain with just over 500 locations. The shares have gyrated since the Strategy’s initial investment just over a year ago, driven by factors such as food commodity prices and concerns over weakening consumer demand. Shares rose in the fourth quarter, then recently pulled back after results showed that new management’s turnaround efforts are taking time. We believe appropriate actions are in process, including a focus on the guest experience and food quality, while derisking the balance sheet via sale leaseback agreements.

Comtech Telecommunications (“CMTL”)  is a key provider of next-generation 911 (NG911) emergency systems sold to municipalities and a provider of highly secure wireless communication systems. The stock experienced a sharp decline following a recent unexpected CEO change caused by an undisclosed non-business-related issue. This led to delays in the filing of CMTL’s 10Q (now current) and debt refinancing efforts. Recent results show that the backlog is still strong and slightly growing, and defense spending on CMTL as part of a recent US government funding bill should help future revenues.

Kimball Electronics (“KE”) is a global outsourced manufacturer for automotive, medical, and industrial applications. After posting 35% growth in its June 2023 fiscal year, the current fiscal year is expected to be down slightly. Profit margins have contracted due to lower volumes and lack of absorption of new facilities. In addition to macro headwinds seen in competitors having greater sales declines, other impacts have come from lower-than-expected electric vehicle growth rates and a recall at a large medical customer. KE is well positioned for growth and margin expansion.

Manitex International (“MNTX”), a provider of highly specialized lifting and hauling solutions to niche end markets, reported slightly lower than expected fourth quarter results that broke a multi-period streak of beating estimates. Despite this, the outlook remains favorable due to strong demand for lifting equipment in traditional energy and mining end markets and the ramp up of infrastructure related projects. Margins should get a boost from better pricing, recent manufacturing productivity improvement efforts, and lower pass-through sales that carry minimal profit.

Market Outlook

Even in the face of a persistently inverted yield curve and ongoing inflation concerns, the US equity markets have reached record highs. At its second meeting of the year in March, the Federal Open Market Committee (FOMC) held the federal funds interest rate within the current target range of 5.25% to 5.50%, while projecting three rate cuts before the year end. The FOMC must time their rate cuts carefully. Any miscue could lead to a rise in unemployment and credit deterioration.

So far, the U.S. economy has been growing at a solid pace with a resilient labor market. The final result for fourth-quarter GDP showed an increase to 3.4%, above the second preliminary estimate of 3.2%. Looking ahead, while the overall projection for 2024 GDP is expected to decline to 2.1%, the trend is still positive. In March, the Institute for Supply Management’s PMI for manufacturing experienced growth for the first time in 18 months, reaching 50.3% compared to February’s 47.8%. Also, the services sector continued its expansion for the fifteenth consecutive month, registering 51.4% in March, albeit at a slower pace than February’s reading of 52.6%.

In February, the core PCE Index, which excludes food and energy, remained steady at 2.8%, matching January’s figure but still surpassing its long-term target of 2.0%. The Labor Department reported that the economy added 303,000 non-farm jobs, which accounts for approximately 80% of the U.S. workforce, surpassing expectations set at 205,000. The unemployment rate declined from 3.9% to 3.8% compared to the previous month. Additionally, U.S. wages experienced a 4.1% year-over-year increase in March, marking a decrease from the 4.3% growth observed in February.

The market outlook for this year reflects cautious optimism, as recent economic growth has been sustained in spite of a persistently inverted yield curve. The key driver of economic and market performance in 2024 is likely to be how well the Federal Reserve balances the risks to inflation, interest rates, and the economy. We keep a close eye on leading indicators that could potentially suggest a long-awaited downturn in employment or economic activity. Large-cap tech stocks have been a significant beneficiary of the market rally over the past several years. Should the economy and markets weaken, investors may become less speculative and more valuation sensitive. Presently, the Russell 2000 Value is trading at a price-to-earnings ratio (PE) of 12.6x for the next fiscal year, whereas the S&P 500 is trading at 21.8x PE for the same period. This significant discount of approximately 40% in small-cap value stocks makes them an attractive investment option with a history of strong long-term performance.

Disclosures

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. Pacific Ridge has been independently verified for the periods June 10, 2010 through December 31, 2023. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Micro Cap Value composite has had a performance examination for the periods June 10, 2010 through December 31, 2023. The verification and performance examination reports are available upon request.

The Micro Cap Value composite was created on June 10, 2010 and incepted on April 1, 2007. Performance from 2007 to 2010 is from portfolios managed at another entity. 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. Smaller capitalization equities have historically had greater volatility than large capitalization equities. 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. Composite dispersion is measured using an asset weighted standard deviation of gross returns of the portfolios included for the entire year. 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. It is not possible to invest directly in the Index.

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 time-weighted and 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. Performance-based fees are available upon request. All returns are calculated after the deduction of the actual transaction costs incurred during the period.

The fee schedule for separately managed accounts 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 of contributors and detractors to portfolio return as well as a complete list and description of composites and pooled funds, policies for valuing portfolios, calculating performance, and preparing GIPS Reports, all of which are available upon request by contacting Peter Trumbo, Chief Operating Officer/Chief Compliance Officer at (503) 886-8972 or Peter.Trumbo@PacificRidgeCapital.com.

GIPS is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Top and Bottom Performing Securities represent those security holdings that had the largest positive and negative total contribution to the portfolio return for the quarter. Top and Bottom Economic Sectors represent those sectors that had the largest positive and negative total contribution to the portfolio return. The holdings identified do not represent all the securities purchased, sold or recommended to clients.

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.