Q1'22 Small Cap Value Strategy

Small Cap Value Performance Review - First Quarter 2022

The Pacific Ridge Capital Partners Small Cap Value strategy returned -8.3%* during the first quarter ended March 31, 2022, underperforming the Russell 2000® Value Index (“Index”) return of -2.4%. 

The strategy’s portfolio characteristics can be significantly different from the Index because we generally invest in smaller-sized and lower-valued stocks, as well as being sector indifferent. This difference is depicted in the charts below.

Size Analysis

The strategy faced a moderate size bias headwind during the quarter, as smaller companies in the Index underperformed larger companies. Those with a market capitalization below the $1,068 million Index median posted a -4.5% return, versus a -2.0% return for stocks with a market capitalization above the breakpoint level. The Index had 83.9% of its weight above its median market capitalization level and 16.1% below that level.

Style Analysis

The strategy benefitted from a moderate style bias tailwind during the quarter as unprofitable companies in the Index significantly underperformed profitable ones. The strategy held 2.3% in stocks with forward PEs lower than 0x compared to 10.0% in the Index. The strategy also benefitted from a slight style value bias tailwind by virtue of being overweight in profitable stocks with PEs 0 - 15x, which returned -0.1% in the Index. Offsetting these tailwinds, the strategy had negative stock selection scores during the quarter, particularly among holdings in the 0 – 15x PE range.

Sector Analysis

The strategy benefitted from a moderate sector tailwind during the quarter by being significantly underweight in Health Care, which returned -12.6% in the Index. On the other hand, the strategy faced a moderate headwind in both the Information Technology (IT) and Energy sectors during the quarter. The strategy was overweight in IT, which returned -8.8% in the Index and underweight Energy, which returned 44.3% in the Index.

Portfolio Characteristics (as of 3/31/22)

Top Contributors*

Frontline, Ltd. (“FRO”) owns and operates a fleet of oil tankers. The stock performed well with the expectation that the Russian invasion of Ukraine will move oil tanker rates higher. This comes on the heels of a subtle recovery in the tanker market that surfaced during the fourth quarter 2021. Historically low tanker order bookings and increased scrapping of older ships should continue to improve the tanker supply picture, leading to continued increases in day rate fees.

Twin Disc, Incorporated (“TWIN”), a manufacturer of power transmission equipment, reported strong revenue growth in the December quarter of 2021 as demand improved across most end markets. Cost inflation and supply chain challenges will likely limit margin expansion in the near term. However, the company should realize leverage benefits as order bookings have significantly increased in the past six months, particularly from oil and gas customers, where it appears a new rebuild cycle is developing.

Kelly Services, Inc. Class A (“KELYA”), one of the most well-known brands in the temporary staffing space, continues to evolve with a focus on higher growth and profitability specialty segments. The company struggled in the education segment during the pandemic. School closures interrupted the trend toward outsourcing K-12 substitute teachers, impacting company revenue. This is improving thanks to the resumption of in-person schooling. Also, KELYA recently monetized an undervalued investment asset and used a portion of the proceeds to make an attractive acquisition of a recruitment process outsourcing firm.

Barrett Business Services (“BBSI”), a provider of human resource outsourcing, reported strong fourth quarter 2021 results. Most of BBSI’s customers are small businesses that were affected by the pandemic in 2020, negatively impacting BBSI’s performance. In 2021, results returned close to 2019 levels. Shares have moved up recently, although they are still trading at below pre-pandemic levels. The outlook remains promising, thanks to significant operational improvements that should lead to greater operating leverage and less risk going forward.

Connection, Inc. (“CNXN”), formerly known as PC Connection, is a long-time holding in the technology Value Added Reselling (VAR) space. Many VARs are transitioning from pure technology resellers to a greater revenue mix of higher margin technology solutions and services. CNXN is an excellent example of a successful transition, having improved gross profit margins and its bottom line over the past several years. While the operational changes may be underappreciated by some investors, the market has slowly taken notice of the company’s results.

Top Detractors*

Cooper-Standard Holdings, Inc. (“CPS”) manufactures sealing, fuel, brake delivery and fluid transfer systems for passenger vehicles. The company’s main customer base is large OEMs (Ford, GM, Stellantis), followed by a small business selling products to automotive suppliers. The stock sold off during the quarter because of continued concerns with light vehicle production, exacerbated by the company’s excessive financial leverage. With a normalized level of auto production expected in the next several years, CPS should see ample cash flow and fetch a reasonable valuation multiple.

Whole Earth Brands Inc. Class A (“FREE”) is a manufacturer and distributor of sweeteners and flavorings for the consumer packaged goods space. The company has completed and integrated several acquisitions in an attempt to leverage higher operating margins. However, inflationary pressures and supply chain hurdles have pushed out expectations on the timing for margin expansion. As a result, the stock currently trades at a substantial discount to its consumer staples peers and has been under pressure over the past year.

Cohu, Inc. (“COHU”), a manufacturer of back-end testing and handling capital equipment used in making semiconductors, saw its shares fall last quarter. Strong demand was offset by component supply challenges and shipping delay/cost issues. Even with favorable results and cash flow generation during 2021, COHU’s shares have languished after a profit margin issue several quarters ago. However, the company’s revenue mix should improve in the coming months as sales of higher margin and quantity-driven consumables picks up. With a cash-rich balance sheet, COHU shares appear very attractive, trading roughly a 10x run-rate PE ratio.

Ultra Clean Holdings, Inc. (“UCTT”) is a developer and manufacturer of critical subsystems in the semiconductor capital equipment industry. Several key UCTT customers (Applied Materials, Lam Research) saw its shares sell off during the quarter primarily due to Covid and supply chain worries, and UCTT followed. However, the company reported very strong quarterly results and a robust outlook for 2022. They should benefit from additional capacity coming online this year at a lower cost, strategically located Malaysian facility. Because of UCTT’s critical role in helping meet the need for semiconductor capacity expansions worldwide, combined with its roughly 8x run-rate PE ratio, we have been adding to this position.

Shyft Group (“SHYF”), a manufacturer of commercial vehicles, reported solid December quarter 2021 results ahead of expectations. However, the stock sold off on a weaker profitability outlook for 2022 due to the timing of chassis supply and growth investments in its proprietary Class 3 electric delivery vehicle. The industry will work through supply chain challenges as it has in past cycles, and we believe there is a low risk of order cancellations on its record high backlog (+101% year over year) because customers do not want to lose their place in line. While 2022 will likely be a transitional year with earnings decline, strong parcel demand and a customer driven EV opportunity should get the company back on track for an earnings turnaround in the near future.

*Past performance does not guarantee future results. The holdings identified do not represent all the securities purchased, sold or recommended to clients. Top contributors and detractors to return represent those securities that had the largest positive and negative total contribution to the overall portfolio return for the quarter. A complete list of contributors to portfolio return can be obtained by contacting Peter Trumbo, Chief Operating Officer/Chief Compliance Officer, at 503-886-8972 or by email at Peter. Trumbo@PacificRidgeCapital.com. For additional information, see the related GIPS® Report on the last page. 

Market Outlook

The market faced several headwinds during the first three months ended March 31, 2022, including the tragic invasion of Ukraine by Russia, oil prices climbing as high as $130/barrel, the transition of the Federal Reserve from accommodative to tighter monetary policy and the increased talk of a looming recession.

We anticipate modest growth in the US economy, limited by continued supply chain disruptions. GDP growth increased to 6.9% in 4Q21, driven by an acceleration in private inventory investment (particularly within the retail industry), and a rebound in personal consumption. We expect low-single digit GDP growth in 2022 due to supply shortages and price concerns.

Sentiment amongst purchasing managers remains positive. The March 2022 US manufacturing PMI reading was 57.1, the twentysecond consecutive month of expansion. New orders and production components remain strong, and inventories are building slightly, though they remain well below pre-pandemic levels.

Finally, transportation bottlenecks have significantly stalled the pace of deliveries, setting up a potential restocking event this year as the flow of goods improves.

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.

Sincerely,

Pacific Ridge Capital Partners

Investment Team Additional Professionals
Mark Cooper, CFA® Co-Senior Portfolio Manager Peter Trumbo Chief Operating Officer/Chief Compliance Officer
Dominic Marshall, CFA® Co-Senior Portfolio Manager Mike McDougall Senior Trader
Ryan Curdy, CFA® Portfolio Manager Manisha Thakkar, CFA® Director of Business Development
Justin McKillip, CFA® Senior Analyst Veronica Orazio Operations Assistant
Adam Wilke, CFA® Senior Analyst

Regulatory Disclosures

The contributors and detractors to return, market capitalization weightings and total effect, economic sector weightings and total effect, portfolio characteristics, and top ten holdings for the Small Cap Value Composite are based on a representative account within the strategy. The representative account statistics are shown as supplemental information and complement the composite’s GIPS® Report as provided on the last page. 

The Russell 2000® Value Index measures the performance of the small cap 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. 

In order to maintain consistency when comparing the Small 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.

*Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year.
**Information is not statistically meaningful due to an insufficient period of time (36 months).

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, 2021. 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 Small Cap Value Composite has had a performance examination for the periods June 10, 2010 through December 31, 2021. The verification and performance examination reports are available upon request.

The Small Cap Value composite was created and incepted on August 1, 2010. The Small Cap Value composite comprises fully discretionary portfolios managed by the Firm invested primarily in an equity portfolio of small companies with market capitalizations similar to those found in the bottom three-quarters of the Russell 2000® 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 2000 Value Index which is used as our benchmark. Eligible portfolios must be managed for a full calendar month prior to inclusion in the Small 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 2000 Value Index measures the performance of the Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. 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 Small 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 1.00% from the quarterly gross composite return. Performance-based fees are available upon request. All returns are calculated after the deduction of the actual trading expenses incurred during the period. The management fee schedule and total expense ratio for the Small Cap Value Fund, which is included in the composite, are 1.00% on all assets and 1.25%, respectively, as of the most recent audit. Total fees for the fund may not exceed 1.25% annually.

The fee schedule for separately managed accounts is a flat rate of 1.00%.

The portfolio characteristics, sector weightings and attribution analysis for the Small Cap Value composite are based on a representative account within the strategy. The representative account statistics are shown as supplemen¬tal information. The Firm maintains a complete list and description of composites and pooled funds, policies for valuing portfolios, calculating performance, and preparing GIPS Reports 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 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 Small 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 incom¬plete 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.